Investing in Municipal Bonds

Q: I’m currently serving in Kuwait and I’m curious to know how someone might go about investing in municipal bonds. Do you go to the local courthouse or to a certified financial planner to invest? I’d like to get more involved in a community project and just wanted more information. Thanks for all you do.

-Ronald, Glen Allen, Va. 

A: Let’s start with Municipal Bond 101. When a state, city, or local government wants to raise funds for a project—from roads and schools to stadiums—they issue bonds as a way to borrow money from the public. The municipality, of course, pays interest to the investors on the money they borrow. To encourage this type of private investment in public projects, the federal government exempts the interest from federal income tax. This tax break allows the municipalities to pay less interest than a comparable quality bond issued by a corporation.

When does it make sense to invest in municipal bonds? From a financial suitability standpoint, this type of investment makes sense for someone in one of the top tax brackets. While you may want to make such an investment for personal reasons, it likely would not make sense particularly at this point in time when you are earning tax-free combat pay.

As a financial planner, I think it makes more sense to invest your combat pay in a Roth IRA. A Roth IRA allows you to save your tax-free combat pay into a tax shelter and growth is withdrawn tax-free after held for at least 5 years and withdraw upon reaching 59 1/2 – sweet, sweet, sweet. Opportunities like that are rare, so take advantage of it and tell your buddies about it! By the way, the IRS limit for 2008 is $5,000.

If you decide to invest in municipal bonds, there are a few ways to do it. With some projects, the municipality will offer the bonds directly to you, the investor. You can also buy individual bonds through a brokerage firm—both discount and full-service houses offer this type of investment. Finally, you can buy a professionally managed portfolio of municipal bonds through a mutual fund. Thanks for your overseas service.

Comments

[Jacqueline O Chaplin]

Best thing for you right now is to sign up for the Savings Deposit Plan. You can put up to $10,000 in it and gain 10% interest. You can only sign up once in country, so go for it.