Tax-Equivalent Yield (TEY)

Tax-equivalent yield, often abbreviated TEY, is a straightforward but essential calculation for any family weighing municipal bonds against taxable alternatives such as corporate bonds or Treasuries. The math converts a tax-exempt yield into comparable taxable terms: divide the municipal yield by one minus the investor's marginal tax rate. The result tells you how high a taxable bond's yield would need to be to deliver the same dollars after taxes.

The concept matters most to families in higher tax brackets. At lower tax rates, the TEY advantage of municipals narrows considerably and may not justify any other trade-offs, such as lower liquidity or credit complexity, that munis can carry. A hypothetical founder who recently sold a business and faces an unusually high income year might find the TEY calculation particularly revealing when designing a transitional fixed-income sleeve.

A common error is running the TEY calculation using only the federal rate and ignoring state and local taxes, which can meaningfully shift the result. Another is applying a single rate uniformly when a family's actual marginal rate varies by income type or jurisdiction. The calculation is also dynamic: as tax laws change, the relative attractiveness of tax-exempt income shifts. Families should work with a CPA to apply their actual blended rate, and should revisit the analysis whenever their tax situation changes. See also general obligation bonds and revenue bonds.