Understanding The 3 Types Of Tax-Free Municipal Bonds

Tax-free municipal bonds are a class of financial vehicles that are interesting to a wide range of investors. Folks can put their money into tax-free bonds from cities and counties for very long or short periods of time, ranging from mere weeks to as long as a century. People often use them in lieu of savings accounts, especially when they have specific dates for when they'll need the money.

It's important to understand, though, that there are three core types of products a tax-free municipal bond adviser will recommend to their clients. These are general obligation bonds, revenue bonds, and assessment bonds. Let's take a look at each of those three kinds of tax-free bonds and the implications of purchasing each one.

General Obligation Bonds

GO bonds are widely seen as the safest investments a tax-free bonds adviser can recommend in the municipal sector. A GO bond is secured by the full faith and credit of the municipal government.

At first blush, that might make the GO category sound like it's less secure. The reality, though, is that a GO bond can be paid off using what the municipality has at its disposal. That means the obligation can be paid using property tax revenues. In theory, a city might even be able to raise property taxes to pay off its GO bonds.

Revenue Bonds

These are bonds that are issued against revenue streams that a municipality has access to. For example, a bond might be issued to pay for the construction of a new bridge on a toll road. The tolls from the use of the road would then be the revenue source used to pay the bond. Revenue bonds typically have maturity dates that are 20 to 30 years out, making them less appealing to people with short-term needs.

Assessment Bonds

An assessment bond is paid out from taxes that are collected through property assessments. Interest is paid out from time to time until the bond fully matures. They usually appear in maturation periods of one to 20 years, making them ideal for medium- to long-term investors. They are riskier because they're not backed by the municipality's credit, and they can crater if tax collections drop significantly. Assessment bonds from regions with high taxes are generally the most popular.

To learn more about your tax-free bond options, contact a municipal bonds adviser like Alan Z Appelbaum in your area.