Taxable Equivalent Yield
Calculate the taxable equivalent yield of tax-free municipal bonds. Compare tax-free vs taxable bond yields using your marginal tax rate to maximize after-tax returns.
About This Calculator
The Taxable Equivalent Yield (TEY) calculator helps bond investors compare tax-free municipal bonds with taxable alternatives. By converting a tax-free bond yield into its taxable equivalent using your marginal tax rate, you can determine which investment provides better after-tax returns.
The formula used is: TEY = Tax-Free Bond Yield / (1 - Marginal Tax Rate). For example, a municipal bond yielding 4% for an investor in the 30% tax bracket has a taxable equivalent yield of 5.71%. This means any taxable bond must yield more than 5.71% to be a better investment after taxes.
Regional Notes
India: Tax-free bonds from NHAI, PFC, REC, HUDCO, IRFC, and NABARD offer interest exempt from income tax under Section 10. The TEY formula helps compare these with taxable fixed deposits and corporate bonds.
US: Municipal bonds (munis) are federally tax-free. If you buy bonds from your state of residence, interest is also state and local tax-free. High-bracket investors benefit most from munis.
UK: Tax-free bond options include ISA-held bonds, Premium Bonds, and certain National Savings products. Gilts are free from capital gains tax but interest is taxable.
Frequently Asked Questions
What is taxable equivalent yield?
Taxable equivalent yield (TEY) is the yield a taxable bond must offer to match the after-tax return of a tax-free bond. It is calculated by dividing the tax-free bond yield by (1 minus your marginal tax rate). This helps investors compare tax-free municipal bonds with taxable alternatives.
How do I calculate taxable equivalent yield?
Use the formula: Taxable Equivalent Yield = Tax-Free Bond Yield / (1 - Marginal Tax Rate). For example, if a municipal bond yields 4% and your marginal tax rate is 30%, the taxable equivalent yield is 4% / (1 - 0.30) = 5.71%. This means a taxable bond would need to yield at least 5.71% to provide the same after-tax return.
What types of bonds are tax-free in India?
In India, tax-free bonds are issued by government agencies like NHAI, PFC, REC, HUDCO, IRFC, and NABARD. Interest earned on these bonds is exempt from income tax under Section 10 of the Income Tax Act. These bonds typically have long tenures of 10-20 years and offer coupon rates lower than taxable bonds.
What types of bonds are tax-free in the US?
In the US, municipal bonds (munis) issued by state and local governments are tax-free at the federal level. If you buy bonds issued by your state of residence, the interest is also exempt from state and local taxes. This double tax benefit makes munis attractive for investors in high tax brackets.
What types of bonds are tax-free in the UK?
In the UK, the main tax-free bond is the ISA (Individual Savings Account) where you can hold bonds and earn interest tax-free. Premium Bonds offer tax-free prizes. Gilts (UK government bonds) are free from capital gains tax but interest is subject to income tax. National Savings & Investments offer some tax-free products.
How does marginal tax rate affect taxable equivalent yield?
The higher your marginal tax rate, the more valuable tax-free bonds become. For a 4% tax-free bond, an investor in the 10% bracket gets a TEY of 4.44%, while an investor in the 37% bracket gets a TEY of 6.35%. Tax-free bonds are most beneficial for high-income earners in top tax brackets.
Is a higher taxable equivalent yield always better?
Generally yes, a higher TEY means better after-tax returns. However, investors should also consider credit risk, liquidity, tenure, and diversification. Tax-free bonds often have lower credit risk (government-backed) but may offer lower liquidity. Always compare bonds with similar risk profiles and time horizons.