Tax-Equivalent Yield Calculator
Tax-Equivalent Yield
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Tax Savings per $10,000
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Understanding Tax-Equivalent Yield
Municipal bonds pay interest that is typically exempt from federal income tax and often from state tax as well. The tax-equivalent yield (TEY) converts this tax-free yield into the equivalent taxable yield you would need to earn to match the muni bond after taxes.
The formula is: TEY = Tax-Free Yield / (1 - Tax Rate). For example, a 3.5% tax-free yield for someone in the 24% federal bracket has a TEY of 4.61%. This means a taxable bond would need to yield at least 4.61% to match the muni after taxes.
The higher your tax bracket, the more valuable tax-free income becomes. For high-income earners in the 37% bracket, a 3.5% muni yield is equivalent to a 5.56% taxable yield. This is why municipal bonds are particularly attractive for high-income investors.
Frequently Asked Questions
What is tax-equivalent yield?
Tax-equivalent yield is the pre-tax yield a taxable bond needs to offer to equal the after-tax yield of a tax-exempt municipal bond. It helps compare munis to taxable bonds on an equal basis.
How is TEY calculated?
TEY = Tax-Free Yield / (1 - Combined Tax Rate). If your combined federal and state rate is 29% and the muni yields 3.5%, TEY = 3.5 / (1 - 0.29) = 4.93%.
Who benefits most from municipal bonds?
High-income taxpayers in the highest federal brackets (32-37%) benefit most because the tax exemption is worth more when your tax rate is higher.
Are all municipal bonds tax-free?
Not all. Interest from most munis is exempt from federal tax. If the bond is from your state of residence, it may also be exempt from state tax. However, some munis (private activity bonds) may trigger the Alternative Minimum Tax.