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Are tax-exempt mutual funds right for you?

Tax-exempt funds can be a smart way to reduce your income taxes, but they're not for everyone.

Find out if you could be saving on taxes

Who doesn't want a lighter tax bill? Although tax-exempt mutual funds usually produce lower yields, you generally don't have to pay federal taxes on earnings from tax-exempt money market and bond funds. And you can save even more if you live in a state that offers similar exemptions.

But before you invest, ask yourself a few questions:

Am I investing outside of an IRA or another retirement plan?

You won't gain anything more by including a tax-exempt mutual fund in an already tax-advantaged account, like an IRA. Instead, you'd actually be giving up potential yields.

Am I in one of the higher tax brackets?

If you're not, tax-exempt funds probably aren't the right fit. You likely won't save enough in taxes to make up for the lower yields you typically get from a tax-exempt fund.

If you answered "yes" to both of these questions, a tax-exempt fund might be worth a look.

Choose your tax-exempt funds

If you've determined you're a good candidate to start investing in tax-exempt funds, take a look at the funds you have to choose from.

See a list of Vanguard tax-exempt money market funds
See a list of Vanguard tax-exempt bond funds
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All investing is subject to risk, including the possible loss of the money you invest.

Vanguard average mutual fund expense ratio: 0.10%. Industry average mutual fund expense ratio: 0.60%. All averages are asset-weighted. Industry averages exclude Vanguard. Sources: Vanguard and Morningstar, Inc., as of December 31, 2020.

Bond funds are subject to the risk that an issuer will fail to make payments on time and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.

Although tax-exempt mutual funds usually produce lower yields, you generally don't have to pay federal taxes on earnings from tax-exempt money market and bond funds.

Although the income from municipal bonds held by a fund is exempt from federal tax, you may owe taxes on any capital gains realized through the fund's trading or through your own redemption of shares. For some investors, a portion of the fund's income may be subject to state and local taxes, as well as to the federal Alternative Minimum Tax.

For more information about Vanguard funds, visit vanguard.com to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.