Municipal bond yields have climbed to levels that would have seemed unthinkable when the Federal Reserve was pinning rates near zero, and a quiet side effect is that ordinary Americans with a brokerage account can now earn tax-free income that beats many savings products.
The catch is that munis were long treated as a playground for the wealthy, sold in $5,000 minimum chunks with brokers collecting fat markups.
A high-grade muni yielding around 4% tax-free is roughly equivalent to a taxable yield of about 6% for someone in the 32% federal bracket, and closer to 7% once state taxes are layered on.
Right now a top-yielding savings account pays around 5% and that interest is fully taxable.
For anyone sitting in a higher bracket, the muni quietly wins.
The reason yields jumped is simple supply and demand.
Cities, school districts, and water authorities rushed to issue debt before rates moved higher, and at the same time the Fed's rate hikes pulled money out of bond funds.
That combination pushed prices down and yields up.
It also created a rare window where investors were being paid more to lend to a water utility than to lend to the federal government.
There are real risks, and they are not small.
Munis can be called away early, which caps your upside, and a single-issuer default, while rare, can sting.
Puerto Rico's restructuring and a handful of hospital and transit failures are the cautionary tales.
If you sell before maturity, a rising-rate environment can mean taking a loss.
And if you buy a single bond from a small town, you may be the last person to know it is in trouble.
The practical path for most people is not hand-picking bonds.
It is a low-cost muni bond fund or ETF, where a manager spreads money across hundreds of issuers and you can buy in for the price of a share.
Vanguard, iShares, and Schwab all offer options with expense ratios under 0.15%.
You give up some yield versus a perfectly timed single bond, but you also give up the risk of one bad credit blowing a hole in your savings.
One more thing that trips people up: the tax-free label only applies to federal tax, and only if the bond is issued in your state.
Buy a New York muni while living in Texas and you likely owe Texas nothing because Texas has no income tax, but buy it while living in California and you may owe California tax on the interest.
Nationally diversified funds sidestep that trap but also give up the state exemption.
Brokers love to quote a muni's yield without mentioning that the markup on a single bond can eat a year of interest.
If a yield sounds too good versus a same-maturity Treasury, someone is usually paying for it somewhere in the fine print.
My take: munis are finally worth a serious look for anyone in the 24% bracket or higher who has money they will not need for several years, but the winning move is boring.
Use a low-cost fund, keep it in a taxable account where the tax break actually matters, and do not reach for yield in a tiny town's debt just because the coupon looks juicy.
Final Thoughts
The free lunch is real here, but only if you avoid the expensive table.