Joseph Gotelli, Senior Portfolio Manager at American Century Investments, has authored an article explaining taxable-equivalent yield and the insights it offers investors.
Gotelli’s How Do Municipal Bond Yields Compare to Taxable Bond Yields? is a reminder that calculating taxable-equivalent yield highlights the tax-savings benefits of municipal bonds. Taxable-equivalent yield indicates the yield a taxable bond would have to generate to “equal” a municipal bond’s tax-free yield.
Yields on traditional core bonds are taxable, while yields on most municipal bonds are tax-free. Taxable-equivalent yields put municipal bond and taxable bond yields on an even playing field, enabling investors to compare their choices.
To calculate a municipal bond’s taxable-equivalent yield, use this equation:
For example, a 3% yield on a tax-free municipal bond is equivalent to earning a 4.16% taxable yield for an investor in the 27.8%[i] tax bracket (.03/(1-0.278)). Therefore, a municipal bond with a tax-free yield of 3% may offer more value than a taxable bond yielding 4% for this investor.
Investors in higher tax brackets typically realize larger tax advantages from municipal bonds. However, Gotelli notes that investors paying lower tax rates also can benefit from today’s tax-exempt yields.
The article’s accompanying table demonstrates this, calculating tax-equivalent yields based on a range of tax rates and tax-free yields. Additionally, American Century Investments’ interactive calculator allows investors to compare different yield, income, and tax-status scenarios.
Investors subject to high state and local tax rates may find municipal bonds to be even more attractive. For example, the combined federal and state marginal tax rate for a married couple in California earning $600,000 annually is 51.1%. For investors in this situation, a 3% municipal bond yield has a taxable-equivalent yield of 6.13%.
Along with their potential tax benefits, investment-grade municipal bonds also tend to have higher credit quality than credit-sensitive taxable bonds. That is, investors may have to accept higher credit risk on taxable bonds to match the taxable-equivalent yield of high-quality municipal securities.
WEBCAST – Munis 101: A Crash Course on Current Conditions
As we head into the final stretch of 2025, we’re sharpening our pencils and examining muni market conditions. While municipal bonds have underperformed other fixed-income securities year to date, compelling opportunities have emerged.
Join us for a seasonal deep dive into the muni market, where we’ll:
- Highlight areas of attractive relative value and why we’re studying them closely.
- Explain how fundamentals and technicals (supply and demand) are defining our fourth-quarter syllabus.
- Outline trends, opportunities and headwinds in key sectors, including higher education.
- Present potential outcomes as we move toward the muni market’s next chapter.
Accepted for 1 CFP® / IWI / CFA CE Credit
[i] Includes a 3.8% Net Investment Income Tax
This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.
IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments’ portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
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