Closed-End Funds and Tax Free Dividends

It's a great feeling to receive a lot of dividends throughout the year, then on the following April 15, realizing that you don't have to pay tax on any of that income. There are many stocks, which are primarily closed end funds or CEFs, which pay dividends that are tax free. This tax free income is generated from municipal bonds in the portfolio. Although many of the Canadian oil income trusts pay income that may be partially or completely tax deferred due to depletion and depreciation deductions, the tax free stocks that invest in munis usually generate dividends that are completely exempt from Federal taxes.

Municipal bonds are issued by states, counties, cities, and other governmental agencies. Income from these bonds is exempt from Federal income taxes, and if the bonds are issued in your state of residence, the income is exempt from state income taxes also. Municipal bonds issued by Puerto Rico and other U.S. dependencies are exempt from state income taxes also for residents of most states. There are over 200 different tax free income stocks according to WallStreetNewsNetwork.com, with 42 of them yielding 7% or more. Just be cautious about investing in extremely high yield muni CEFs which may use leverage to attain their high yields.

One of the highest yielding tax free stocks is Federated Premier Municipal Income Fund (FMN) which yields 7.8%. They have been paying monthly dividends since 2003.

For you New Yorkers, there is the BlackRock New York Municipal Income Trust (BNY) which pays 6.7%. It invests in New York education, hospitals, housing, pollution control, tobacco, transportation, and water and sewer bonds. It has paid quarterly dividends since 2001.

If you live in California, you might want to consider the Van Kampen California Value Municipal Income Trust (VCV) which yields 7.6%. They mostly invest in California investment grade municipals. The fund was founded in 1992 and pays dividends monthly.

Van Kampen also has a high yielder for Massachusetts residents, the Van Kampen Massachusetts Value Municipal Income Trust (VMV), which pays 6.8%. The fund invests in Massachusetts municipals including bonds for education, general purpose, and water and sewer. They have paid monthly dividends since 1995.

There is also their Van Kampen Pennsylvania Value Municipal Income Trust (VPV), which yields 7.0%. This holder of Pennsylvania municipal securities has been paying monthly dividends since 1995.

You can download a free Excel database spreadsheet list of over 200 tax free stocks at WSNN.com. Keep in mind that both yields and share prices fluctuate, and there is the possibility of bonds in the portfolios defaulting, as junk munis do exist, such as some 'dirt bonds' used to fund infrastructures of new housing developments (some of which never get built).

Disclosure: Author does not own any of the above.

Comments

[prairiedog555:]

Don't forget MLPs that pay little or no tax till you sell.

Nov 16 08:57 AM

[YoYoMama:]

FMN is a great tax-free play (I own it), but it's been over NAV for quite some time. PMM has a similar yield, but it's priced 8% under NAV, and would be one of the better choices out there.

Nov 16 10:46 AM

[GlobalTrekker:]

I'd have to agree with YoYoMama. Good introductory article for people on tax-free muni CEFs, but be very cautious of chasing yield alone. I'd view BNY and FMN as shorts and VCV and VMV as sells if I owned them. Only VPV looks decent, but there are better PA muni funds with lower management fees, deeper discounts, and only slightly less yield. The deeper discounts and lower management fees are better long-term bets than those with high yield alone. Disclosure: long and short dozens of munis.

Nov 16 11:46 AM

[Georgey:]

PMM was mentioned in a fixed income report in Barrons this spring as a likely candidate for being converted to an open ended fund which would sell at par, eliminating the -8% discount to nav.
own pmm
G

Nov 16 11:50 AM

[cato:]

It is utterly irresponsible not to mention that most of these funds are leveraged with Auction Rate Securities and that many of them, like FMN, trade at substantial PREMIUMs to their NAVs.

Some of these funds also got into big trouble recently because they hedged against rate increases by shorting treasuries. Many were forced to liquidate holdings at big losses under the 1940 act.

Again, an irresponsible and disingenuous article.

Nov 16 04:14 PM

[mbkelly75:]

Actually, it is an outstanding idea with a good link for more information. It is ALWAYS up to you to do your own Due Diligence. Any article here on SA can give you a good idea, but it is up to you to figure out if it fits your own investment needs. Everyone is different with different needs so there is NO good way for the writer to check it out for everyone. The writer is responsible for the idea - you are responsible for the DD and seeing if it fits your needs.


