Looking for tax-free income with higher returns than traditional bonds? High yield municipal bond funds might be your answer. These funds invest in lower-rated municipal bonds (also known as “junk” munis) that offer elevated yields to compensate for increased credit risk — making them attractive to income-seeking investors in higher tax brackets.
In this article, we’ll break down the top high yield municipal bond funds in 2025, their pros and cons, how they work, tax benefits, and how to evaluate them.
💡 What Are High Yield Municipal Bond Funds?
High yield municipal bond funds invest in municipal bonds with below-investment-grade credit ratings (i.e., rated below BBB by S&P or Baa by Moody’s). These bonds are issued by state and local governments or related agencies that are considered higher risk — in exchange, they offer higher interest rates.
Key Benefits:
- Tax-free income: Most interest is exempt from federal income tax, and sometimes state/local taxes.
- Higher yields than regular municipal bond funds.
- Monthly income distributions.
Risks:
- Credit/default risk: Higher chance of issuer default.
- Interest rate risk: Prices drop when interest rates rise.
- Liquidity risk: Some bonds may be hard to sell in downturns.
📈 Top High Yield Municipal Bond Funds (2025 Picks)
Here’s a look at some of the best-performing and most popular high-yield muni funds investors are considering in 2025:
| Fund Name | Ticker | Yield (30-day SEC) | Expense Ratio | Credit Focus | Tax Advantage |
|---|---|---|---|---|---|
| Vanguard High-Yield Tax-Exempt Fund | VWALX | ~4.3% | 0.17% | BB/Ba average | Federal tax-free |
| T. Rowe Price Tax-Free High Yield Fund | PRFHX | ~4.5% | 0.66% | High-yield muni | Federal tax-free |
| BlackRock High Yield Municipal Fund | MDYHX | ~4.2% | 0.74% | BB-B rated | Federal tax-free |
| Nuveen High Yield Municipal Bond Fund | NHMAX | ~4.6% | 0.72% | Below investment grade | Federal & some state |
| Invesco High Yield Municipal Fund | ACTHX | ~4.7% | 0.85% | BB-B average | Federal tax-free |
Note: Yields vary over time; check latest SEC yield and performance on fund provider sites or Morningstar.
🧮 Tax-Equivalent Yield: Why High-Yield Munis Make Sense
Municipal bond income is generally exempt from federal taxes. For high earners, this makes the tax-equivalent yield of muni funds very attractive.
Tax-Equivalent Yield Formula:
TEY=Municipal Bond Yield1−Tax Rate\text{TEY} = \frac{\text{Municipal Bond Yield}}{1 – \text{Tax Rate}}TEY=1−Tax RateMunicipal Bond Yield
Example: If you’re in the 35% tax bracket and a muni bond fund yields 4.5%: TEY=4.5%1−0.35=4.5%0.65=≈6.92%TEY = \frac{4.5\%}{1 – 0.35} = \frac{4.5\%}{0.65} = \approx 6.92\%TEY=1−0.354.5%=0.654.5%=≈6.92%
That’s equivalent to a taxable bond yielding nearly 7%, which is tough to find elsewhere.
🧭 Who Should Invest in High Yield Municipal Bond Funds?
These funds can be a great fit if:
- You’re in a high federal tax bracket (24%+).
- You want monthly, tax-free income.
- You can tolerate some price volatility and credit risk.
- You prefer diversification over individual bonds.
Not ideal if:
- You’re risk-averse.
- You need short-term liquidity.
- You rely on stable principal value.
🧠 Tips to Evaluate High Yield Muni Funds
- Credit Quality: Look for funds that balance risk and return by diversifying across sectors and issuers.
- Duration: Longer duration = higher sensitivity to interest rate changes.
- Manager Experience: Actively managed funds can outperform passive ones in complex credit markets.
- Expense Ratio: Lower fees mean more yield in your pocket.
- Yield vs. Risk: Don’t chase yield blindly — check historical drawdowns and default rates.
✅ Pros and Cons Summary
| Pros | Cons |
|---|---|
| Tax-free income (federal) | Higher risk of default |
| Higher yields than traditional munis | Interest rate and liquidity risks |
| Monthly income distribution | Sensitive to economic downturns |
| Suitable for high-tax-bracket earners | Not ideal for short-term investors |
🔒 Are High Yield Municipal Bonds Safe?
“Safe” is relative. While municipal bonds overall have low historical default rates, high-yield munis carry greater credit risk.
According to Moody’s:
- Investment-grade munis: ~0.1% 10-year default rate
- High-yield munis: ~5% 10-year default rate
That’s why diversified bond funds are safer than individual high-risk bonds — they spread your risk across hundreds of issuers.
🧾 Tax Considerations
- Federal tax exemption: Applies to most muni bond interest.
- State/local tax exemption: May apply if you live in the issuing state.
- Capital gains: Fund distributions or sales can still trigger capital gains taxes.
Always consult a tax advisor for personalized advice.
🏁 Conclusion: Are High Yield Municipal Bond Funds Worth It?
Yes — for the right investor. High yield municipal bond funds offer attractive, tax-exempt income with higher potential returns than traditional munis. They’re a smart choice for income-focused investors in higher tax brackets who can handle a bit more volatility.