The Tax Exempt Yield Calculator is a financial tool designed to help investors compare the yields of tax-exempt securities with those of taxable investments. By inputting the tax-exempt yield and your marginal tax rate, the calculator computes the tax-equivalent yield (TEY). This allows investors to understand how much a taxable investment would need to yield to match the after-tax return of a tax-exempt investment. This comparison is crucial for making informed investment decisions and maximizing returns.
Formula of Tax Exempt Yield Calculator
The formula to calculate the tax-equivalent yield (TEY) of a tax-exempt investment, like a municipal bond, is:
Here’s what each part of the formula means:
- TEY: This is the tax-equivalent yield. Which represents the yield a taxable investment would need to generate to provide the same after-tax return as the tax-exempt investment.
- Tax-exempt yield: This is the annual interest rate offered by the tax-exempt security.
- Marginal tax rate: This is your federal income tax bracket expressed as a decimal. For example, if you are in the 25% tax bracket, your marginal tax rate would be 0.25.
Understanding and applying this formula helps investors make better financial decisions by accurately comparing tax-exempt and taxable investment yields.
Table for General Terms
To make it easier for you. Here is a table of pre-calculated tax-equivalent yields for various marginal tax rates and tax-exempt yields:
| Tax-Exempt Yield (%) | 10% Tax Rate | 22% Tax Rate | 24% Tax Rate | 32% Tax Rate | 37% Tax Rate |
|---|---|---|---|---|---|
| 2.0 | 2.22 | 2.56 | 2.63 | 2.94 | 3.17 |
| 3.0 | 3.33 | 3.85 | 3.95 | 4.41 | 4.76 |
| 4.0 | 4.44 | 5.13 | 5.26 | 5.88 | 6.35 |
| 5.0 | 5.56 | 6.41 | 6.58 | 7.35 | 7.94 |
Example of Tax Exempt Yield Calculator
Let’s consider an example to illustrate how the Tax Exempt Yield Calculator works. Suppose you are in the 32% federal income tax bracket and you are considering investing in a municipal bond that offers a tax-exempt yield of 4%.
Using the formula:
TEY = 4% / (1 – 0.32) TEY = 4% / 0.68 TEY ≈ 5.88%
This means that a taxable investment would need to yield approximately 5.88% to provide the same after-tax return as the 4% tax-exempt yield from the municipal bond. This calculation helps you compare different investment options and choose the one that maximizes your returns after taxes.
Most Common FAQs
The tax-equivalent yield (TEY) is the yield that a taxable investment would need to generate in order to provide the same after-tax return as a tax-exempt investment. It helps investors compare the value of taxable and tax-exempt investments.
To use the Tax Exempt Yield Calculator, you need to input the tax-exempt yield of the investment and your marginal tax rate. The calculator will then compute the tax-equivalent yield, allowing you to compare it with the yields of taxable investments.
The tax-equivalent yield is important because it helps investors make informed decisions by comparing the true value of tax-exempt and taxable investments. This ensures that they can maximize their after-tax returns and choose the best investment options.