Municipal bonds are debt securities issued by various governmental entities. These interest payments made by these bonds are not subject to federal income tax. Although muni bond interest can be taxed by state and local governments, most states exempt their own bonds from their own taxes. Thus, an investor residing in Colorado can buy municipal bonds issued by entities within Colorado and be exempt from paying interest on both federal income taxes, and Colorado state income taxes. As a result, many muni bond offerings are tax free municipal bonds.
However, an investor residing in another state may still be required to pay state income taxes in their state on the bond interest. Additionally, investors are generally still liable for capital gains tax on any investment, including municipal bonds, sold for a profit.
There are two ways to buy municipal bonds. One way is to purchase new issues. A new issue is a new bond being issued by the governmental entity. Typically, there are minimum purchase amounts or other restrictions when purchasing new issues. In addition, the coupon, or interest rate is usually not set until after the bond is issued. These factors make purchasing new muni bond issues better suited to experience municipal bond investors.
The second way to purchase municipal bonds is in the secondary market. Bonds have a fixed maturity date and cannot be redeemed prior to this date. If an investor wishes to end their investment in a particular municipal bond, they cannot simply cash it in. Instead, the bondholder can sell the bond and its remaining interest payments on the open market. Typically, the bondholder’s broker will purchase the bond either through their own bond desk, or through a third-party bond desk.
Investors may then purchase these bonds. Bond markets are not as heavily traded or as liquid as the stock markets, so an investor may not be able to dictate exactly which muni bond they wish to purchase and when. Instead, investors typically search the available inventory of their brokerage firm, or ask their broker to check around for the availability of the desired bonds from other firms.
Bonds prices are quoted in basis points relative to the standard $1,000 principal of bonds. Thus, a bond quote of 1.15 would be a purchase price of $1,150 for each bond. Commissions for bond trades are typically worked into the pricing of the bond, and known as the spread.
Online brokerages like Fidelity offer account holders the ability to search their municipal bond inventory and place online orders to buy bonds similar to an online stock purchase. Traditional brokers will quote bond prices over the phone. Those quotes are considered bona-fide and are valid for a specific period of time.
See also: Buying Government Bonds, Treasuries, and Savings Bonds Online