Compare tax-free municipal bond yields against taxable bonds. See how your tax bracket affects your real returns.
Tax Equivalent Yield (TEY) is the yield a taxable bond would need to provide in order to match the after-tax return of a tax-free municipal bond. Since municipal bond interest is generally exempt from federal income tax (and sometimes state tax), comparing muni yields to taxable bond yields requires adjusting for your personal tax situation.
Municipal bonds ("munis") are issued by state and local governments to fund public projects like schools, highways, and hospitals. The key attraction is that the interest income is typically exempt from federal income tax — and often from state tax if you live in the issuing state.
For investors in higher tax brackets, this tax exemption can make a meaningful difference. A seemingly modest 3% tax-free yield from a muni bond might actually be equivalent to a 4.41% taxable yield for someone in the 32% federal bracket. That's why comparing bond yields without considering taxes can be misleading.
The TEY calculation is straightforward, but its implications are powerful. The formula adjusts a tax-free yield upward to show what a taxable bond must earn to produce the same after-tax income. Your combined marginal tax rate is the total of your federal rate and your effective state rate (which depends on whether the bond is in-state).
Scenario: You're in the 32% federal bracket, have a 5% state tax rate, and are considering an in-state muni yielding 3.5%.
This means the muni bond is the better choice unless you can find a taxable bond yielding more than 5.56%.
State taxes add another layer to the TEY calculation:
If you live in a state with high income taxes (like California at up to 13.3%, New York up to 10.9%, or Oregon up to 9.9%), the in-state vs out-of-state distinction can dramatically affect your TEY calculation. Investors in these states should strongly prefer in-state munis for maximum tax benefit.
If you live in a state with no income tax (Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, Wyoming), the toggle between in-state and out-of-state won't affect your calculation.
Here are some general guidelines for when tax-exempt munis make sense vs taxable bonds:
| Factor | Favors Munis | Favors Taxable Bonds |
|---|---|---|
| Tax Bracket | Higher brackets (24%+) | Lower brackets (22% and below) |
| State Tax | High state tax, in-state muni | No state income tax |
| Yield Environment | When muni yields are relatively high | When taxable yields significantly exceed TEY |
| Risk Profile | Lower risk, steady income | Higher yield potential with more risk |
| Tax-Advantaged Accounts | Taxable accounts (munis don't help in IRAs) | IRAs and 401(k)s (tax already deferred) |
This calculator is for educational and illustrative purposes only. It does not constitute financial advice. Tax laws are complex and vary by jurisdiction. The Alternative Minimum Tax (AMT) may apply to certain private-activity municipal bonds. Consult a qualified tax professional or financial advisor before making investment decisions. Past performance does not guarantee future results.