Tax Free Bond Funds

Tax free bond funds can be a great investment for anyone looking to recognize good returns on a low-risk opportunity. Long popular with wealthy investors, tax free municipal bond funds invest primarily in, you guessed it, municipal bonds exempt from federal (and sometimes state and local) income taxes.   Municipal bonds are defined as bonds issued by your state or local city. The bond funds are not subject to any federal tax regulations in the sense that the mutual fund that is investing in the bond has been setup to be a tax free investment. Increased profits and less tax burden is the direct result of investing money in tax free bond funds.

The Two Primary Types Of Tax Free Bond Funds

There are two types of bonds that can be invested in with tax free bond fund money. Revenue bonds guarantees that the bond will eventually be repaid through means that correlate with what the bond is supposed to be used for, as agreed to between the issuer and the holder of the bond. General obligation bonds are basically a state or city government’s way of telling the bond holder that they will repay the bonds in any way that is legal under local or state laws.

There is also a third type of municipal bond called “private activity bonds” you should stay away from.  Why?  Because while private activity bonds are not taxable under the regular income tax code, they are taxable under the Alternative Minimum Tax (AMT), which is hitting more and more middle class investors these days.  If there’s any possibility you could be subjected to the AMT in the near future, it’s vital to know if there are any private activity bonds in your basket of tax free muni bonds.  Most of the best tax free bond funds (particularly those at Vanguard), already avoid private activity bonds.

The main function of a tax free bond fund is to invest only in those municipal bonds that will create the highest amount of wealth for investors while limiting the amount of tax exposure that they will be subject to. These bonds can provide an effective means for investors to get their money into a more secure speculation than if they were to purchase stock in a public company. Tax free bond funds are a great way to get your money into a safe investment without being concerned about the tax ramifications resulting in your return on investment.