Fredrickson Financial

Muni bonds make April less taxing

April 1st, 2014

As last minute filers square away their tax returns, there may be an opportunity for some investors to make the tax season a bit less painful next year.

For many people, some municipal bonds may offer an advantage as compared with taxable corporate bonds of similar maturity and credit quality.

An interesting comparison can be made between the Vanguard Limited Term Tax Exempt  fund and the Vanguard Short Term Investment Grade fund. The federally tax-exempt fund, in the Admiral share class, recently yielded 1.72 percent, while the taxable (Short Term Investment Grade) fund yielded 1.91 in the Admiral share class, according to Yahoo! Finance.

Both funds are rated as having limited interest-rate sensitivity by Morningstar, the fund-rating company. But the tax-exempt fund is rated as offering high credit quality, whereas the taxable fund is rated as offering only intermediate credit quality.

Despite the higher credit quality, the tax-exempt fund may offer a higher after-tax return for people even at the 15 percent federal marginal tax bracket. On a tax-equivalent basis for investors at that tax rate, the tax-exempt fund is yielding 2.02 percent, vs. the 1.91 percent for the taxable fund. That may not sound like much of a lead  for the municipal fund, but it’s more typical to see an advantage for tax-exempt bonds for people at the 25 percent marginal rate and above, not down to the 15 percent level.

The edge for some short-term municipal bonds compared with short-term corporate bonds could be fleeting. The tax-exempt fund has declined a bit more in the past 30 days than the corporate fund, accounting for much of the advantage. The situation could reverse quickly in this volatile market.

Investors generally are better off considering their long-term situation and not reacting to short-term market opportunities. This commentary is intended to be educational and should not be viewed as specific advice. Consult your financial and tax advisors to see if and how this may commentary may apply to your specific situation.

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