State Tax Free Bonds

If you purchase state tax free bonds, you are not required to pay federal income taxes on your earnings. If you purchase the tax free state bonds in your state of residence, you can be exempt from paying state taxes on your earnings as well.

There are several types of tax free state bonds which are issued by state and local government municipalities. General obligation bonds promise to repay based on the credit of the issuing municipality. Revenue bonds promise to pay from new revenue created by a future income stream. Assessment bonds are paid out from the assessments of property within the issuer's territory.

The benefits of investing in state tax free bonds come from not having to pay federal taxes on the income that you earn. You also get a benefit by investing in bonds in your own community. If you buy tax free California bonds - and you live in California, the money stays in your own state to make improvements, plus the interest is not taxed by your home state as well.

State tax free bonds differ from state to state and even from city to city. Like people, bonds have credit ratings. Rating agencies like Moody's, Standard & Poor's and Fitch all rate bonds using a letter grade system. A Triple A bonds(AAA or Aaa) have almost no credit risk. B, C and D bonds are more speculative.

If you don't want to research and purchase individual state tax free bonds, you may want to consider buying shares in a tax-exempt bond fund. You can purchase a fund that has all of it's bonds from a single state like a fund for CT tax free bonds, or a fund that holds bonds from different states. Keep in mind then that the income received from bonds not in your state would be taxable on your state income tax - but still tax exempt on your federal income tax.

State tax free bonds are usually a high credit quality investment. Many are even insured by municipal bond insurers, making them a very secure investment.