By Mary Pilon

wikimedia.org

We havent seen this much interest in the New Jersey Turnpike since Being John Malkovich

Build America Bonds (or BABs, for short) are a buzzed-about piece of President Obamas American Recovery and Reinvestment Act of 2009.

Investors and financial advisers like BABs because theyre a slightly different flavor of municipal bond that offers yields and some tax advantages. But they may be more suited for institutional investors than individuals.

Interest payments on BABs, unlike those of most muni bonds, are taxable on your federal income return. But the bonds pay a higher rate than munis: Some of the 20-year BABs, for example, are paying 7%-7.3%, says Joseph Kovar, a financial adviser and CPA with Sweeney Kovar. And theyre considered to be relatively safe, rated A to AAA.

Where else can you get that security and that kind of yield? he says.

The reason BABs can pay higher returns is that theyre subsidized by the federal government to the tune of 35% of the interest paid to investors. Most issuers use this subsidy to increase the rate they pay investors. Conversely, BABs can give them a nonrefundable federal income tax credit of 35% of the interest paid on the bond. Some bondholders might not be able to fully utilize this credit because of tax liability, but unused credit can be carried forward in future years.

The downside of Build America Bonds is that theyre locked up for long periods. Kovar recommends laddering BABsthat is, buying staggered maturitiesto ease that long-term lockup. He likes them as part of a fixed-income portion of a diversified portfolio.

Diversification within BABs is important, too. Investors should look to vary between states and types of projects. With a plethora of projects, from schools to parks to toll roads to invest in, variety is relatively easy to accomplish. It also protects you from anxiety when you see headlines about a states budget going bust. (Were looking at you, California !)

The appeal of BABs will depend largely on your own tax bracket, so talk with a financial adviser before investing. Like any product, theyre not a one-size-fits-all. Most of the early BAB offerings were geared toward institutional, not individual, investors, so its likely that your financial adviser is still reading up on them.

Theyre still not widely or easily available to individual investors. But ask a financial planner or search for bond auctions that interest you by issuer. Another option is the secondary market.

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