If you're comparing municipal bonds with other fixed income investments, understanding Tax Equivalent Yield (TEY) is essential. It helps investors assess the true return on tax-free bonds—like municipal bonds—by translating them into a taxable equivalent. This guide breaks down what TEY is, how it’s calculated, and how to use it effectively when evaluating investments in 2025.
What Is Tax Equivalent Yield?
Tax Equivalent Yield (TEY) is the pre-tax yield that a taxable bond must offer to equal the after-tax yield of a tax-free investment, usually a municipal bond.
Municipal bonds are often exempt from federal income taxes, and in some cases, state and local taxes as well. TEY allows investors to compare apples to apples by determining what a taxable bond would need to yield to match the tax-free return.
Example:
If a municipal bond yields 3.5% and you're in the 32% federal tax bracket, a taxable bond would need to yield about 5.15% to offer the same after-tax return.
Why Tax Equivalent Yield Matters in 2025
With interest rates fluctuating and taxes potentially increasing, TEY is more important than ever:
Municipal bonds may seem to underperform—until you factor in tax savings.
High earners benefit more from tax-exempt income.
Bond ETFs, CDs, Treasuries, and corporate bonds are all taxable, and may offer higher yields on paper, but not after taxes.
According to a 2024 Fidelity Investor Survey, 72% of investors in the 32%+ tax bracket misjudge muni bonds’ competitiveness because they fail to factor in TEY.
How to Calculate Tax Equivalent Yield
Basic Formula (Federal Taxes Only):
TEY = Tax-Free Yield / (1 - Marginal Tax Rate)
Where:
Tax-Free Yield = the stated yield of the municipal bond
Marginal Tax Rate = your federal income tax bracket (as a decimal)
Example:
Let’s say:
Tax-free muni bond yield = 3.5%
Federal tax bracket = 32%
Then:TEY = 0.035 / (1 - 0.32) = 0.035 / 0.68 = 5.15%
That means a taxable bond must yield 5.15% to match a 3.5% tax-free municipal bond.
Federal + State Tax Equivalent Yield
In many cases, muni bonds are exempt from state income tax, especially if you buy them in your home state. To account for this, you can use an expanded version of the formula:
Expanded Formula:
TEY = Tax-Free Yield / [1 - (Fed Tax Rate + State Tax Rate - (Fed Rate x State Rate))]
This adjusts for the combined marginal tax rate.
Example with State Tax:
Federal rate = 32%
State rate = 6%
Muni bond yield = 3.5%
Combined tax rate = 32% + 6% - (0.32 × 0.06) = 0.32 + 0.06 - 0.0192 = 36.08%
TEY = 0.035 / (1 - 0.3608) = 0.035 / 0.6392 = 5.48%
So factoring in both taxes, the taxable bond would need to yield 5.48% to match the muni.
Chart: Tax Equivalent Yields by Tax Bracket (2025)
| Tax-Free Yield | 24% Bracket | 32% Bracket | 37% Bracket |
|---|---|---|---|
| 3.0% | 3.95% | 4.41% | 4.76% |
| 3.5% | 4.61% | 5.15% | 5.56% |
| 4.0% | 5.26% | 5.88% | 6.35% |
| 4.5% | 5.92% | 6.62% | 7.14% |
| 5.0% | 6.58% | 7.35% | 7.94% |
Note: This assumes no state taxes. Actual results may vary depending on your jurisdiction.
When TEY Helps Investors
1. Comparing Muni Bonds to CDs or Treasury Bonds
If a muni bond yields 3.5% and a 5-year Treasury yields 4.6%, which is better?
If you’re in a 37% bracket:
TEY = 3.5% / (1 - 0.37) = 5.56%
So even though the Treasury bond yields more on paper, the muni bond is better after tax.
2. Assessing Municipal Bond ETFs
Many municipal bond ETFs (e.g., VTEB, MUB, TFI) yield 3%–4% tax-free. TEY helps determine whether they beat taxable bond ETFs (e.g., AGG, BND) after taxes.
3. Deciding on Asset Location (IRA vs Taxable Account)
Use TEY to determine which bonds belong in taxable vs. tax-deferred accounts:
Muni bonds: best in taxable accounts
Taxable bonds: best in IRAs, 401(k)s
Common Mistakes When Using TEY
1. Using Effective Rate Instead of Marginal Tax Rate
Always use your marginal rate, not your average or effective rate.
2. Ignoring AMT (Alternative Minimum Tax)
Some municipal bonds (especially private activity bonds) are subject to AMT.
These may not be fully tax-free for high-income investors.
3. Not Accounting for State or Local Tax Treatment
State tax rates can make a major difference, especially in high-tax states like California, New York, and New Jersey.
Expert Insight
Christine Benz, Morningstar:“TEY is one of the most overlooked calculations among DIY investors. It’s essential for anyone comparing muni yields to CDs, Treasuries, or bond funds.”
Rick Ferri, CFA:“Municipal bonds can be extremely competitive—especially for those in high tax brackets. TEY helps put that in clear perspective.”
Vanguard Fixed Income Research (2024):
In the 32%+ tax bracket, muni bonds outperformed comparable corporate bonds 65% of the time on an after-tax basis between 2010 and 2023.
Pros and Cons of Relying on TEY
Pros:
Standardizes comparisons
Helps uncover hidden value in municipal bonds
Encourages tax-efficient investing
Cons:
Assumes tax rates stay constant (which may not be true)
Doesn’t account for total return (just income)
May not apply if muni bond is subject to AMT
Conclusion: Is TEY Useful in 2025?
Absolutely. In a year when tax rates are under political scrutiny and interest rates remain unpredictable, understanding TEY is a must for any fixed income investor—especially retirees and high-net-worth individuals.
Use TEY to:
Compare municipal bonds to taxable fixed-income options
Decide where to hold bonds in your asset location strategy
Optimize after-tax income in your portfolio
And remember: what matters most is not what you earn—but what you keep.