What are the risks, if any, of investing in ''AAA'' municipal bonds paying tax-free interest? They certainly sound like a better investment than six-month certificates of deposit offered by banks, from a tax point of view, but would there be any risk in losing part of your initial investment when you wished to redeem them? At least a bank guarantees the return of your initial investment although the interest is liable to taxation. - D. B. M.
As long as the bonds maintain their security - and an AAA bond should do that easily - there should be almost no risk for your intitial investment. The interest on municipal bonds is exempt from federal income taxes, as well as state income taxes if the investor lives in the state in which the bond was issued. As for redemption, the interest on municipal bonds sold at a profit is subject to full federal and state income taxes. However, if the bond is kept for the minimum capital-gains holding period, the profits will not be taxed at the higher ordinary income rate, but at the lower capital-gains rate.
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