Question

A married couple from California is in the 31% Federal tax bracket and the 8% California tax bracket. They are considering a 5¼% Hawaii municipal bond (Federal tax-free), a 5% California bond (double tax-free) or a 7¾% corporate bond (fully-taxable). Which bond offers the highest after-tax interest rate?

Answer 1

We need to calculate equivalent post-tax returns on all three bonds.

For Hawaii, they need to pay the state tax. Post-tax Return = 5.25% x (1 - 8%) = 4.83%

For California, no tax, Post-tax return = 5.00%

For corporate bond, Post-tax return = 7.75% x (1 - 31% - 8%) = 4.73%

Hence, the California bond offers the best after-tax rate.