Tax-Equivalent Yield Calculator
A 4% tax-exempt municipal bond is not the same as a 4% taxable corporate bond for a high-income investor. At a 32% tax rate, you'd need a taxable yield of 5.88% to match the muni's after-tax income. This calculator shows the exact comparison for your tax rate.
Enter your tax-exempt yield, marginal tax rate, and optional taxable investment yield to see the full comparison instantly.
Understanding Tax-Equivalent Yield
The tax-equivalent yield (TEY) formula converts a tax-exempt yield into the equivalent taxable yield — the return a taxable bond must offer to produce the same after-tax income:
Example: 4% muni bond, 32% combined tax rate:
TEY = 4% ÷ (1 − 0.32) = 4% ÷ 0.68 = 5.88%
A taxable bond must yield more than 5.88% to beat this muni after taxes.
The formula works because municipal bond interest is federally tax-exempt (and state-tax-exempt if you own bonds from your home state). For every dollar of muni interest, you keep the full dollar. For taxable interest, you keep only (1 − tax rate) of each dollar. The TEY formula normalizes both to the same after-tax basis.
When Municipal Bonds Beat Taxable Bonds
Municipal bonds become more attractive as your tax rate rises. At a 22% rate, a 4% muni has a TEY of only 5.13% — many investment-grade corporate bonds offer 5%+ yields, so the muni is competitive but not clearly superior. At 37%, the same muni has a TEY of 6.35% — most comparable corporate bonds can't match that after-tax yield, making the muni clearly advantageous.
| Combined Tax Rate | Tax-Equivalent Yield | After-Tax on $100K | Muni Worth It? |
|---|---|---|---|
| 15% | 4.71% | $4,000 | Maybe — depends on taxable options |
| 24% | 5.26% | $4,000 | Competitive — compare carefully |
| 32% | 5.88% | $4,000 | Often yes — hard to match after-tax |
| 37% | 6.35% | $4,000 | Usually yes — clear advantage |
Including State Tax Exemption
For municipal bonds issued by your home state, interest is exempt from both federal and state income tax. This makes in-state bonds especially valuable. A California investor in the 37% federal + 13.3% state bracket has a combined marginal rate of approximately 50.3% on investment income. A 4% California muni has a TEY of 4% ÷ (1 − 0.503) = 8.05% — almost nothing in the taxable bond market can compete with that after-tax yield.
For a comprehensive guide to placing investments in the right accounts to minimize taxes, read tax-efficient investing. To understand how capital gains taxes affect your investment returns, see the Capital Gains Tax Calculator.
Frequently Asked Questions
What is tax-equivalent yield?
Tax-equivalent yield (TEY) is the taxable return needed to match a tax-exempt investment's after-tax income. Formula: TEY = Tax-Exempt Yield ÷ (1 − Marginal Tax Rate). At 32% rate, a 4% muni bond has a TEY of 5.88% — you need a taxable investment yielding more than 5.88% to beat the muni after taxes.
When are municipal bonds better than corporate bonds?
Municipal bonds beat comparable corporate bonds when your combined marginal rate exceeds the break-even rate. For a 4% muni vs. 5.5% corporate: break-even = 1 − (4% ÷ 5.5%) = 27.3%. If your rate is above 27.3%, the muni produces more after-tax income. For investors in the 32%+ bracket, high-quality munis are usually the better fixed-income choice in taxable accounts.
Should I use the federal rate or combined federal+state rate?
Use your combined federal + state marginal rate if the municipal bond is from your home state (providing state tax exemption too). Use only the federal rate for out-of-state munis that are state-taxable. The home-state exemption can significantly increase the effective TEY, especially in high-tax states like California, New York, and Massachusetts.
Should I hold municipal bonds in an IRA or taxable account?
Always in a taxable account. Municipal bonds are designed for taxable accounts — their tax-exempt interest saves the most when you'd otherwise owe taxes on it. In a traditional IRA, all withdrawals are taxed as ordinary income regardless of the source; the muni's tax exemption is wasted. In a taxable account, you keep 100% of the muni interest.
What is the break-even tax rate for munis vs. taxable bonds?
Break-even rate = 1 − (Tax-Exempt Yield ÷ Taxable Yield). Example: 4% muni vs. 5.5% corporate: 1 − (4% ÷ 5.5%) = 27.3%. If your marginal rate exceeds 27.3%, the muni produces more after-tax income. Below 27.3%, the corporate wins. This calculator computes it automatically.
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