Should you buy taxable bonds or tax-exempt municipal bonds? Your tax bracket and the makeup of the bond market will determine your choice. Generally, you’ll want the highest aftertax yields.
Suppose you prefer high-quality bonds maturing in 10 years. If 10-year Treasuries yield 6%, you’d net 4.1% in a 31% bracket. If you can earn higher yields in sound 10-year municipal bonds, you may prefer the munis.
The higher your tax bracket, the more appealing you’ll find municipal bonds. That’s particularly true if you live in a high-tax state: you can buy local issues with double or triple tax exemption.
The catch? If President Bush’s proposal to lower tax brackets is approved, municipal bonds would become less attractive. Prices might fall, pushing up yields, so you might want to wait before making a major investment in municipal bonds.
