1. What is tax equivalent yield?
Tax equivalent yield (TEY) is the yield a taxable bond must offer to equal the after-tax return of a tax-free municipal bond. It helps investors compare taxable and tax-free investments fairly.
2. How is tax equivalent yield calculated?
TEY = Tax-Free Yield ÷ (1 – Tax Rate). For example, a 4% municipal bond in a 32% tax bracket has a TEY of 5.88% (4% ÷ 0.68).
3. What is a good tax equivalent yield?
A good TEY depends on your tax bracket and available taxable alternatives. If you can find a taxable bond yielding more than the TEY, the taxable bond is the better after-tax choice.
4. What is the difference between tax equivalent yield and after-tax yield?
TEY converts a tax-free yield to its taxable equivalent. After-tax yield converts a taxable yield to its after-tax equivalent. Both help compare investments.
5. Who benefits most from municipal bonds?
Investors in higher tax brackets (24%+) benefit most from municipal bonds. The higher your tax bracket, the greater the tax savings from tax-exempt interest.
6. Are municipal bonds always tax-free?
Most municipal bonds are exempt from federal income tax. Some are also exempt from state and local taxes, especially if issued in your state of residence. Capital gains may still be taxable.
7. What is the difference between TEY and taxable equivalent yield?
They are the same concept. Tax equivalent yield (TEY) and taxable equivalent yield are used interchangeably.
8. How does state tax affect TEY?
State tax increases the combined tax rate, which increases TEY. If your state taxes municipal bond interest, include it. In-state municipal bonds are often state-tax exempt.
