A tax-free bond offering 5.5% and a taxable fixed deposit offering 7.5% look like an easy choice at first glance. The FD wins, right? Not necessarily.
For an investor in the 30% tax bracket, the FD’s after-tax yield is only 5.25%. The tax-free bond’s 5.5% stays at 5.5% because there is no tax on the interest. In this case, the tax-free instrument is actually the better deal, even though its nominal yield is lower.
This is exactly what Tax-Equivalent Yield (TEY) measures. It converts a tax-free yield into the equivalent pre-tax yield that a taxable instrument would need to offer to match it, after accounting for the investor’s tax bracket. It makes the comparison fair and accurate.
For CFP exam candidates in India, TEY is a practical tool tested under Investment Planning (Module 4) and Tax Planning. It sits at the intersection of fixed income analysis and tax efficiency, which makes it directly applicable to advising real clients on debt portfolio construction.
1. What Is Tax-Equivalent Yield?
Tax-Equivalent Yield (TEY) is the pre-tax yield that a taxable fixed-income investment must offer to deliver the same after-tax return as a tax-free investment. It is the benchmark that puts tax-free and taxable instruments on an equal footing for comparison.
The tax-equivalent yield of a tax-free instrument is the effective pre-tax yield that you would need to earn to equal the tax-free yield on that instrument. It is critical to make this calculation so that you are getting the highest after-tax return on your money.
In simpler terms: TEY answers the question, “What taxable yield do I need to match what I am already getting tax-free?”
If a tax-free bond offers 5.5% and an investor’s TEY calculation shows that a taxable instrument would need to offer 7.86% to match it (for a 30% bracket investor), then any taxable bond yielding below 7.86% is inferior on an after-tax basis, even if its nominal yield appears higher.
This concept is tested in the CFP exam through scenario-based questions where candidates must compare two investment options and determine which offers a better after-tax outcome.
2. Why TEY Exists and Why It Matters
Fixed-income investing in India involves a wide spectrum of instruments with different tax treatments. Some instruments, such as PPF and tax-free bonds, deliver interest that is fully exempt from income tax. Others, such as fixed deposits, RBI Floating Rate Savings Bonds, and corporate bonds, deliver interest that is fully taxable at the investor’s slab rate.
Without a standardised comparison tool, an investor looking at a 5.5% tax-free bond and a 7.5% FD is comparing two numbers that are not in the same category. One is post-tax; the other is pre-tax. Comparing them directly leads to the wrong decision.
TEY solves this by answering: “If the tax-free bond gives me 5.5% in hand, what taxable yield would give me the same?” The answer depends entirely on the investor’s tax bracket. This is why the same tax-free bond can be highly attractive for a 30% bracket investor but relatively unattractive for someone in the 5% bracket.
TEY makes tax efficiency visible and quantifiable, which is exactly what a financial planner needs when constructing a client’s debt portfolio.
3. The TEY Formula
The standard Tax-Equivalent Yield formula is:
TEY = Tax-Free Yield / (1 - Marginal Tax Rate)Where:
- Tax-Free Yield: the yield on the tax-exempt instrument (as a decimal or percentage)
- Marginal Tax Rate: the investor’s applicable income tax rate, expressed as a decimal
This formula gives the pre-tax yield a taxable instrument must offer to match the tax-free instrument on an after-tax basis.
Tax-equivalent yield equals the municipal bond yield divided by the difference of 1 minus the total tax rate. For example, if you pay tax at 30% and a tax-free instrument offers 3%, the tax-equivalent yield is 3 divided by 0.70, which is 4.28%. A taxable bond would need to pay more than 4.28% before you would earn more after-tax than with the 3% tax-free instrument.
The logic applies equally to India’s tax-free instruments. Substitute the relevant Indian tax rate and yield, and the formula works identically.
4. The Reverse Calculation: After-Tax Yield
TEY works in both directions. The reverse calculation converts a taxable yield into its after-tax equivalent for comparison with a tax-free instrument:
After-Tax Yield (of taxable instrument) = Taxable Yield x (1 - Marginal Tax Rate)This is useful when comparing from the other side: “What does my FD actually earn me after tax?”
If an FD offers 7.5% and the investor is in the 30% bracket:
After-Tax Yield = 7.5% x (1 - 0.30) = 5.25%Now compare this 5.25% directly against the tax-free yield of 5.5%. The tax-free instrument wins for this investor, despite having a lower headline rate.
Both the TEY formula and the after-tax yield formula serve the same purpose: creating an apples-to-apples comparison between instruments with different tax treatments.
