Why is this Topic Important to Wealth Managers? This week we continue our series on “Wealth Management in Today’s Economic Environment”. The series is designed to address the specific question many wealth managers are currently asking: “what are the best investment, retirement and financial planning tools given the current global financial position?” We explore alternatives from “safe” to “risky” from “traditional” to “emerging” to discover and discuss the most relevant wealth management tools and techniques available today. We look forward to presenting this discussion and think you will find the information quite valuable. Please note that this series is presented in continuation starting with last week’s entries. That being said each blogticle resumes discussion from the previous day.
Interest received from bonds is generally taxed at ordinary income rates, this includes both government and corporate bonds unless otherwise excluded by the tax code.  Dividends though (as discussed earlier in this series) are taxed at capital gains rates, which for the meanwhile, can provide a significant tax advantage.
However, some state and local municipal bonds often called “muni” bonds, are tax—exempt under Internal Revenue Code § 103. The general obligation interest on state or local bonds fall into this category,  as distinguished from private activity bonds. 
A comparison between tax-exempt and taxable income bonds is illustrated with rates of return below:
“A 4% yield on a muni is the equivalent of a 5.6% payout on a taxable bond if you’re in the 28% tax bracket and 6% if you’re in the 33% bracket. And these yields are relatively safe. Muni defaults have been rare over the years.”  However, some state and local municipalities are currently facing financial difficulties. This may affect the traditional ability of the issuers to pay. See generally though Advisorfyi.com, Change in Muni Bond Market Could Help Producers.
The advantage of municipal bonds over corporate bonds is that income from the latter is not specifically excluded from gross income. Another example adapted from Advanced Markets Advisor FX: 
Individual A can chose to purchase, a $1,000 Corporate Bond with an annual interest rate 7.5%, or a $1,000 State/Local Bond at 5.5%. The first option will yield Interest Income of $750 with a tax of $210 (28% bracket), therefore a net return of $540. The State/Local bond will yield $550 and the income is specifically excluded from gross income. Even though the corporate bond has a higher stated return the muni bond is most likely a better overall investment. But why are the muni rates lower?
The “exclusion is intended to benefit state and local governmental units” because the cost of borrowing to these institutions becomes less and in turn “enabling them to market bond issues to investors at lower rates of interest than ordinary private sector bonds.” Additionally, because “the interest on these bonds is tax-free, investors are generally willing to purchase them at prices that provide a lower rate of return than regular bonds.” 
Our series continues tomorrow to continue to explore financial planning in today’s economy.
We invite your questions and comments by posting them below, or by calling the Panel of Experts.
Series Author: Benjamin Terner
 26 U.S.C. § 61(a)(4).
 26 U.S.C. § 103 (a).
 Municipal Securities Rulemaking Board. http://www.msrb.org/msrb1/glossary/view_def.asp?param=PRIVATEACTIVITYBOND. 2010. Last Accessed 10/9/10; A detailed discussion of private activity bonds in comparison to general obligation bonds can be found at Tax Facts: Q 1123. Is interest on obligations issued by state and local governments taxable?
 “Tax-Free Bonds”. Kiplinger’s Personal Finance Magazine. March 2008. Jeffrey R. Kosnett and David Landis. http://www.kiplinger.com/magazine/archives/2008/03/maximize-returns-with-bonds.html#ixzz11tDv5mBV. Last Accessed 10/9/10.
 AUS Main Libraries. Section 19. Income Taxes. Subheading 3-“Interest On State And Local (“Muni”) Bonds—I.R.C. §103.” http://www.advisorfx.com/articles/f19_1_8_3240.aspx?action=13. Last Accessed 10/9/10.