How Does the Tax-Free Income Fund Work?

The tax-free income fund is a type of investment many individuals prefer. Here are the basics of the tax-free income fund and why you might want to consider investing in one.

Tax-Free Income Funds

This type of mutual fund is designed to provide you with a regular source of income that does not require you to pay any taxes on the money. With this type of investment, the mutual fund will invest completely in municipal bonds.

Municipal Bonds

This type of fund chooses municipal bonds because of their safety and tax advantages. Municipal bonds are issued by municipalities such as schools and local and state governments. To raise a certain amount of money, a municipality offers bonds to private investors. The investors can then purchase the bonds, and the municipality is free to use the money as needed. The municipality will then pay the investor a monthly interest payment and will eventually pay back the entire principal of the loan. The money that you receive from interest payments on municipal bonds is not taxable at the federal level. This makes them very desirable investments for some individuals.

How the Funds Work

Investors will provide a certain amount of money to a tax-free income fund. The fund will pool all of the money together and use that money to purchase municipal bonds. This creates a very large and diversified portfolio for all of the shareholders in the fund. The municipalities will then send their monthly interest payments to the mutual fund. The mutual fund will collect all of the interest payments and divide them evenly among all of the investors. The investors will receive a monthly check with their portion of the interest income.

Advantages

The main advantage of this type of fund is that you can receive a regular income that is not taxable. For individuals that do not want to have to worry about paying income tax on an investment, this can be a very attractive form of investment.

Another advantage to this type of investment is that it makes it easy for the average investor to get involved in municipal bond investment. Many people do not like to invest directly in municipal bonds because of the difficulty of getting involved. For example, you have to open an account with a bond broker, which typically takes a $5000 minimum investment.

By investing in this type of fund, you will not have to worry about doing any research on individual municipal bonds. You will also not have to make the individual investment decisions that come with investing in bonds. You simply give your money to a fund manager, who makes all of the decisions for you.

Disadvantages

With this type of fund, you will not be able to bring in as high of a return as you would with other types of investments. This means that, depending on your tax bracket, the benefit of not paying taxes may or may not help you significantly.

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