What is the difference between taxable and tax-exempt fixed income securities?

Taxable and taxexempt fixed income securities differ based on how they are treated for taxation purposes. The primary distinction lies in whether the interest income earned from these securities is subject to income tax at the federal, state, and local levels. Here's a breakdown of the key differences:

1. Taxable Fixed Income Securities:
Tax Treatment: Interest income generated from taxable fixed income securities is subject to income tax at the applicable tax rates. The interest earned is added to the investor's taxable income for the year and taxed accordingly.
Examples: Corporate bonds, Treasury bonds, municipal bonds issued for certain purposes (e.g., private activity bonds), and international bonds are typically considered taxable fixed income securities.

2. TaxExempt Fixed Income Securities:
Tax Treatment: Interest income earned from taxexempt fixed income securities is not subject to federal income tax. Additionally, if the bonds are issued by the investor's home state, they may also be exempt from state and local income taxes, depending on the individual state's tax laws.
Examples: Municipal bonds (also known as "munis") are the most common type of taxexempt fixed income securities. Municipal bonds are issued by state and local governments or their agencies to fund public projects like schools, highways, or utilities.

Investors are drawn to taxexempt fixed income securities because the tax benefits can enhance their aftertax returns, making them particularly attractive for those in higher income tax brackets. However, the yields on taxexempt securities are generally lower than those on taxable securities due to the tax advantage they offer.

It's important to note that not all municipal bonds are taxexempt. Some municipal bonds, known as "taxable munis" or "private activity bonds," may be subject to federal income tax. Additionally, taxexempt status varies from country to country, so investors outside the United States should consider the tax implications based on their respective tax regulations.

Investors should evaluate their individual tax situation and consult with a tax professional or financial advisor to determine whether taxable or taxexempt fixed income securities are more suitable for their investment needs and tax planning strategies.