Adding bonds to your investment portfolio can be a smart move, mainly because of two reasons. First, bonds can bring stability to your portfolio if it mainly comprises of volatile stocks. Second, bonds offer a regular source of income. But like any other form of investment, bonds are not perfect, especially when it comes to tax. The Internal Revenue Service’s tax rules and regulations for bonds can get a bit complex. When you buy stocks, you don’t need to pay taxes until they are sold and realized with a capital gain. But that’s not the case with bonds. They have instant tax consequences because you earn an income from them roughly twice a year. You might shy away from buying bonds due to the tax hassles related to it. Realistically, they are not expected to outperform stocks. It may happen from time to time, but it is a rare sight to witness. However, they can help grow your savings, if you choose the right one. US Treasury issues The US Treasury issues are considered to be risk-free investments because the chances of the federal government failing to fulfill their debt obligations are quite slim. This is because the government enjoys the authority to print money as well as manage taxes. The notes and bills are charged with federal income tax but are exempt from local or state liabilities. Some states might mandate you to report earned interests on government securities as income even though they don’t levy any taxes. Municipal bonds Also known as munis, municipal bonds are exempt from federal taxes. If you purchase bonds issued by your state, local and state taxes will be waived off too. These are excellent for investors wanting to lower their taxable investment income. Municipal bonds that are bought and then sold in the secondary market might be taxed at long-term or short-term rates if any capital gains were made. As compared to other bonds, municipal bonds render a lower interest rate, but they are a compelling choice due to the tax benefits they offer. Corporate bonds Corporate bonds carry a substantial risk of default. At the same time, they are high performing investments that give better returns than any other type of bond. Unfortunately, there are no tax-benefit provisions for corporate bonds. So, while receiving lucrative returns, you’ll have to bear the brunt of taxes too. Zero coupon bonds These bonds are sold at deeply discounted prices and offer no annual interest. The full face value of zero coupon bonds is paid when they mature. The Internal Revenue System calculates the implied annual interest on the bond, obliging you to pay taxes even though you don’t get the sum until the bond matures. In simple words, you will be taxed now for the income that you will get after many years. Want the best tax deal? Then the obvious choice should be municipal bonds. On the other hand, if you are looking for higher returns, then consider the other options provided. Before making any hasty decisions, discuss your choices with a broker. It is important to carefully analyze your portfolio, current financial obligations as well as any future plans before investing a significant amount of money in any bond.
