What Are Municipal Bonds?

NEW YORK (TheStreet) -- While the returns on municipal bonds are not going to put you on par with Donald Trump, in times of market uncertainty, there's nothing wrong with slow and steady. Even better, they're exempt federal income tax.

Municipal bonds, also known as munis, are debt securities issues by states and local governments looking to raise money to build new roads, schools or to pay for other initiatives. The interest paid to investors over the course of the muni is tax free at the federal level. And, if the investor resides in the city or state that issued the debt, state and local taxes are normally waived as well. However, if you sell the muni for a profit, the capital gains from the sale are taxable.

Muni bonds, which may have maturity dates more than 50 years away, come in two types. The distinction arises from how the municipality pays the interest on the debt. The first type is called a revenue bond; these munis make interest payouts from a revenue stream such as highway tolls. General-obligation municipal bonds, like Treasuries, are backed by the ability of the issuer to levy taxes, if necessary, to pay the interest and repay the loan.

The mutual fund industry has been quick to tap the investor interest in modest but tax-exempt returns of municipal bonds. There are many muni bond funds from which to choose, including funds that focus on munis from within a single state. These funds are not only tax free at the federal level, but also at the state and local level for residents.

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