7 Best Tax-Free Municipal Bond Funds

These muni bond funds offer tax-exempt income.

Municipal bonds, sometimes referred to as munis, are issued by various government entities such as states, counties and municipalities. The income from these bond funds is typically exempt from federal taxes and, if issued within your state, the interest will also be free of state income taxes. This means that municipal bond investors don’t need to pay tax on the income from these funds. Frequently, these tax-free bond funds pay higher relative interest payments than comparable corporate and government bonds. To check the tax equivalent yield of a corporate or government bond versus a muni bond you can use a tax-equivalent yield calculator. An investor in the 24% federal tax bracket would need a nearly 4% yield in a normally taxed bond to get the same take-home yield as a 3% municipal bond. Thwart taxes and increase income with these seven best municipal bond funds.

iShares National Muni Bond ETF (ticker: MUB)

This national municipal bond fund is one of the most popular, with access to more than 2,000 U.S. muni bonds. With MUB’s $17.9 billion in assets under management, municipal bond investors have voted for this fund with their pocketbooks. In terms of credit ratings, the fund is predominantly invested in AAA, AA and A investment-grade bonds. Consequently, these high-quality bonds will offer a lower yield than a bond fund that includes lower-credit-quality issues. The intermediate-term fund has a weighted average maturity of 5.4 years and a current yield of 2.32%. The 0.07% expense ratio means you get the underlying bonds for next to nothing. MUB makes for an excellent core fixed-income holding in a taxable investment account.

VanEck Vectors High Yield Muni ETF (HYD)

This VanEck fund is appropriate for those with a higher risk tolerance. Scott Krase, president at CrossPoint Wealth, likes this high-yield, long-term muni bond fund. With $2.7 billion in assets under management, the fund has a 12-month yield of 4.21%, which is superior to other bond funds, and the current 3.78% yield looks downright juicy. Those in the 24% federal tax bracket would receive a tax-equivalent yield of 4.97%. The fund owns more than 1,800 issues, providing reasonable diversification against default. The 0.35% expense ratio is also quite competitive. Krase suggests that HYD would be a sound addition to a conservative bond portfolio within a taxable account. Monthly distributions offer higher-income individuals regular earnings.

Vanguard Ohio Long-Term Tax-Exempt Fund (VOHIX)

For those living in a high-tax state, it’s advisable to seek out a tax-free municipal bond fund from your area. Randy Carver, president of Carver Financial in Cleveland, recommends this municipal bond mutual fund from low-fee powerhouse Vanguard. The actively managed fund seeks to provide current income that is exempt from Ohio and federal personal income taxes. The fund holds 723 bonds and currently yields 1.51%. The 0.13% expense ratio is low, while the 10-year average return is 4.55%, handily beating its benchmark. “Each investor’s specific needs, risk tolerance and tax situation needs to be reviewed before investing,” Carver says. Investors from other states can investigate the state-specific lineup of municipal bond funds at Vanguard and other investment firms.

Nuveen AMT-Free Municipal Value Fund (NUW)

This closed-end fund trades on a public exchange like a mutual or exchange-traded fund but is distinct in that it has a fixed number of shares that were sold through an initial public offering. Closed-end funds typically sell at a discount or premium to their net asset value. Steven Jon Kaplan, founder of True Contrarian Investments, recommends this value-oriented fund that offers monthly tax-free income. The fund invests at least 80% of its assets in investment-grade bonds and the remaining 20% or so may be of lower credit quality. The fund is currently selling at a -5.11% discount (as of Oct. 6, 2020), which means that an investor would buy the underlying issues for less than their true value. The distribution rate is currently 2.93%. Kaplan recommends waiting until after Thanksgiving to buy as the price could decline due to tax-loss selling.

Vanguard High-Yield Tax-Exempt Fund (VWAHX)

It’s no surprise that Eric Kelley, executive vice president at UMB Bank, recommends another high-yield, tax-free bond fund. Yield-seeking investors are fed up with the low interest rate environment and are pushing their risk tolerance to include sub-investment-grade issues. Despite the name, this entrant into the best municipal bond fund list only allows a maximum of 20% of its holdings in less-than-investment-grade bonds. Since there is no limit to maturity, the fund tilts toward an average duration of 6.3 years. This means that when interest rates rise, investors can expect the value to fall more than funds with a shorter duration due to the inverse relationship between bond value and interest rates. The current tax-exempt yield is 2.21%, while the expense ratio is a reasonable 0.17%. With 2,720 bonds, the fund is also well-diversified.

iShares iBonds Dec 2022 Term Muni Bond ETF (IBMK)

For investors who prefer a stable return of principal at maturity while enjoying the diversification of a fund, this defined maturity fund fits the bill. IBMK offers exposure to investment-grade muni bonds that mature in 2022. So regardless of whether interest rates rise or fall, you’ll get a return of principal in 2022. As of early October, the fund is selling at a -0.11% premium to net asset value. The diversified fund holds 1,443 bonds and has a 12-month yield of 1.42%. The management fee is a low 0.18%. Investors seeking to preserve capital for the next two years, while receiving a small tax-free bond payment, might consider this fund. IBMK is one of several defined maturity bond funds available.

Columbia Multi-Sector Municipal Income ETF (MUST)

“Investors have relied on municipal bonds because of their history as high-quality, tax-free assets, but the muni market has shifted, and finding income in today’s low-rate environment demands a new approach,” says Catherine Stienstra, head of municipal bond investments at Columbia Threadneedle. Stienstra suggests this new, actively managed muni bond fund that aims to benefit from the inefficiencies in today’s market. Unlike competing funds, which focus on the biggest issuers of debt and may exclude higher-yield munis such as hospital and housing bonds, MUST leverages less popular muni bonds. For example, this rules-based muni bond fund seeks to deliver greater returns by including certain exposures to income-generating sectors such as transportation and health care. The two-year-old fund has a current tax-exempt yield of 1.33% and a 0.23% expense ratio. MUST also trades at a 0.5% premium to net asset value, which means investors pay a tiny premium to the bonds’ actual worth if purchased now.

Best tax-free municipal bond funds:

— iShares National Muni Bond ETF (MUB)

— VanEck Vectors High Yield Muni ETF (HYD)

— Vanguard Ohio Long-Term Tax-Exempt Fund (VOHIX)

— Nuveen AMT-Free Municipal Value Fund (NUW)

— Vanguard High-Yield Tax-Exempt Fund (VWAHX)

— iShares iBonds Dec 2022 Term Muni Bond ETF (IBMK)

— Columbia Multi-Sector Municipal Income ETF (MUST)