HOW IS THE TAXABLE EQUIVALENT YIELD USED?

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 do.

So is the tax break worth it? 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.

On the next screen, we will show you how to calculate this taxable equivalent yield when only federal taxes are involved.