Tax Free Bonds

Are bonds tax free? Yes -- for some. States do not tax securities issued by the federal government . The federal government does not tax bonds issued by the states and their local municipalities. State governments usually do not tax interest on bonds coming from municipalities in their own state.

Utilities are also able to issue bonds that are tax exempt on a state level if the purpose of the bond is to mostly benefit the public such as building a new waste treatment plant to service a growing local population. Water companies, power companies and natural gas companies are all able to offer high yield tax free bonds if the purpose of the bond is eligible.

If you like to research you may find you are happy to invest in tax free bonds -- individual bonds -- that suit your needs. However, if you just want a nice, safe tax free income you may want to purchase shares in tax free mutual bond funds. This is where a mutual fund company purchases a variety of tax free securities and you buy shares in their investment then earn shares of the income it generates. For most investors, mutual funds offer the safety of the municipal investments without the research headaches.

You can purchase bond funds from companies such as T. Rowe Price, Fidelity, Oppenheimer, and other investment firms. There will be bond funds where all the bonds come from a single state and other funds where they come from a wider area. If your fund is a single state fund, and you live in that state, your interest income is usually tax free whereas if you opt for the multi state fund, only a portion of the income may be tax free.

Tax free zero coupon bonds can be purchased from David Lerner Associates, the GMS Group and Vanguard. A zero coupon bond is simply a bond that is sold for less than face value, pays no interest during the term of the loan and then pays back the principle and interest all at once at the end of the loan term. Utilities often issue tax free zero coupon bonds.

Investing in tax free bonds makes sense especially if you are in a high income bracket and are seeking to minimize your taxes. You may choose a bond from your own area so you can keep an eye on your investment or let the professional managers of the bond funds handle the details for you.