A tax-free municipal bond is used below the state government level as a way to raise money for projects. Bonds are typically used to fund parks, restorations, and improvements to local schools and airports. An investor buys the bond, and the government uses the bond to loan the money to the municipality. Any income from the bond is 100% exempt from federal taxes. If the bondholder lives in the state where the bond is issued, the income is also typically exempt from taxes on the state level as well. There is always some risk involved in these investments, because the government may not be able to pay back the bond if the project goes badly.

The payout time frame varies by bond and issuer. Larger bonds for more important projects can last up to 30 years, but some bonds may only be issued for a few months. As the bond lists the principal amount, the interest rate, and the maturity date, or the date the bond must be paid back, sometimes the bond will be paid in full at the maturity date, while other times interest will be paid accordingly, typically once every six months in the United States. Larger bonds may have an amortization schedule, where the bond is paid back over a period of years, with interest included. Interest rates are higher for higher risk investments.

Not all municipal bonds, also known as munis, are tax-free. Check with your local are to determine if there are any bonds available and if there are, which ones are available as tax-free options.