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Author: Lokicious Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35468  
Subject: Re: muni vs federal bonds? Date: 2/5/2003 7:51 AM
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I'm looking into buying some bonds and was wondering what people considering the primary trade offs of the two types (interest rates, risk, tax advantages, etc).

I'm assuming you mean treasury bonds—there are also federal agency bonds.

Normally, high rated, especially insured, muni bonds are considered almost as safe as treasuries. With state and local governments strapped for cash and, unlike the treasury, unable to print money, that might be less so. I would be looking at insured munis, for greater safety, but these will probably have a lower yield, for that very reason.

The trade off is interest rate (yield) vs. tax savings. With treasuries you pay US taxes but not state taxes. With munis you don't pay US taxes or taxes for munis from your own state, but you do for munis from other states. (There may be some exceptions—this is how it works for Michigan, and I believe most states.) Of course, you should be comparing bonds with equivalent maturity dates (and watch for munis with call dates).

You can do a simple comparison: take the muni interest rate and divide by 100% minus your federal tax bracket plus (minus you state tax, if the bond is not exempt from state tax). For example, a 3% Michigan muni bond, at 30% tax bracke would have the equivalent yield of a 4,286% treasury (3/70%). A muni from another state, with 4% Michigan tax, would have the equivalent yield of 4.054% (3/74%).

Last time I looked, state specific munis yielded about the same as investment grade corporates, and somewhat more than treasuries, in a 30% federal tax bracket. But munis are mostly for people in the top brackets.

What will happen to munis if either the dividend tax break or the lifetime savings account proposal passes is a good question.
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