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Taxable equivalent yields of Municipal Bonds in rising interest rate environment

06.28.2022 |BY

For our clients that reside in states with high personal income tax rates such as California municipal bonds appear particularly attractive in the current market with tax equivalent yields at levels that have not been seen for some time. Tax equivalent yield is the pretax yield a taxable bond needs to possess for its yield to be equal to that of a tax-free municipal bond.

The tax equivalent yields on high grade municipal bonds now range between 3.5% to over 6% which reflects a top marginal tax rate of 40.8% (including the 3.8% net investment income tax). If state income taxes are taken into consideration, the tax equivalent yields can range from 4% to 6.8% on average.

See this example:
A 3% AA municipal bond with a 10-year maturity has a tax equivalent yield of 6.67% given a top marginal rate of 40.8%. California residents are subject to a 54.1% top marginal rate ( 37% + 3.8% + 13%). Comparing the interest rates on high quality 10-year corporate bonds which are yielding approximately 4.7% could make the municipal bonds a compelling suggestion for investors in the top tax brackets.

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