Tax-Equivalent Yield

Tax-equivalent yield lets you compare a tax-free investment, such as a municipal bond, against a taxable one on a fair basis. It calculates the yield a taxable bond would need to offer to match the after-tax return of the tax-free bond, given your tax rate. Because a tax-free yield is worth more than the same headline yield on a taxable bond, this conversion is the only honest way to compare the two.

Because you keep all of a tax-free bond's yield but only the after-tax portion of a taxable bond's yield. For someone in a high tax bracket, a modest tax-free yield can deliver more spendable income than a higher taxable yield once tax is deducted. The higher your tax rate, the more valuable tax-free income becomes - which is why municipal bonds appeal most to higher earners.

Yes, decisively. The higher your marginal tax rate, the higher the equivalent taxable yield needed to match a tax-free bond, so tax-free investments become relatively more attractive. For someone in a low bracket, the advantage shrinks and a taxable bond may win. This is why the same two bonds can be the right or wrong choice for different people depending purely on their tax situation.

No. It is an educational comparison based on the yields and tax rate you enter. Real tax treatment of different bonds can be nuanced - some may be subject to certain taxes and not others - and rules vary by jurisdiction. Use it to compare on a like-for-like basis, and consult a tax professional for decisions specific to your circumstances.