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Definition of 'Tax-Equivalent Yield'
The pretax yield that a taxable bond needs to possess for its yield to be equal to that of a tax-free municipal bond. This calculation can be used to fairly compare the yield of a tax-free bond to that of a taxable bond in order to see which bond has a higher applicable yield.
Also known as "after-tax yield."
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Investopedia explains 'Tax-Equivalent Yield'
For example, if a tax-free bond has a yield of 20% and the tax rate is 10%, a taxable bond would need a pretax yield of 22.2% (20% / 90%) in order to be considered an equivalent investment. Therefore, all bonds with the same risk but with a pretax yield of less than 22.2% should be considered inferior investments compared to the 20% municipal bond.
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These instruments may shed their bad rap to bring you a hefty tax break.
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Investing in these bonds may offer a tax-free income stream but they are not without risks.
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Interest may not be tax-exempt for seniors with Medicare or Social Security benefits.
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