Advanced Diploma of Financial Planning (ADFP) Practice Test

What is a common characteristic of municipal bonds?

1. They are typically taxable

2. They offer higher risk than corporate bonds

3. They provide tax-exempt income

4. They have no secondary market

The correct answer is: They provide tax-exempt income

Municipal bonds are commonly known for providing tax-exempt income, making them an attractive option for investors, especially those in higher tax brackets. The interest earned on these bonds is generally exempt from federal income tax, and in many cases, state and local taxes as well, depending on the investor’s residency and the issuing municipality. This tax benefit can result in a more favorable after-tax return compared to other bonds, such as corporate bonds, where interest is fully taxable. The tax-exempt nature of municipal bonds is a key feature that differentiates them from other investment options, making them particularly appealing for conservative investors looking to preserve capital while minimizing tax liabilities. As a result, they serve as a powerful tool for wealth management and financial planning, particularly for individuals seeking steady income streams without the burden of high tax implications.