Municipal bondholders breathed a sigh of relief when the details of the Fiscal Cliff Bill were released. There were concerns that the tax free status of municipal bonds would be affected, but for now, the tax free status is preserved. The non-taxable feature means that states and local governments can borrow money at lower rates than corporations. Taking away this benefit would mean that states and municipalities could be stuck competing with the debt of companies, paying higher rates and putting them more in jeopardy of going bankrupt. Municipalities are in severe financial shape as it is, and taxing muni interest would be the last straw.
This news, plus the goal of the government to keep interest rates low for a while longer, is good news for investors in municipal bonds and tax-free closed end funds. The biggest risk is if interest rates rise significantly, the price of munis and muni CEFs will tank.
Investors who are looking for tax free income may want to consider the municipal bond closed end funds, sometimes referred to as tax-free stocks. There are many advantages besides the tax free income feature to these CEFs. Almost all of them pay dividends monthly, whereas, if you by an individual bond, the interest is paid semi-annually. CEFs have no minimum investment, whereas municipal bonds are sold in $5,000 denominations and many brokers have minimum purchases ranging from $15,000 to $25,000. You also have better liquidity with CEFs as prices are quoted real time and quotes are immediately available on the Internet. In addition, CEFs provide diversification through a group of bonds in the portfolio.
Municipal bonds pay interest that is exempt from Federal taxes and may be exempt from state taxes if issued in the state you live in or issued by one of the US territories, such as Puerto Rico, the Virgin Islands, or Guam. Munis are generally issued by states, counties, cities, and other governmental entities such as school districts, sewer districts, bridges, and water and power departments. WallStreetNewsNetwork.com just recently updated its list of over 150 tax-free income CEFs, and more than 100 sporting yields greater than 5%.
One example, appropriate for New York residents, is Nuveen New York Investment Quality Municipal Fund (NQN) which has a goal of current income exempt from regular Federal and New York State and City income tax, and pays a decent yield of 5.3%. However, it does use leverage, to the tune of about 37%, to achieve its high yield. The fund trades at about a 0.7% discount to net asset value, also referred to NAV. The management fee of 0.61% is below the overall average of all tax free CEFs. It has been paying dividends since 1990. A very small portion of the bonds in the portfolio are subject to the alternative minimum tax, also referred to as AMT.
California residents might want to take a look at the Nuveen California Municipal Value Fund (NCA), which doesn't use any leverage to achieve its 4.5% yield, free of Federal and California state income taxes. It currently trades at an 0.8% discount to NAV, and carries a reasonable 0.54% management fee. The CEF, which has been around since 1987, has a little over 10% of its portfolio in AMT bonds.
For a CEF that is diversified nationwide, there is the Federated Premier Intermediate Municipal Income Fund (FPT), which seeks to provide current income exempt from federal income tax, including AMT. The fund yields 4.9% and has no AMT bonds in the portfolio. It is trading at a very slight 0.7% premium to net asset value. Leverage is quite high at 29% but the management fee is a reasonable 0.55%. Income has been paid since 2002.
The issues to watch out for with tax free CEFs:
* high leverage
* high management fees
* trading at a premium to NAV
* bonds in the portfolio that may be subject to the Alternative Minimum Tax
* quality of bonds in the portfolio
For a list of tax free income closed end funds, which includes yields, discounts and premiums, leverage, management fees, date founded, and other information, go to WallStreetNewsNetwork.com.
Disclosure: Author did not own any of the above at the time the article was written.