What Is Taxable Equivalent Yield?

Perhaps the most attractive feature of municipal bonds is that, in almost all cases, they are free of federal income tax. They are often free of state taxes, too. However, they can also have lower coupon rates than their taxable bond cousins.

So is the tax break of municipal bonds worth it? Or do the higher yields of other bonds make up for the lost tax savings? To answer that question, you may need to compare the yields of tax-free bonds to the yields of bonds that are taxable (such as corporate bonds). Taxable equivalent yield is the amount you would have to earn on a taxable bond to equal what you would earn on a municipal bond. Sometimes you can earn more on a municipal bond than on a bond that is taxed. In other cases, you may earn more on a taxable bond.

The taxable equivalent yield lets you compare the yields of taxable bonds with those of municipal bonds. This information will help you determine whether gains from the higher interest rates on taxable bonds will be greater than the tax bite on them.

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