A 4% tax-free return can beat a 5.5% taxable one, depending on your tax rate. Enter the two yields and the rate you’d pay on the taxable one — your marginal tax rate — to see which leaves you with more.
The tax-equivalent yield is the taxable return that would leave you with the same amount after tax as a tax-free return: TEY = tax-free yield ÷ (1 − tax rate). At a 33% rate, a 4% tax-free yield is worth the same as 4 ÷ 0.67 = 5.97% taxable.
The other way round, a taxable yield after tax is yield × (1 − rate): 5.5% × 0.67 = 3.69%, which is less than the 4% tax-free option — so here the tax-free option wins.
Use your marginal tax rate (the rate on your next dollar of income), because investment income sits on top of your other income. Examples of tax-advantaged options include US municipal bonds, UK ISAs, some PIE funds in New Zealand, and superannuation or retirement accounts in many countries.
The pre-tax yield a taxable investment would need to match a tax-free investment’s return after tax. Formula: tax-free yield ÷ (1 − your tax rate).
Your marginal rate — the rate your next dollar of income is taxed at — plus any other tax that applies to that income, such as a state or local tax.
Not always. If your tax rate is low, a higher taxable yield can leave you with more. The calculator shows which wins at your rate; at the break-even rate both leave you the same.
Enter that lower rate in the optional box. For example, a fund taxed at a capped 28% versus income taxed at 39%. The comparison then uses both after-tax yields.
When 1 − rate = tax-free yield ÷ taxable yield. For 4% tax-free versus 5.5% taxable, that’s 1 − 4/5.5 = 27.3%: above that rate the tax-free option wins.