On Nov 16 04:14 PM cato wrote:

> It is utterly irresponsible not to mention that most of these funds
> are leveraged with Auction Rate Securities and that many of them,
> like FMN, trade at substantial PREMIUMs to their NAVs.
>
> Some of these funds also got into big trouble recently because they
> hedged against rate increases by shorting treasuries. Many were
> forced to liquidate holdings at big losses under the 1940 act.<br/>
>
> Again, an irresponsible and disingenuous article.

Nov 16 08:54 PM

[cato:]

"A good link for more information"?? I assume you are a shill.

The referenced link is mostly a site with Google adwords and paid Amazon book links. Obviously the creators aren't doing so well with their investment ideas, since they need to make money this way.....


On Nov 16 08:54 PM mbkelly75 wrote:

> Actually, it is an outstanding idea with a good link for more information.

Nov 16 09:00 PM

[mbkelly75:]

Your need to assume anything simply points out your ignorance. I am hardly a shill and the referenced link is full of excel lists that can give you a nice start for Due Diligence. It is hard to figure out if you know the meaning of DD and I will not assume that you do. I will assume you can click on a link:
www.investopedia.com/t...

You have not shown any ability to read or understand what you read. Good luck with any more education on the subject.


On Nov 16 09:00 PM cato wrote:

> "A good link for more information"?? I assume you are a shill.
>
>
> The referenced link is mostly a site with Google adwords and paid
> Amazon book links. Obviously the creators aren't doing so well with
> their investment ideas, since they need to make money this way.....
>

Nov 16 09:13 PM

[buyitcheap:]

Ironically, even after adjusting for Mass taxes, the california fund is still a better yield. The October downturn last year brought a tremendous buy opportunity. Pray we get another one.

MEH - is also good for Mass taxpayers.

Nov 16 09:54 PM

[Alan Young:]

Perhaps a better source for analysis of CEFs, with current information updated daily: CEFConnect.com

Nov 16 10:54 PM

[American in...:]

Don't see the advantage of CEFs over municipal ETFs.

Nov 17 07:55 AM

[mbkelly75:]

It is a good question. More information is here:
www.investopedia.com/a...
The short version is that a Closed End Fund does not issue new units. What is out there in the market place is all there is. An ETF can issue new shares whenever it needs to. The advantage of a CEF to an ETF is that it is possible at times to buy a CEF for less than the underlying Net Asset Value - a discount to what it is worth. In general, that is not possible with an ETF.


On Nov 17 07:55 AM American in Paris wrote:

> Don't see the advantage of CEFs over municipal ETFs.

Nov 17 09:20 AM

[willydo:]

Not leveraged?
The article says to be careful of funds that have high yields as they may use leverage. According to CEFConnect, FMN is leveraged 39% and BNY is 38%. This IS high leverage. I'm not necessarily trying to criticise the article as I agree with others about doing your own homework but this could be misleading to a newcomer. From the original post:

"Just be cautious about investing in extremely high yield muni CEFs which may use leverage to attain their high yields.
"One of the highest yielding tax free stocks is Federated Premier Municipal Income Fund (FMN) which yields 7.8%. They have been paying monthly dividends since 2003".
Willydo

Nov 17 03:09 PM

[mbkelly75:]

Good catch - that is WHY you should do your own DD.


On Nov 17 03:09 PM willydo wrote:

> Not leveraged?
> The article says to be careful of funds that have high yields as
> they may use leverage. According to CEFConnect, FMN is leveraged
> 39% and BNY is 38%. This IS high leverage. I'm not necessarily trying
> to criticise the article as I agree with others about doing your
> own homework but this could be misleading to a newcomer. From the
> original post:
>
> "Just be cautious about investing in extremely high yield muni CEFs
> which may use leverage to attain their high yields.
> "One of the highest yielding tax free stocks is Federated Premier
> Municipal Income Fund (FMN) which yields 7.8%. They have been paying
> monthly dividends since 2003".
> Willydo

Nov 17 03:49 PM

[iel76:]

California muni's?? I'd rather own Arkansas, Mississippi and West Virginia. Did anyone ever think we'd come to this??

Nov 27 05:30 PM