A tax-friendly alternative to municipal bonds / Tax-free income has long been favored by investors, especially retirees.

Amit Chopra for MarketWatch.com writes: Municipal bonds have been the focus of investors who are seeking tax-free income for many years. These bonds paid a good income and relatively safe, but the downside is that in today's low interest rate environment, tax-free income from municipal bonds is very hard to achieve and can yield very little.

There is an often overlooked alternative for investors that could prove pivotal in helping retirees maintain their desired income on a tax-free basis.

Current tax laws provide a significant tax advantage for individuals investing in companies that pay a "qualified" dividend. Couples who have an income less than $72,500 and file taxes "jointly" typically pay zero taxes on the income generated from dividends. That's right, its tax-free income. For those earnings earning more than $72,500 taxes on qualified dividends are generally taxed at a maximum rate of 15% — potentially a better deal than being subject to the Alternative Minimum Tax.

Undoubtedly, there are different risks associated with dividend-paying stocks and bonds. While a stock has no maturity date and therefore has no set date at which it can be redeemed for “par value,” both stocks and bonds will fluctuate in value — stocks as are result of market conditions, bonds as a result of interest rate movements. Dividend-paying stocks won't as a rule provide "explosive" growth, but they can grow and compound faster than inflation (or a CD in a bank).

Comparably, short-term fluctuations in neither bond or stock value impact stocks' dividend payment nor bonds' interest payment. Rather, payments of dividends, as well as bond interest (or coupon as it is often referred to), is based on the overall health of the issuer and the issuers ability to make the payments.

More important, the value of bonds and, particularly bond funds, will come under pressure, given that interest rates are widely expected to rise in the coming years.

Dividend-paying stocks have another advantage to them: Dividends can increase.

There are many companies that have a strong track record of consistently raising the amount of their dividend, providing investors with a de-facto raise every time the dividend payment is raised. Choosing a creditable company with dividend paying stocks is tapping into the upside potential the stock market has to offer without having to try to "pick a winner" from unfamiliar companies that just happen to be in the news a lot.

Moreover, companies like McDonald’sMCD -1.21% , Verizon VZ +2.46% , and MerckMRK +0.16%  have all doubled their dividend since 2000 — meaning investors who have owned these stocks over those years have more than doubled their income, in addition to the capital appreciation.

You can reach Amit Chopra here.

Oliver Pursche contributed to this article.