Tax-exempt municipal bonds serve not only as an investment option but also as a significant contributor to public projects like roads, schools, and hospitals. These debt instruments are issued by local or state governments, attracting investors due to their tax-advantaged income.

Usually, the interest income from munis is exempt from federal tax and may also not be taxable per state laws, making these especially attractive for investors in the high tax bracket looking to reduce their tax liability.

This is totally different from interest on Treasury and corporate bonds that are taxed as regular income. Apart from investors’ desire for a tax-shelter, improving fiscal health of many municipal bond issuers make a rewarding combination.

The peak of the pandemic was worrying for muni bonds. Since entities like airports, schools and colleges were closed during the lockdown, munis were severely hurt. Lower levels of tax collections were a concern. But now, with economies returning to the pre-Covid level, munis have a brighter outlook. In any case, bonds backed by states and cities have the lowest default risks.

Munis Normally Yield Higher

Yields are normally higher in muni bonds than treasuries. U.S. Treasury yields remained higher than they’ve been in years due to rapid Fed rate hikes in the past one year. The 10-year U.S. treasury edged past 4.5% several times lately. Agreed, muni bonds are costly now. Municipal-Treasury 10-year ratio is hovering around 62%, much lower than the historical standard of 85%.

As of September 2023, a 10-year AAA-rated municipal bond yielded 2.89%, according to Raymond James, quoted on Yahoo Finance. While these returns may appear less impressive than those of stocks or corporate bonds, they offer a distinct set of advantages.

Nature of Tax Exemption

Municipal bonds generally carry lower risk than stocks and offer tax exemptions, effectively increasing the return rate for investors in higher tax brackets. For example, a $50,000 investment in municipal bonds yielding 2.89% could save an investor in the 35% tax bracket over $500 in federal taxes annually.

Below we highlight a few bond ETFs that yield handsomely.

ETFs in Focus

First Trust Municipal High-Income ETF (FMHI Quick QuoteFMHI - Free Report) ) – Yields 4.42% annually, down 2.9% Past Month

First Trust Flexible Municipal High-Income ETF (MFLX Quick QuoteMFLX - Free Report) ) – Yields 4.33% annually, down 1.3% Past Month

IQ MacKay Municipal Insured ETF (MMIN Quick QuoteMMIN - Free Report) ) – Yields 3.91% annually, down 3.4% Past Month

Franklin Dynamic Municipal Bond ETF (FLMI Quick QuoteFLMI - Free Report) ) – Yields 3.0% annually, down 3.7% Past Month

First Trust Managed Municipal ETF (FMB Quick QuoteFMB - Free Report) ) – Yields 3.31% annually, down 2.4% Past Month