Tax Equivalent Yield Calculator: When Municipal Bonds Beat Taxable Bonds
Quick Answer
- *Tax equivalent yield (TEY) converts a tax-exempt muni bond yield into the taxable yield you'd need to match it after taxes.
- *Formula: TEY = Muni Yield ÷ (1 − Tax Rate). A 3.5% muni for a 37% bracket investor equals a 5.56% taxable yield.
- *Munis typically make sense at the 32% bracket and above — the higher your rate, the bigger the advantage.
- *Bonds issued in your home state may be triple tax-exempt — exempt from federal, state, and local taxes — increasing TEY further.
What Is Tax Equivalent Yield?
Tax equivalent yield (TEY) is the return a taxable bond would need to produce to match the after-tax income of a tax-exempt municipal bond. Because muni bond interest is exempt from federal income tax (and often state and local taxes too), comparing a muni yield directly to a corporate or Treasury yield is apples-to-oranges.
TEY puts them on equal footing. If a muni bond yields 3.5% and you're in the 37% federal tax bracket, a taxable bond would need to yield 5.56% to net you the same after-tax income. Any taxable bond yielding less than that is a worse deal for you.
The Municipal Bond Market at a Glance
The U.S. muni market is large and well-established. A few figures worth knowing:
- The U.S. municipal bond market totals over $4 trillion in outstanding debt, according to the Municipal Securities Rulemaking Board (MSRB) 2024 Fact Book.
- SIFMA reported $396 billion in new muni issuance in 2024, reflecting steady demand from states, cities, and school districts.
- According to Moody's Investors Service, the 10-year cumulative default rate on investment-grade municipal bonds is approximately 0.1%, compared to roughly 2.2% for investment-grade corporate bonds.
- The Investment Company Institute (ICI) reports that muni mutual funds and ETFs held over $1 trillion in assets as of year-end 2024, reflecting heavy use by individual investors in higher tax brackets.
- AAA-rated 10-year muni bonds averaged a yield of approximately 3.2%–3.6% through much of 2025, per Bloomberg Municipal Bond Index data — competitive with Treasuries on an after-tax basis for top-bracket investors.
The Tax Equivalent Yield Formula
The formula is straightforward:
Tax Equivalent Yield = Muni Yield ÷ (1 − Marginal Tax Rate)
Worked example using the 37% federal bracket:
- Muni yield: 3.5%
- Tax rate: 37% (0.37)
- TEY = 3.5% ÷ (1 − 0.37) = 3.5% ÷ 0.63 = 5.56%
That means a 37% bracket investor holding this muni bond is effectively earning the equivalent of a 5.56% taxable bond. If the best comparable taxable bond offers 5.0%, the muni wins.
TEY Across All 2026 Tax Brackets
Here's how the tax equivalent yield for a 3.5% muni bond changes across each federal income tax bracket in 2026:
| Federal Tax Bracket | Muni Yield | Tax Equivalent Yield | Beat This Taxable Yield |
|---|---|---|---|
| 22% | 3.5% | 4.49% | Any taxable bond < 4.49% |
| 24% | 3.5% | 4.61% | Any taxable bond < 4.61% |
| 32% | 3.5% | 5.15% | Any taxable bond < 5.15% |
| 35% | 3.5% | 5.38% | Any taxable bond < 5.38% |
| 37% | 3.5% | 5.56% | Any taxable bond < 5.56% |
The jump from 24% to 32% is particularly meaningful. At 24%, the TEY advantage is modest. At 32%+, munis start delivering real after-tax value that's hard to replicate in taxable bonds without taking on more credit risk.
When Municipal Bonds Make Financial Sense
The Breakeven Bracket
The general rule: munis become worth considering at the 32% federal bracket and become clearly advantageous at 35% and 37%. Below 32%, the tax savings are smaller, and you can often do better with a high-yield savings account or short-term Treasuries on a pure after-tax basis.
The actual breakeven depends on current rates. When the spread between muni yields and Treasury yields narrows (munis become more expensive relative to Treasuries), the breakeven bracket rises. When munis are cheap relative to Treasuries, even 24% bracket investors may benefit.
Taxable Account vs. Tax-Deferred Account
Munis belong in taxable brokerage accounts — not IRAs or 401(k)s. In a tax-deferred account, all withdrawals are taxed as ordinary income regardless of what the underlying investment was. The tax-exempt feature of munis is wasted inside a retirement account. Put your munis in your taxable account and your corporate bonds in your IRA.
State and Local Taxes Change the Math
Federal tax is only part of the picture. If you live in a high-tax state and buy bonds issued within your state, the interest is typically exempt from state and local taxes as well — making it triple tax-exempt. In California (13.3% top rate), New York (10.9%), or New Jersey (10.75%), this can add several percentage points to the effective TEY.
