How to use it
- Choose tax-equivalent yield (you have a tax-free yield) or after-tax yield (you have a taxable yield).
- Enter the yield and your marginal tax rate on interest.
- Optionally enter the amount invested to see yearly income.
Formula
- Tax-equivalent yield = tax-free yield ÷ (1 − tax rate)
- After-tax yield = taxable yield × (1 − tax rate)
- Yearly income = amount × yield
Worked example
A tax-free bond yields 3.5%, your marginal rate is 24%, you invest 10,000:
- Tax-equivalent yield = 3.5 ÷ (1 − 0.24) = 3.5 ÷ 0.76 = 4.605 %.
- Yearly tax-free income 350.00; a taxable bond would need to pay 460.53 before tax for the same.
The other way: a taxable 5% at a 30% rate leaves 5 × 0.7 = 3.5 % after tax, 700.00 of 20,000 a year, with 300.00 of tax.
Tips
- The higher your tax rate, the more a tax-free bond is worth to you; at low rates a taxable bond often pays more.
- Compare bonds of similar maturity and credit quality.
- Tax rules decide which interest is exempt and from which taxes; check them where you live.