Tax Equivalent Yield Calculator
With this tax equivalent yield calculator, we aim to help you to calculate the actual yield of tax-free bond investment. The tax equivalent yield enables you to understand the actual return of your tax-free bond investments.
We have written this article to help you understand what the tax equivalent yield is and how to calculate the tax free equivalent yield. We will also demonstrate some examples to help you understand the concept.
What is tax equivalent yield?
Tax equivalent yield is the implied bond yield if you invest in any tax-free bond investments. The most popular of these is the tax-free municipal bonds. This metric can help you understand the real annual return of your bond investments after taking into account your tax situation.
Understanding how to interpret tax equivalent yields is crucial as they are the real return you will get from your bond investments.
Let’s say you need to decide whether to invest in a vanilla bond or a tax-free bond, both with a bond yield of 5% and a marginal tax rate of 20%. How do you know which is better? Even though both bonds have the same bond yield, the real bond yield is different due to taxation. The tax-free bond will give you a higher return since you do not need to pay tax on those returns. To understand more on this topic, check out our bond yield calculator, bond YTM calculator, and yield to maturity calculator.
Now, let's talk about the tax-equivalent yield calculation.
How to calculate tax equivalent yield?
To understand the tax free equivalent yield calculation, let's take Bond A with the following information as an example:
- Bond: Bond A
- Bond yield: 6%
- Marginal tax rate: 30%
You can calculate the tax equivalent yield in three steps:
-
Calculate the bond yield
The first step is to determine the
bond yieldof your bond investment. For our example, thebond yieldof Bond A is6%. -
Determine the marginal tax rate
The
marginal tax rateis the tax rate applied to the last dollar of your income. Themarginal tax ratein our example is30%. To understand more about taxation, check out our tax bracket calculator. -
Calculate the tax equivalent yield
The last step is to calculate the tax equivalent yield using the following formula:
tax equivalent yield = bond yield / (1 - marginal tax rate)For this example, the
tax equivalent yieldfor Bond A is6% / (1 - 30%) = 8.571%.
What is the tax equivalent yield if bond yield and marginal tax rate is 10%?
The tax equivalent yield will be 11.11%. You can calculate this metric using the tax equivalent yield formula below:
tax equivalent yield = bond yield / (1 - marginal tax rate)
How can I calculate the tax equivalent yield?
You can calculate the tax equivalent yield in three steps:
- Calculate the bond yield;
- Determine the marginal tax rate; and
- Apply the tax equivalent yield formula:
tax equivalent yield = bond yield / (1 - marginal tax rate).
Can the tax equivalent yield be negative?
Yes, the tax equivalent yield can be negative. Since the marginal tax rate can never be above 100%, this will only happen when the bond yield is negative.
What is bond yield?
Bond yield is rate of return for bond investors, given that the bond investors hold the bond until it matures and reinvest the coupons at an interest rate equal to the YTM.