Some tax-exempt municipal bonds are safer than others. Among the safest are "pre-refunded" tax exempt bonds, often referred to as "pre-res." Unlike other municipal bonds, pre-res are secured by U.S. Treasury bonds so there is virtually no risk of default.
The Treasuries securing the pre-res are held in escrow so that they can be used to redeem the pre-refunded municipal bonds at the latter’s call or maturity date. Brokers generally can buy pre-res for you; typically, the required investment is in the $5,000 to $25,000 range.
Even though they have the same credit quality of Treasuries, pre-res offer higher yields, with the best buys usually in pre-res maturing in two to six years. Today, for example, a pre-re maturing in three years might have a yield of 1.65 percent while a Treasury bond with a three-year maturity might yield 1.41 percent.
What’s more, interest on the pre-re is tax-exempt. If you are in a 25 percent federal income tax bracket, for instance, you’d net only 1.05 percent from that Treasury bond, after tax, so 1.65 percent after tax from the pre-re is quite a bit higher. Investors in a higher tax bracket would net less than 1 percent from the Treasury bond so a pre-re is an even better buy.