3. Municipal Bonds: Municipal bonds, or “munis,” generally have lower yields than other bonds. But they are still a popular investment, especially with high-income earners, for a compelling reason: They pay interest that is potentially exempt from federal, state and local income taxes. Typically, munis are exempt from state taxes if you own securities issued from within your state of residence, while the local tax exemption applies if you hold securities issued from within your city of residence. Munis can be broadly classified into two groups: general obligation and revenue bonds. General obligation bonds are backed by the taxing authority of the state or municipality. Meanwhile, revenue bonds are issued by an agency, commission or authority to pay for things like airport construction, a new bridge, highways or college dorms. Fees, taxes or tolls from these projects are used to pay off the debt. Keep in mind that municipal-bond interest can be subject to the Alternative Minimum Tax.
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