Understanding AMT Muni Bonds and Their Benefits

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AMT Muni Bonds are a type of municipal bond that's exempt from federal taxes, but not from alternative minimum tax (AMT).

These bonds are issued by municipalities to finance public projects, such as infrastructure development, public buildings, and utilities.

They offer a relatively low-risk investment option, with tax-free interest for investors who don't pay AMT.

Investors who do pay AMT can still benefit from the tax-free interest, but they'll need to consider the impact on their overall tax liability.

Investing in MUB

Investing in MUB is a great way to diversify your portfolio and earn a steady income. MUB is a municipal bond fund that invests in short-term tax-exempt bonds.

Investors in MUB can expect to earn a relatively low return, around 1-2% per year, but with minimal risk. This makes it a good option for those seeking a low-risk investment.

MUB's portfolio is comprised of short-term bonds with maturities ranging from a few months to a few years.

Owning Shares in a Fund

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If you own shares in a municipal bond fund, you should be aware that the sponsor may have purchased bonds subject to the Alternative Minimum Tax (AMT) to increase the yield on the fund.

The fund's prospectus can describe the types of securities the sponsor is allowed to purchase, including the types of bonds by purpose, ratings, and whether it will purchase up to a percentage of bonds subject to the AMT.

In a national or state specific fund, this percentage can range from zero percent upward to 20 percent or even higher.

You should read all of the offering documents to familiarize yourself with the bond or the bond fund's holdings if the AMT is a factor in your financial picture.

The vast majority of municipal bonds are non-AMT, so there are options in finding the appropriate investment if you choose to purchase bonds individually.

Mutual fund companies are now marketing funds that are "AMT-free", or contain no AMT obligations in response to the greater numbers of people who are finding themselves subject to the AMT.

Fees

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Investing in MUB comes with some fees that you should be aware of. The management fee is a significant 0.05% of your investment.

The good news is that you won't have to pay any acquired fund fees and expenses, which is a 0.00% savings. Other expenses are also non-existent, at 0.00%.

Here's a breakdown of the fees you can expect to pay:

This expense ratio is the total of all fees and expenses, and it's also 0.05% of your investment.

Finra Rule Enhances Transparency

The FINRA rule has made a significant impact on the municipal bond sales process. It requires broker-dealers to disclose a bond's "prevailing market price" (PMP) and the dealer's markup on the sale.

This change was made to improve transparency, which has been a challenge for investors purchasing individual municipal bonds. The market is huge, with over a million issues, making it difficult to determine the fair market price for a given day.

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Prior to May 14, 2018, broker-dealers weren't required to disclose their markups, which could be folded into the sales price of the bond. This lack of transparency made it hard for investors to know if they were paying a fair price.

The new FINRA requirements aim to address this issue by requiring broker-dealers to compute the PMP by reviewing similar trades of the same security, if available. This provides a more reliable pricing benchmark for potential purchasers.

However, if there haven't been recent trades of the same security, broker-dealers must compute the PMP by reference to trades of securities that are similar in terms of factors such as credit rating and yield.

Understanding MUB

MUB offers a convenient way to access over 2000 municipal bonds in a single fund, providing a cost-effective fixed income solution that helps you keep more of what you earn.

The fund has undergone a name change, effective March 1, 2016, from iShares National AMT-Free Muni Bond ETF to iShares National Muni Bond ETF.

Investing in MUB can help you diversify your portfolio by providing equity diversification and pursuing tax-exempt income.

Why MUB?

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MUB offers access to 2000+ municipal bonds in a single fund, making it a convenient investment option.

The cost of investing in MUB is low, providing a cost-effective fixed income solution that helps you keep more of what you earn.

MUB can help diversify your investments, serving as the core of your portfolio to provide equity diversification and pursue tax-exempt income.

MUB changed its fund name from the iShares National AMT-Free Muni Bond ETF to the iShares National Muni Bond ETF effective March 1, 2016.

Price Yield Calculator

The Price Yield Calculator is a valuable tool for understanding the performance of an ETF like MUB. It provides an indication of the ETF's yield and duration for a given market price.

The calculator estimates the Aggregate Cash Flow Yield (ACF Yield) which is the discount rate that equates the ETF's aggregate cash flows to a given ETF price. This is based on the yield to worst methodology.

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For a given ETF price, the calculator will also estimate the corresponding ACF Yield and spread to the relevant government reference security yield. Note that the ACF Yield will differ from the ETF's Weighted Avg YTM.

Here's a snapshot of the calculator's output for MUB:

The calculator's output is for illustrative purposes only and is not representative of any specific investment outcome. If you're interested in standardized performance, be sure to check out the Performance section.

The ACF Yield to Worst is 3.75%, which is an important metric to consider when evaluating MUB's performance. This value is as of 01/03/25.

Zero-Coupon

Zero-Coupon bonds offer a unique advantage over taxable bonds. They don't make any interest or coupon payments, which means you buy them at a discount.

You can buy a zero-coupon municipal bond for a fraction of its face value, such as $500 for a $1,000 bond. This is known as the original issue discount or OID.

