q&a

August 31, 2008|By ANDREW LECKEY | ANDREW LECKEY,Tribune Media Services

Q. When investing in municipal bonds, how and why do you calculate the tax-equivalent yield?

- H.E., via the Internet

A. A municipal bond is a debt security issued by a state, municipality or county to finance its capital expenditures. It is exempt from federal taxes and from most state and local taxes.

The tax-equivalent yield is the pretax yield that a taxable bond needs for its yield to equal to that of a tax-free municipal bond.

"Munis usually make sense for investors in the 25 percent or higher tax brackets," said Mark Balasa, certified financial planner. "Below that, the advantage is marginal, and it almost never makes sense in the 15 percent bracket."

To compute the tax-equivalent yield, you take your tax bracket and subtract it from 1, Balasa said. For example, subtracting a 28 percent tax bracket from 1 results in 0.72.

In that example, a muni yielding 4 percent divided by 0.72 results in 5.56 percent. That means a muni yielding 4 percent is the equivalent of a taxable bond that yields 5.56 percent.

Andrew Leckey is a Tribune Media Services columnist. E-mail him at yourmoney@tribune.com.

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