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Tax Equivalent Yield Calculator – Is it Worth Your Investment?

Written by:
PK

Here you'll find a tax equivalent yield calculator, sometimes called a TEY calculator. When presented with investments that are free from taxation at the state, federal, and/or local level, you can use your tax rate to determine the equivalent taxable yield using this tool.

Tax Equivalent Yield Calculator

Current Yield to Maturity Calculator Inputs

  • Investment Yield (%) - The tax-free yield on the account or bond (or the interest rate).
  • Federal Marginal Tax Rate (%) - Your current marginal tax rate at the federal level.
  • State (and/or Local) Marginal Tax Rate (%)* - Your current marginal tax rate at the state level.
  • Yield Free From: - Whether the investment is free from federal tax, state tax, or both.

*If you live in a location with local tax (for example, New York City) and a security is exempt from tax there as well, add it here. Additionally, note that due to the maximum state tax exemption of $10,000, the calculator adds marginal tax at the state and local level to the federal marginal tax. If you have tax cap space, omit this field.

Bond Yield Calculator Outputs

  • Tax Equivalent Yield (%): If the investment was taxable, what would the yield be? (You can use this number to directly compare a taxable investment to the tax-free investment you are considering.)

What is tax equivalent yield (TEY)?

Tax equivalent yield is the yield you would need on a taxable investment to match the return you receive on a tax-advantaged investment.

Since most investments are taxable, you have to pay for any dividends, capital gains, coupon payments, and interest you receive at the end of the year. By applying tax "in reverse" such as with this tool, you normalize payouts on tax free investments to other potential investments.

Tax Free Investment Examples

It's impossible to list every tax-advantaged or tax-free investment in the United States, especially since some are only tax-free under certain conditions (for example, sometimes the alternative minimum tax (AMT) cancels tax-advantaged treatment).

Always consult with your tax advisor if you have any doubts – but here are examples of nominally tax-advantaged investments:

Note that for most securities, the interest might be tax-advantaged, while any capital gains (or, in the case of TIPS, inflation adjustments) are probably not. Again, check with your tax advisor with any questions.

Tax Equivalent Yield Formula

The tax current yield formula is:

\frac{yield}{1-marg\_tax}

Where:

  • yield - Interest rate or yield of the bond, account, or security
  • marg_tax - Your marginal tax rate which the security is exempt from

Example: Calculating the Current Yield on a Bond

Let's say you live in California and are evaluating a municipal bond which pays 1.2% and is exempt from taxes at the Federal and State level.

Your Federal marginal tax rate is 37% and you would owe an additional 3.8% Medicare surcharge on taxable interest, for a total of 40.8%. Your California marginal rate is 12.3%, for a total marginal tax rate of 53.1%.

What would yield more after tax – a bank savings account at 2.15% or the municipal bond?

  • yield – 1.2%
  • marg_tax = 53.1%
\frac{yield}{1-marg\_tax} = \\~\\\frac{.012}{1-.531}=\\~\\0.025586 = 2.56\%

In this case, the Municipal Bond would provide as much income as a savings account paying 2.56%, handily defeating the 2.15% account.

(Note, however, there are other considerations than yield – liquidity, default risk vs. FDIC insurance, etc. Always consult your advisor with any questions.)

Other Financial Basics Calculators

Taxes are very complex. Since there are so many security types and tax systems even in the United States, it's important to compare like to like when evaluating your asset allocation. Normalizing every security to the taxable-equivalent is good practice for your own portfolio.

Note that it's not the only way to "increase" your tax equivalent yield, however. By investing in tax-advantaged account types – such as IRAs, HSAs, 401(k)s, and 529s – you can defer or eliminate tax even on taxable accounts.

For other retirement account posts, plus financial basics and bond calculators, please see:

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