How do you know if a corporate bond fund is a better investment than a treasury bond, or a municipal bond?

The answer depends on your income, your federal and state tax rates, and your state’s tax laws. We have built this tax equivalent yield calculator to help you quickly determine which type of fixed income investment will provide you with the highest after-tax return.

 

Tax Equivalent Yield Calculator

This calculator currently uses the 2019 Federal Tax Brackets. All states 2018 tax rates are used with the exception of Iowa, which has new rates for 2019. I can’t promise to keep up with the changes of all state tax brackets – So if you see that your state’s tax bracket is incorrect, please let us know.

We also have a video walkthrough of how to use the calculator further down the page.

The embedded calculator below is fully interactive, start by selecting your state and entering your income in the fields below:

How to Use the Tax Equivalent Yield Calculator

For an example, let’s assume you live in California, and have a taxable income of $100,000. When you are looking at fixed income investments, you have a few choices.  You have the option of a corporate bond ETF, a treasury bond ETF, a national municipal bond fund, or a municipal bond fund that only holds muni bonds issued from your state. How do you determine which investment has the high tax-adjusted yield?

To start, here is a the latest yield from the Vanguard funds:

Vanguard’s intermediate term corporate ETF (Ticker symbol: VCIT) currently has a yield of 4.29%:

While Vanguard’s intermediate term treasury bond ETF has a yield of 2.63%:

Vanguard’s municipal bond ETF (which holds muni bonds from every state), which currently yields 2.64%:

And lastly, Vanguard’s California municipal bond fund gas a yield of 2.71%:

Since corporate bonds typically have higher interest rates, they must have higher after tax returns right? Not necessarily. In fact, the answer differs from person to person depending on their federal tax bracket and state of residence.

This is because different bonds are taxed at different rates.

• Corporate bonds (along with bank CDs, high yield savings accounts, etc.) are taxed by the IRS (internal revenue service) at the federal level, AND at your state’s level (if they have a personal income tax).
• Treasury bonds are not taxed by states. So although you will still pay the federal tax rate, if you are in a state with very high state income taxes, treasury bonds could give you a nice tax break.
• Municipal bonds are not taxed by the federal government, and typically IF they are offered by your home state, they are not taxed at the state level either.

 

So for our California resident who makes $100,000, they would input their state of residence and income. The calculator will automatically calculate your federal and state tax rates.

Then, you want to select a type of bond for comparison, and enter the yield. So, let’s type in corporate bond, and 4.29% in the calculator:

 

The calculator tells us that to produce the same after tax return of a 4.29% yielding corporate bond, a treasury bond fund would need to have a yield of 3.85% or higher,  a municipal bond fund (which will hold mostly out of state muni bonds) needs a yield of 3.26% or higher, and a fund that holds just California municipal bonds would need a yield of 3.0% in order to have an equivalent after-tax return for the investor.

So based on these numbers, Vanguard’s corporate bond fund will have the highest tax-adjusted return.

Video – Walk-through of Using a Tax Equivalent Calculator

What to Consider When Finding Tax Equivalent Yield

Of course, not all bond funds are the same. Vanguard’s corporate bond fund has 52% of its assets invested in corporate bonds with a Baa credit rating. That is the lowest rating before bonds fall into the “Junk” or high yield territory. Comparing these types of bonds with risk-free treasury bonds is not a fair comparison, since the corporate bonds also have a lot higher risk, so investors should be rewarded with a higher interest rate. Likewise, muni bonds also carry a certain credit risk that should be considered before investing.

Also worth considering is a bond fund’s duration – that is, whether the bond fund holds short term bonds (which have a short duration) or long term bonds (which have a long duration).

The funds compared below are not identical, but within about a year. But comparing a long term corporate bond fund with a short term treasury bond is not a fair comparison.