Because interest payments from municipal bonds are usually exempt from federal income tax, their after-tax rates of return are attractive if you're in a higher tax bracket—even though a tax-free bond usually has a lower yield than a taxable bond. For comparison purposes, you can determine your net (after-tax) yield from a taxable bond by subtracting the amount of yield from your marginal tax rate (based on your filing status).
Figuring Taxable Equivalent Yield
Figuring the taxable equivalent yield of a municipal bond is the first step in deciding whether to buy it.
For example, if a municipal bond is offered at a yield of 6% and you are in the 30% bracket, do the following:
- Convert your tax bracket to a decimal, or 0.30.
- The taxable equivalent yield is 6 divided by (1 - .30) = 6 ÷ .70 = 8.57.
To match the 6% tax-free yield, you'd need a taxable bond paying at least 8.57%.
Useful Resource: SIFMA offers a Tax Year Tax-Exempt Taxable Yield Equivalent Chart on its Web site.
|
