A Look at Muni Bond Yields

Muni bond yields tend to be lower than for other bonds of similar quality because of the tax advantage you receive. These bonds typically do not require you to pay federal income tax on the interest payments you receive. Therefore, in order to make an apples-to-apples comparison, you must figure in the tax savings to the yield offered by a municipal bond. The recalculated yield is referred to as the tax equivalent yield (TEY) because it sets the after-tax yields on the same footing. The equation for tax equivalent yield is TEY = yield / (1 – tax rate). If you are in the 28 percent tax bracket and buy a 6 percent muni bond, the TEY is 8.33 percent. This means that you are just as well off buying a 6 percent muni as an 8.33 percent corporate bond.

You may notice that the higher the tax bracket you are in, the more advantage you get from buying muni bonds. This is why munis are often referred to as bonds for the rich. Some munis are tax exempt at the state level as well, so these offer an even greater advantage.  It is important that you make sure you are comparing similar interest rates when making investment decisions.

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