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The longer the bond has to mature, the bigger the discount you'll receive. Most zero-coupon municipal bonds mature between eight and 20 years.

As long as you hold onto the bond until maturity, the return is tax-free. You'll receive one payment at maturity based on the principal invested plus the interest earned.

You'll need to remain patient until the bond matures to see the greatest benefits. This means not selling the bond before it reaches its maturity date.

If you sell the bond before it matures, you'll be subject to a capital gain or loss. This can be a capital gain if you sell higher than the adjusted issue price, or a capital loss if you sell for less.

Market and Performance

The market for municipal bonds has experienced a slight decline as of the end of 2019, with a total market value of approximately $4 trillion.

The TCJA's elimination of the tax exemption for new advance refunding bonds has eliminated new offerings of these tax-exempt bonds, which had accounted for about one-fifth of new municipal bond offerings.

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Despite this, the demand for municipal bond investments has been strong in recent years, with a record $93.19 billion inflow to municipal bond funds in 2019.

Municipal bond investments, as measured by the S&P Municipal Bond Index, were up 7.26% for the 12-month period ending Dec. 31, 2019.

However, the COVID-19 pandemic has had a significant impact on the municipal bond market, with investors withdrawing nearly $27 billion from muni mutual funds for the two weeks ending March 25, 2020.

Market

The municipal bond market has experienced some shifts in recent years. The TCJA's elimination of the tax exemption for new advance refunding bonds eliminated new offerings of these tax-exempt bonds, which had accounted for about one-fifth of new municipal bond offerings.

The total market for municipal bonds had a slight decline for the year as of the end of 2019, dropping to approximately $4 trillion. The TCJA's reduction in the corporate tax rate has made municipal bonds less attractive to corporate investors, who have shifted to other alternatives like asset- and mortgage-backed securities and taxable bonds.

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Demand for municipal bond investments has been strong in recent years, with a record $93.19 billion inflow to municipal bond funds in 2019. This was a significant increase from the previous record of $81.06 billion set in 2009.

Municipal bond investments were up 7.26% for the 12-month period ending Dec. 31, 2019, according to the S&P Municipal Bond Index. The COVID-19 pandemic has, however, affected the market, with investors withdrawing nearly $27 billion from muni mutual funds for the two weeks ending March 25, 2020.

Return

Return is a key aspect of municipal bonds, and it's essential to understand how tax implications can affect your investment. A discount bond purchased at a price lower than its par value will be taxed at a capital gains rate of 15% upon redemption.

For example, a bond purchased at a discount of $96.22, which is worth $95.62 after tax, can lead to a loss of $0.60 due to capital gains tax. This highlights the importance of considering tax implications when buying munis on the secondary market.

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The yield-to-maturity figure is usually sufficient to determine an expected return for bonds purchased at a premium, but for discount bonds, you must also factor in the negative tax implications that can arise from capital gains.

Here's a comparison of the cash flows for the premium and discount bonds:

Note that the coupon payments are not taxed, only the principal of the bond is subject to capital gains tax.

Exposure Breakdowns

In the world of market and performance, exposure breakdowns are a crucial aspect to understand. Exposure breakdowns refer to the way a portfolio's assets are distributed across different asset classes, sectors, and geographic regions.

A typical portfolio might have a 60/40 split between stocks and bonds, with 20% allocated to international stocks and 10% to real estate. This breakdown can greatly impact overall performance.

The 60/40 split is a common allocation, but it's not a one-size-fits-all solution. Some investors may prefer a more aggressive 70/30 split, while others may opt for a more conservative 50/50 split.

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A study found that a 60/40 split outperformed a 70/30 split in 70% of the periods analyzed. This highlights the importance of considering individual risk tolerance and investment goals.

Investors should regularly review and rebalance their exposure breakdowns to ensure they remain aligned with their goals. This can help maintain optimal performance and minimize potential losses.

Tax Implications

The number of individual taxpayers subject to the Alternative Minimum Tax (AMT) dropped significantly after the Tax Cuts and Jobs Act (TCJA) was passed, from 5 million in 2017 to 200,000 in 2018.

This reduction in AMT applicability has created new investment opportunities, such as increased viability of private activity bonds, which are tax-exempt securities issued by a governmental entity for the benefit or use of a private entity. Private activity bonds paid 50 basis points more than other tax-exempt government bonds.

Investors should be aware that some municipal bonds are federally taxed if the holder is subject to AMT, and it's essential to consult the broker before purchasing a bond to determine if it's subject to AMT. A bond used for a municipal improvement backed by a corporation's credit, such as an airline backing an airport improvement bond, would be subject to AMT.

How Does It Affect the Holder?

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Most individuals hold municipal bonds in one of two ways: they either own the bond outright or own municipal bond funds.

Determining if an individual bond is subject to Alternative Minimum Tax (AMT) is fairly simple. You can find this information in the confirmation sent to you when you purchase a bond, which includes details such as the name, maturity, and whether the income is subject to the AMT.

If the bond was purchased in the primary market, an official statement was sent to you, and the front cover will tell you if the bond is subject to the AMT.

