How to Invest in Tax Exempt Bonds

Municipal bonds are U.S. securities that are exempt from taxes.
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Tax-exempt bonds, otherwise known as municipal bonds, are issued by the government at the state and local agency level. The reason behind these bonds is to allow the money that the government agency is issuing to be borrowed at a lower interest rate; this is all done while investors reap the benefits of tax-exempt interest income. The borrower is essentially the government issuer and the funds from these bonds are used for public purposes. To invest in tax-exempt bonds, certain steps must be taken prior to signing on the dotted line.

Step 1

Know what types of municipal bonds are available. There are two types of municipal bonds you can invest in. You can either choose to invest in the general obligation bond or the revenue bond. The difference is that general obligation bonds are issued based on the fact that the issuer is able to tax and are generally considered safer than revenue bonds. Revenue bonds are issued by sanctioned entities at the local and state government levels such as utility companies. The interest is paid from the business’ revenue that is backing the obligation. For instance, interest is paid from the money that is generated from customers who pay the water bill if the company that backs the obligation is a water company.

Step 2

Find out who is responsible for paying the interest on the bonds. Once you find out exactly who is responsible, conduct your background research of the entity including a credit check and consumer complaints. Knowing this type of information helps to ensure the safety of your investment. Two of the bond-rating agencies are Moody’s and Standard and Poor's (S&P). When investigating the bond, ensure that the municipality has a population of over 10,000 with a diverse economy and punctual payments on obligations from the past.

Step 3

Contact a dealer or broker that is registered with the Municipal Securities Rulemaking Board and express your interest in investing. Request an offering statement and review the risks, terms and features that are outlined. Once you have reviewed and fully understand the statement, sign the necessary paperwork if you agree with the terms.

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