One of the few downsides of passive income from stocks and bonds is that the income generated by those investments is subject to federal and state income tax. The significant advantage of owning municipal bonds is that their interest is usually exempt from federal taxes and sometimes from state and local taxes. State and local governments issue municipal bonds to finance public projects and services. Investors can purchase municipal bonds individually or through mutual funds and exchange-traded funds (ETFs). While these bonds typically pay lower interest rates than corporate bonds with similar credit ratings, residents of high-tax states like New York and California can minimize or entirely avoid their state tax liabilities by choosing bonds issued within their own states.
Unlike open-end mutual funds, ETFs trade on major exchanges like stocks. They own financial assets, such as stocks, bonds, currencies, and debt, as well as commodities, such as gold bars. One major advantage ETFs have is that they can be bought or sold at any time the markets are trading. In addition, there is a large market and strong investor demand for exchange-traded funds tracking municipal bonds. Some are national funds that hold bonds from all over the United States, and some are state funds that hold only bonds from their specific state.
We selected five national municipal bond ETFs. By investing $30,000 in each fund, investors can generate $5,600 in tax-free income each year, paid monthly. The funds are offered and managed by companies with a long history of success in the municipal bond industry. The prices and yields are as of the time of this writing.
Why we recommend Municipal Bond ETFs
Municipal bond ETFs are generally free from federal and state taxes if they hold only tax-exempt bonds. However, if the municipal bond ETF has a combination of tax-free and taxable interest, taxes may be due at the federal and state levels. These featured funds exclusively hold municipal bonds.
iShares National Muni Bond ETF (NYSE: MUB). With $42.6 billion in assets under management, MUB is one of the largest and most trusted names in the muni bond space and currently pays a 3.17% dividend. Its 0.05% expense ratio is nearly negligible, and its portfolio spans more than 6,000 investment-grade U.S. municipal bonds, which is hard to beat for broad diversification. Morningstar’s Gold medal rating speaks to the fund’s consistent quality. If you want low-cost, reliable tax-exempt income, this is the benchmark most others are measured against.
$30,000 will purchase 280 shares, which pay $3.40 per share per year for $952 and $0.2798 per month for a total of $78.35 per month.
Vanguard Tax-Exempt Bond ETF (NYSE: VTEB). This low-cost Vanguard fund pays a solid 3.08% dividend yield while investing in almost 10,000 bonds and has an extremely low expense ratio of just 0.03%, the cheapest in the muni bond space.
$30,000 will purchase 595 shares, which pay $1.55 per share per year for $923 and $0.1381 per month for a total of $82.17 per month.
VanEck High Yield Muni ETF (BATS: HYD). This is the highest-yielding investment-grade fund, offering an impressive 4.25% dividend yield. While the expense ratio is higher at 0.32%, that’s a fair exchange for the higher monthly payout. The trade-off with HYD is straightforward: you accept a little more volatility and credit risk, and the fund rewards you with a significantly higher yield. The portfolio is well-diversified, so that risk is spread across many issuers rather than concentrated in a handful of names. A solid pick if your priority is maximizing tax-free monthly income, and occasional price swings do not rattle you.
$30,000 will purchase 585 shares, which pay $2.18 per share per year for $1,275 and $0.1522 per month for a total of $89.04 per month.
SPDR Nuveen Bloomberg High Yield Muni Bond ETF (NYSE: HYMB). Yielding a rich 4.52% dividend and having an expense ratio of 0.35%, this fund sits in the same high-yield muni lane as HYD, so comparing the two is worth your time before committing. Where it earns its place on this list is tax efficiency, as distributions are generally free from federal taxes and, depending on where you live, may dodge state taxes as well. That combination of elevated yield and tax-advantaged income has made it a go-to for retirees who want their monthly check to go as far as possible.
$30,000 will purchase 1,185 shares, which pay $1.14 per share per year for $1,350 and $0.0962 per month for a total of $114 per month.
Invesco National AMT-Free Municipal Bond ETF (NYSE: PZA). This one has a 3.66% dividend yield, with a reasonable 0.28% expense ratio. This fund takes a longer-duration approach than most muni ETFs, which means its price will move more when interest rates shift. Something to keep in mind if rates stay uncertain, and it could likely run higher this year. The upside is a higher yield than shorter-duration peers and built-in AMT protection, a detail that matters more than most investors realize for those in higher tax brackets. For investors who can tolerate some rate sensitivity and want dependable monthly income without AMT exposure, this fund makes a compelling case.
$30,000 will purchase 1,282 shares, which pay $0.86 per share per year for $1,103 and $0.0731 per month for a total of $80.63 per month.
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