You can also find out this information from your account representative if you maintain an account at a securities firm, or by accessing the AMT information using the CUSIP number.

Experts agree that municipal bonds play an important role in a diversified portfolio.

Distributions

As you review your investment portfolio, you'll notice that distributions are a crucial aspect of tax implications. The record date is the day when your investment company determines which shareholders are eligible to receive the distribution.

The ex-date, or ex-dividend date, is the first day when the new share price reflects the distribution. This is usually one business day before the record date.

On the payable date, you'll receive the distribution, which can include income, short-term capital gains, long-term capital gains, and return of capital.

TCJA Tax Impact

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The TCJA Tax Impact is a significant aspect of municipal bond investing, and it's essential to understand how it affects noncorporate taxpayers. The number of individual taxpayers subject to the Alternative Minimum Tax (AMT) has dropped dramatically, from 5 million in 2017 to 200,000 in 2018.

The reduction in AMT applicability has created new investment opportunities, particularly for private activity bonds. These bonds are tax-exempt securities issued by government entities for the benefit of private entities, and their interest rates are often 50 basis points higher than other tax-exempt government bonds.

Private activity bonds are subject to the AMT, but with the reduced applicability of the AMT, their viability has increased. This change may lead to a decrease in their premium over other tax-exempt government bonds as the market adapts.

The diminished application of the AMT has also affected municipal bond investment choices, particularly with regards to state and local taxes. Under prior law, taxpayers often avoided municipal bonds from outside their state of residence due to the AMT provision. However, with the reduced application of the AMT, this incentive has decreased.

Special Topics

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Muni bonds are often used to finance infrastructure projects, such as building new roads and bridges. This is because they offer tax-exempt status, making them an attractive option for investors.

Investors can earn a steady stream of income from muni bonds, with some bonds offering yields as high as 5%. This can be especially appealing to those looking to generate passive income.

The tax-exempt status of muni bonds can also make them a more cost-effective option for investors, as they don't have to worry about paying federal income taxes on the interest earned.

Puerto Rico Debt Restructuring

In 2019, a plan for restructuring Puerto Rico's debt was unveiled, which could serve as a model for states with heavy debt loads.

The plan's payout structure varies significantly from traditional bankruptcy plans, with payment reductions averaging 45% for bondholders and no more than 8.5% for retirees.

Senate Majority Leader Mitch McConnell suggested in 2020 that states should be allowed to declare bankruptcy, which could impact investors in state bonds.

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Investors in state bonds should be aware that if Puerto Rico's restructuring serves as precedent for future congressional action, protection against default may not be as certain as it has been in the past.

The restructuring plan prioritizes payment reductions for bondholders over pension beneficiaries, despite Puerto Rico's constitution placing general obligation bondholders ahead of pension beneficiaries.

This is notable because some single-state tax-exempt funds hold Puerto Rico bonds to generate higher income and provide diversification.

These funds are tax-exempt in all 50 states due to Puerto Rico's status as a territory.

Climate Change as Valuation Factor

Climate change is becoming a significant factor in bond valuations. Moody's Corp. purchased a controlling stake in Four Twenty Seven, a company that measures hazard risks, in 2019.

This purchase allows Moody's to make more precise assessments of climate risk, including potential costs for remediation of global-warming-related damage. The risk of climate-related factors making certain areas and properties less desirable for homes is also being considered.

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Investment bankers are now including climate-change risk language in bond due-diligence statements. Bloomberg analyzed 40 due-diligence statements for coastal Florida bond offerings and found a majority included climate-change or storm-related risk language.

A bond's rating can now be downgraded simply because a bond rating agency's climate-change experts find an increased level of climate-related risk.

Emergence of Green

Green bonds have emerged as a significant tool in the fight against climate change. These bonds are specifically designed to finance environmentally friendly projects, with the most common use being for water and wastewater projects.

The market for municipal green bonds is dominated by a small number of issuers. The New York MTA is the largest issuer, accounting for 18% of the total volume from 2013 to 2018.

Issuers hoping to achieve a "greenium", or a premium for being a green bond, face a challenge. Market recognition of "green" status can require significant costs for detailed disclosures and/or external certification.

The International Capital Market Association defines green bonds as any type of bond where the proceeds are exclusively applied to finance or refinance green bond projects.

Frequently Asked Questions

What is AMT in municipal bonds?

Alternative Minimum Tax (AMT) in municipal bonds refers to a tax status that requires interest income to be taxed, even if it's normally tax-exempt. This tax status affects a specific type of municipal bond, so it's essential to understand how it impacts your investment

What is the downside of tax-free municipal bonds?

Muni bonds are tax-free from federal taxes, but may be subject to state or local taxes, and could increase your Social Security tax liability

Kristin Ward

Writer

Kristin Ward is a versatile writer with a keen eye for detail and a passion for storytelling. With a background in research and analysis, she brings a unique perspective to her writing, making complex topics accessible to a wide range of readers. Kristin's writing portfolio showcases her ability to tackle a variety of subjects, from personal finance to lifestyle and beyond.

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