Wealthy Use Bonds to Save on Taxes

America’s wealthiest investors use municipal bonds, which yield tax-exempt income, as part of a strategy to save on taxes, according to Spectrem Group research.

Municipal bonds are issued by cities, counties, states and local agencies – such as sewer and water authorities – to raise funds for general operating expenses or capital improvement projects. Municipalities repay the bonds with revenue collected through taxes and fees. When revenues are lower than expected – as they were throughout the Recession – municipalities struggle to repay their bonds. A small percentage defaults each year.

The municipal bond market has traditionally appealed to investors who want to invest in a safe fixed-income product and also lower their tax burden. Municipal bonds traditionally fit this need because the interest they yield is exempt from federal income tax, and, in some cases, state income tax, as well. When the bond comes due, or matures, municipalities repay the initial investment so that capital is preserved. Though defaults can and do occur, municipal bonds have a lower default rate than corporate bonds and their yields are typically higher those offered by savings accounts and certificates of deposit.

Wealthy investors remain heavily invested in muni bonds. A December survey by Spectrem shows that 75 percent on investors with $25 million or more own individual muni bonds. More than half of these affluent investors say they will buy more munis in 2011.

An April survey by Spectrem Group shows that Millionaire investors value a good tax advisor, IRA accounts and real estate –as well as bonds - as a means to save on taxes.