To account for state taxes, use the combined marginal rate in the formula:
TEY = Muni Yield ÷ (1 − Federal Rate − State Rate)
For a California investor in the 37% federal bracket facing a 13.3% state rate: TEY = 3.5% ÷ (1 − 0.37 − 0.133) = 3.5% ÷ 0.497 = 7.04%. That's a significant hurdle for any taxable bond to clear.
5 Things to Know Before Buying Municipal Bonds
- Know your effective marginal rate. Your federal bracket rate isn't always your true marginal rate. The Net Investment Income Tax (NIIT) adds 3.8% on investment income above $200,000 ($250,000 married). Including NIIT, a 37% bracket investor may face a 40.8% effective rate on bond interest, pushing TEY even higher.
- Understand the difference between GO bonds and revenue bonds. General obligation (GO) bonds are backed by the full taxing power of the issuer — generally the safest munis. Revenue bonds are repaid from a specific revenue stream (tolls, utilities, hospital fees) and carry more credit risk.
- Check the AMT status. Some private activity bonds are subject to the Alternative Minimum Tax (AMT). If you're subject to AMT, those bonds lose their tax-exempt status for you. Look for bonds explicitly labeled “not subject to AMT.”
- Liquidity is lower than Treasuries. The muni market is large but can be illiquid, especially for smaller issuances. Bid-ask spreads can be wide. Muni ETFs and mutual funds offer better liquidity for most individual investors than buying individual bonds.
- Compare after-fee yields on muni funds. Muni mutual funds and ETFs charge management fees that reduce your effective yield. A fund yielding 3.5% with a 0.4% expense ratio nets you 3.1% — adjust your TEY calculation accordingly.
4 Risks of Municipal Bonds
- Interest rate risk. Like all bonds, muni prices fall when interest rates rise. A 10-year muni bond with a 5% duration loses roughly 5% in value for every 1 percentage point rise in rates. Shorter duration bonds reduce this exposure.
- Credit risk. While muni default rates are historically low, they are not zero. Detroit, Puerto Rico, and several Illinois pension obligations have demonstrated that credit analysis matters. Stick to investment-grade or use a diversified fund.
- Call risk. Many muni bonds are callable, meaning the issuer can repay you early when rates fall. Callable bonds typically pay a higher yield but you lose the income stream right when you'd most want to keep it.
- Tax law risk. The tax exemption for munis exists by federal statute and could be changed by Congress. Any reduction in the exemption would immediately reduce muni prices and effective TEY.
Find your break-even point instantly
Use our free Tax Equivalent Yield Calculator →Frequently Asked Questions
What is tax equivalent yield?
Tax equivalent yield (TEY) is the pre-tax yield a taxable bond would need to match the after-tax return of a tax-exempt municipal bond. For example, a 3.5% muni yield for a 37% bracket investor has a TEY of 5.56% — meaning any taxable bond yielding less than 5.56% is a worse deal after taxes.
At what tax bracket do municipal bonds make sense?
Municipal bonds generally become advantageous at the 32% federal tax bracket and above. Below 32%, the tax savings from munis are modest and may not offset their typically lower yields. Investors in the 35% and 37% brackets usually benefit the most from muni bond allocations, especially in high-tax states.
What is the tax equivalent yield formula?
The formula is: Tax Equivalent Yield = Muni Yield ÷ (1 − Your Marginal Tax Rate). If you hold a muni yielding 3.5% and are in the 37% tax bracket, the calculation is 3.5% ÷ (1 − 0.37) = 3.5% ÷ 0.63 = 5.56%. Any taxable bond yielding less than 5.56% produces less after-tax income.
Are municipal bonds triple tax-exempt?
Some municipal bonds are triple tax-exempt, meaning interest is free from federal, state, and local income taxes. This applies when you buy bonds issued in your home state. Triple exemption makes the effective TEY even higher for investors in high-tax states like California, New York, and New Jersey, where state rates can exceed 10%.
How safe are municipal bonds compared to corporate bonds?
Municipal bonds have historically been much safer than corporate bonds. According to Moody's Investors Service, the 10-year cumulative default rate for investment-grade munis is approximately 0.1%, compared to roughly 2.2% for investment-grade corporate bonds. General obligation bonds backed by taxing authority carry the lowest default risk.
Do municipal bonds belong in a tax-deferred account like an IRA?
No. Placing municipal bonds in a traditional IRA or 401(k) wastes their tax advantage — withdrawals are taxed as ordinary income anyway, eliminating the tax-exempt benefit. Munis make the most sense in taxable brokerage accounts, where you keep the full after-tax yield. Hold taxable bonds in tax-deferred accounts instead.