Tax-Equivalent Yield (TEY) Calculator
This tax-equivalent yield (TEY) calculator provides you with a basic method by which you can determine the tax-equivalent yield for a municipal bond.
How to use this calculator: Simply input your annual taxable income, select your tax filing status, input the tax rate in your state, input your tax-free yield, and click on the "Calculate" button to get your TEY.
Please note: The tax-equivalent yield calculator has been fully updated for the 2024/25 tax year.
Understanding the Tax-Equivalent Yield and How It Is Calculated
The tax-equivalent yield provides a method of determining the return on a taxable bond or alternative investment in comparison with the return on a tax-exempt bond or investment. The TEY is frequently employed to assess the expected returns on municipal bonds, which are frequently referred to as "muni" bonds. These types of bonds take the form of debt security that is issued by a local or state government. Municipal bonds frequently achieve lower rates of return than comparable taxable corporate bonds. However, as they have tax savings, they can be more advantageous. The TEY helps investors determine whether a taxable bond or tax-exempt bond will yield the most significant return.
The formula that is employed to determine a taxable equivalent yield is as follows:
Taxable Equivalent Yield (TEY) = Return on Tax-Free Investment / (1 − Marginal Tax Rate)
For instance, let's say that Investor 1 is currently in the 32% tax bracket and is making a decision as to whether to invest in a muni that has a 5% rate of interest. Using the formula provided above, we can determine the TEY of the municipal bond for this investor:
TEY = 0.05 / (1 − 0.32) = 0.0735 = 7.35%
As such, to represent a more attractive investment potential, the taxable bond would need to offer a yield in excess of 7.35%.
As municipal bonds have a tax-free advantage, they can make a significant difference to the overall level of return that an investor achieves. This can be particularly the case if the investor is in a high tax bracket.
For instance, let's say that Investor 2 is currently in the 24% tax bracket and is making a decision as to whether to invest in the same muni as Investor 1; i.e., a municipal bond that has a 5% rate of interest. Using the formula provided, we can determine the TEY of the municipal bond for this investor:
TEY = 0.05 / (1 − 0.24) = 0.0657 = 6.57%
In the case of Investor 1, the taxable bond would need to generate a rate of return over 7.35% to be more profitable than the 5% municipal bond. However, because Investor 2 has a lower tax rate, the taxable bond would only need to generate a rate of return over 6.57% to be more profitable than the 5% municipal bond.
Note: Municipal bonds that are issued in the state in which you reside may be tax-free on both state and federal levels. These bonds are "double tax-free". In such cases, you will need to take into consideration the income tax rate in your state. For instance, if the state tax rate is 6% and the federal tax rate is 32%, the correct calculation would be as follows:
(1 − (0.32 + 0.06)) = 0.62.