Bond ETFs are ETFs that are made up of similarly themed bonds. There are several different types of Bond ETFs that correspond to the types of bonds they are made up of. Bond ETFs tend to be more stable than other bonds, especially during economic recessions. Thanks to the events of the last few years, they are more popular than ever. Like other ETFs, they are more tax-efficient, allowing you to save more money and earn more profit. That said, Bond ETFs’ do have some potential downsides that are you should be aware of before you invest in Bond ETFs.

Bond ETF Basics

ETFs are Exchange-Traded Funds, investment vehicles that are traded in the stock market the way you would trade stocks. These vehicles are made up of similarly themed assets. In case of Bond ETFs, those assets are (naturally) bonds. The Bond ETFs are traded at the net asset value of its underlying assets. This reduces the risk and increases profitability.

There are several types of Bond ETFs you can choose from. Broadly speaking, they can be divided into two categories — Bond ETFs that are made up of bonds issued by private entities and Bond ETFs made up municipal entities. The later tend to be more stable than the former, since government entities are less likely to collapse due to financial difficulties. However, the former tend to generate more profit than the later.

Tax Benefits of Bond ETFs

As with other ETFs, the biggest tax advantage of Bond ETFs is that while you do have to pay a capital gains tax on profits earned from them, you only have to do it once the entire ETF is sold. This gives you more time to gather the money necessary to pay the taxes, allowing you to spend more money during each given year.

While the above is true for there are some types of bond ETFs that are taxed differently, which creates it’s own benefits and downsides.

International Bond ETFs and Taxes

International Bond ETFs are ETFs that are made up of bonds issued by foreign governments. The issuing governments have the right to tax those bonds. Furthermore, the profits earned outside United States are subject to different tax rates and regulations than the profits earned in America. Together, this can add to your overall tax burden. The situation is further complicated by the fact that different countries will levy different taxes. If you want to invest in International Bond ETFs, you will have to research each ETF’s country of origin and figure out what kind of bond-related tax laws they have.

Municipal Bond ETFs and Taxes

Municipal bond ETFs are ETFs that are made up of municipal bonds that are issued by towns, cities, counties and other municipal objects in order to generate capital. Unlike other types of Bond ETFs, Municipal Bond ETFs are completely tax-free. The only exception to this rule is when the profits you earn from Bond ETFs get large enough to be taxed under the Alternate Minimum Tax (AMT). Since AMT isn’t adjusted to inflation, this threshold will get lower and lower with each passing year.

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