There are many benefits to having tax-free municipal bonds in your investment portfolio.

Nevertheless, a typical misunderstanding exists about buying this asset class at a premium. A premium is any dollar price paid over the $1000 face value of the bond. The misunderstanding lies in the idea that paying a premium would end in a loss because, at maturity or the decision date, the investor generally receives $1000 per bond returned to them, not their cost. In point of fact, a premium bond is just a bond that’s value greater than its face value, and it could actually offer unique advantages to the investor.

A part of this misunderstanding stems from the confusion between the coupon and the yield. The coupon is a hard and fast rate of interest the investor will receive annually on the investment. This fixed amount is not going to change throughout the lifetime of the bond. The yield, then again, is the return on the general investment at the decision date or maturity (taking all aspects like coupon, maturity, call and price into consideration). Understanding these concepts is crucial as they determine the return in your investment and may enable you to make informed decisions.

When buying a premium municipal bond, investors should consider the YTW (yield to the worst-case scenario) when making decisions on this asset class. YTW is a measure that takes into consideration the potential worst-case scenarios, corresponding to the bond being called before maturity, and determines the dollar value. It protects the investor from paying the next premium than mandatory for a bond that might be called before maturity.

Whether to purchase a premium or not starts with the return on the general investment. Next, do you wish a more good portion of your income now or later? In case you want it now, a premium bond gives you the next annual income rate than the discount, but ultimately, the 2 must have like overall yields. If a bond trades at a premium, which means rates have dropped since that bond was issued, and it’s now value greater than the initial face value. This difference is because recent issues are coming to market with lower coupon rates and your higher coupon is now more desirable. You’re paying a premium dollar price to receive the next income now, vs. later, but you usually are not paying above value.

An investor who purchases a bond at a premium must amortize that premium over the lifetime of the bonds in your Federal Taxes. The premium amount is provided by your broker annually on an IRS 1099 Form. This amount is subtracted out of your taxable income for a similar yr; thus, the premium is written all the way down to zero by the point the primary call arrives or at maturity so there isn’t any “loss”.

For instance,

10 Dallas Wtr & Swr 4% 2/35 trading at 4% (face value of $1000 per bond) – no premium.

Now, same bond but with a 5% coupon.

10 Dallas Wtr & Swr 5% 2/35 trading at 4% ($103 or $1030 per bond – the whole premium for 10 of $300) is amortized over the 10-year lifetime of the bond and likewise has the precise yield of 4% bond.

In this instance, each have the identical overall return on the investment, however the 5% bond earns $500 a yr, while the 4% bond earns $400.

You may select the 5% bond if the goal is income now.

After clarifying the above points, there are several the explanation why investors might need to buy premium bonds.

• Investors receive higher annual coupon payments/money flow, providing a gradual, predictable higher income stream than a par or discount bond.

• Premium bonds are less sensitive to rate of interest fluctuations and have fewer large swings or volatility. In comparison with discounts, premiums are more of a defensive move.

• The premium paid offsets taxable income when amortized on Federal Income Taxes, thus dispelling the parable that investors buying premium bonds take a loss at maturity.

• Investors haven’t any risk of being subject to the De Minimis Tax that might apply to some discount bond purchases.

• If a premium bond isn’t called on the primary call date, the yield to maturity continuously ‘bumps’ for annually the bond isn’t called. Which means that the effective yield in your investment increases annually the bond stays outstanding, potentially increasing your overall return.

In conclusion, premium-priced municipal bonds will be an excellent option for investors on the lookout for higher income streams, a defense against rates moving higher, and a possible yield bump for bonds not called on the decision date.

To assist navigate the complexities of municipal bond investments, investors should seek the advice of with an experienced fixed-income advisor. This guidance could make investors feel confident and supported of their investment decisions.

At The DRL Group, we take great pride in working with investors like yourself to debate the market, demystify complexities, and share our experiences. We now have seen all of it, from rates as high as 15% to levels below 1%. Our team, with over 8 many years of combined experience on this highly specialized area, offers extensive insight to our clients, helping them navigate and maximize their fixed-income investment goals. You’ll be able to trust in our vast experience and meticulous attention to your fixed income needs; we encourage you to allow us to put that to give you the results you want. For more information, visit our website at drlgroup.