How to use the tax equivalent yield calculator
- Enter the tax-exempt yield, for example the yield of a tax-exempt bond.
- Enter your own marginal tax rate. The tool has no rates built in.
- Optionally enter a taxable yield to compare.
- Read the taxable yield that matches the tax-exempt one, and the tax rate where the two are equal.
Formula
Tax equivalent yield = tax-exempt yield / (1 - tax rate)
After-tax taxable yield = taxable yield x (1 - tax rate)
Break-even tax rate = 1 - tax-exempt yield / taxable yield
Above the break-even rate the tax-exempt yield is better, and below it the taxable yield is better.
A 3.0% tax-exempt yield and a 24% rate
The tax equivalent yield is 3.0 / 0.76 = 3.947%. A taxable investment would need to pay at least that to leave you with the same 3.0% after tax. Compared with a taxable 3.8% yield, the after-tax yield is 3.8 x 0.76 = 2.888%, so the tax-exempt one is better.
The two are equal at a tax rate of 1 - 3.0 / 3.8 = 21.05%. At a 35% rate the equivalent yield rises to 4.615%, and at 12% it is only 3.409%, which is why exemptions matter more to people in higher brackets.
Comparing like with like
A tax-exempt yield and a taxable yield are not directly comparable, because the taxable one is reduced by tax before you keep it. The tax equivalent yield puts them on the same footing. It answers the question, how much would a taxable investment have to pay to match this one after tax.
Whether an investment is tax-exempt, and from which taxes, depends on where you live and your own situation. A bond may be free of one kind of tax and not another. Enter the rate that applies to you, which may be a combination of several taxes.
Beyond the yield
The comparison leaves out risk, the quality of the issuer, fees and what else the income does to your tax position. It is arithmetic and not advice, and a tax professional can say what applies to you. For related tools see the Real Rate of Return Calculator, the Bond Yield Calculator, the CD Ladder Calculator and the Investment Return Comparison Calculator.
Assumptions and limits
- The tax rate is the rate on the next dollar of interest, and you enter it yourself.
- The investments have the same risk, term and fees.
- The yields shown are examples. Use the yields of your own options.
- No tax rates or brackets are stored in this tool.
Frequently asked questions
What is a marginal tax rate?
The rate on your next dollar of income, as opposed to the average rate on all of it. Use the one that applies to the interest you would earn.
Why does a higher rate raise the equivalent yield?
You keep less of a taxable yield, so a taxable investment must pay more to match the same tax-exempt return.
What if the tax rate is zero?
Then the tax-exempt yield and the equivalent taxable yield are the same, because there is no tax to avoid.
Can I leave the taxable yield blank?
Yes. You then see only the equivalent yield, without the comparison and the break-even rate.