Transparent method
The formula
Worked example
Example inputs
How to interpret the result
Municipal bond interest is usually free of federal income tax, so it is compared with a taxable bond after tax. A 5 percent taxable yield at a 32 percent marginal rate is worth about 3.4 percent after tax, while a 3.8 percent municipal yield is worth about 5.6 percent on a taxable basis. On these numbers the municipal bond wins. The result flips at a lower tax bracket, which is why the choice depends on your own marginal rate.
Before you rely on it
What to check
Use your marginal rate including any state tax and, where it applies, the tax on investment income. Then compare credit quality and call features on the two bonds.
The common error
Where people go wrong with muni vs. taxable bond calculator
Comparing a municipal yield with a taxable yield directly. The two are taxed differently, and only the after-tax figures are comparable.
Sensitivity evidence
How taxable yield changes the taxable after-tax yield
| Taxable yield | Taxable after-tax yield | Tax-exempt equivalent yield |
|---|---|---|
| 3.0% | 2.0% | 5.6% |
| 4.0% | 2.7% | 5.6% |
| 5.0%worked example | 3.4% | 5.6% |
| 6.0% | 4.1% | 5.6% |
| 7.0% | 4.8% | 5.6% |
Every input, tested
Which input moves the taxable after-tax yield most
| Input | Tested from | To | Taxable after-tax yield at each end | Swing |
|---|---|---|---|---|
| Taxable yield | 4.0% | 6.0% | 2.7% to 4.1% | 1.4% (40%) |
| Marginal tax rate | 30.0% | 34.0% | 3.5% to 3.3% | 0.200% (5.9%) |
| Tax-exempt yield | 2.8% | 4.8% | 3.4% to 3.4% | none |
Two variables at once
Taxable after-tax yield by taxable yield and marginal tax rate
| Taxable yield \ Marginal tax rate | 28.0% | 32.0% | 36.0% |
|---|---|---|---|
| 3.0% | 2.2% | 2.0% | 1.9% |
| 4.0% | 2.9% | 2.7% | 2.6% |
| 5.0% | 3.6% | 3.4% | 3.2% |
| 6.0% | 4.3% | 4.1% | 3.8% |
| 7.0% | 5.0% | 4.8% | 4.5% |
Step by step
The worked example, input by input
| Input | Value used |
|---|---|
| Taxable yield | 5.0% |
| Tax-exempt yield | 3.8% |
| Marginal tax rate | 32.0% |
| Taxable after-tax yield | 3.4% |
| Tax-exempt equivalent yield | 5.6% |
Where the inputs come from
Taxable yield is the yield on a comparable taxable bond, such as a corporate or Treasury bond with a similar maturity and credit quality, tax-exempt yield is the municipal bond's yield, and the marginal tax rate is your federal bracket, plus the net investment income tax if it applies. If the municipal bond is from your own state, include state tax in the rate. Compare bonds of similar maturity and credit rating.
When the result stops applying
Munis and taxable bonds have different credit and liquidity profiles, and a comparable maturity does not make the risk equal. Some municipal bonds are subject to the alternative minimum tax. Munis in tax-advantaged accounts waste the exemption. Yields change, and capital gains on municipal bonds are taxable.
What to compare it with
See the single-bond version on the tax-equivalent yield calculator, and the effect of inflation on the real yield page. The bond price and yield to maturity pages give the yields to compare. The federal income tax calculator helps identify your bracket.
People also ask
Frequently asked questions
Who should buy municipal bonds?
Investors in high tax brackets holding bonds in taxable accounts, especially those in states with high income taxes who buy in-state bonds.
Are municipal bonds safe?
Many are high quality, but they carry credit and interest rate risk, and defaults, though rare for general obligation bonds, do occur.
Should I hold munis in an IRA?
No. The IRA already defers tax, so you would give up yield for an exemption you cannot use.