5. India’s Tax Bracket Structure for FY 2025-26
TEY calculations in India depend on the investor’s marginal tax rate, which varies significantly based on income level and the chosen tax regime.
New Tax Regime (Default for FY 2025-26):
Under the New Tax Regime for FY 2025-26: income up to Rs 4 lakh is nil, Rs 4 to 8 lakh is taxed at 5%, Rs 8 to 12 lakh at 10%, Rs 12 to 16 lakh at 15%, Rs 16 to 20 lakh at 20%, Rs 20 to 24 lakh at 25%, and income above Rs 24 lakh is taxed at 30%.
In the Union Budget 2026-27, Finance Minister Nirmala Sitharaman announced no changes to the personal income tax slabs and rates for both the new and old tax regimes.
Old Tax Regime (Optional): Income up to Rs 2.5 lakh: nil. Rs 2.5 to 5 lakh: 5%. Rs 5 to 10 lakh: 20%. Above Rs 10 lakh: 30%.
Health and Education Cess: A 4% Health and Education Cess is levied on the total income tax including surcharge.
This means the effective marginal tax rate for a 30% bracket investor is: 30% + (4% of 30%) = 31.2%
For TEY calculations, it is standard practice to use the base slab rate (30%) unless the question specifically requires cess and surcharge inclusion. The CFP exam typically specifies whether to include cess. Where not specified, use the base rate.
6. TEY for Different Investor Brackets: A Full View
Since TEY is bracket-dependent, the same tax-free instrument has a different TEY for every investor. This table shows how TEY changes for a tax-free instrument yielding 5.5%, across all applicable brackets under the new regime:
| Tax Bracket | Tax Rate (incl. 4% cess) | TEY at 5.5% Tax-Free Yield |
|---|---|---|
| 5% slab | 5.2% | 5.80% |
| 10% slab | 10.4% | 6.14% |
| 15% slab | 15.6% | 6.52% |
| 20% slab | 20.8% | 6.94% |
| 25% slab | 26.0% | 7.43% |
| 30% slab | 31.2% | 7.99% |
The key insight from this table is clear. For an investor in the 5% bracket, a taxable instrument only needs to yield 5.80% to beat the 5.5% tax-free instrument. That is an easy threshold to cross. But for a 30% bracket investor, a taxable instrument must yield nearly 8% to match the same 5.5% tax-free yield. That is a much harder bar to clear, which is why tax-free instruments are most valuable for high-income investors.
7. Tax-Free Instruments in India and Their Current Yields
Tax-Free Bonds (Secondary Market):
The government of India stopped issuing fresh tax-free bonds after 2016. No new tax-free bonds from NHAI, REC, or PFC have been issued since 2016. Available bonds can only be purchased in the secondary market on NSE or BSE, subject to market availability.
Most tax-free bonds currently trade at a 15 to 20% premium in the secondary market, reducing their yield to maturity (YTM) to approximately 5 to 5.5%.
Despite the lower YTM compared to their original coupon rates, these bonds remain attractive for investors in the 30% bracket because the interest income is fully exempt from tax under Section 10(15)(iv)(h) of the Income Tax Act.
Key issuers of tax-free bonds in India include NHAI (National Highways Authority of India), REC (Rural Electrification Corporation), PFC (Power Finance Corporation), IRFC (Indian Railway Finance Corporation), and HUDCO (Housing and Urban Development Corporation). Both REC and NHAI bonds are AAA-rated, offering tax-free interest with similar safety.
Public Provident Fund (PPF):
PPF currently earns 7.1% per annum, fully exempt from tax at all three stages: investment, accumulation, and withdrawal (EEE status). For TEY purposes, the relevant yield is 7.1% because no tax is payable at any point. However, PPF has a 15-year lock-in, which limits its use as a liquid income instrument.
Sovereign Gold Bonds (SGBs) at Maturity:
Capital gains on SGB redemption at maturity (8 years) are fully exempt from tax. The 2.5% annual interest component is taxable at slab rate. For TEY purposes, only the capital appreciation component qualifies for the tax-free treatment, making the calculation more nuanced than a straightforward bond comparison.
8. Taxable Instruments in India: The Comparison Side
For TEY to be useful, there must be taxable alternatives to compare against. The primary taxable fixed-income instruments in India for FY 2025-26 include:
Fixed Deposits: Leading banks currently offer 6.5 to 7.5% on 1 to 3 year FDs. Interest is fully taxable at slab rate.
RBI Floating Rate Savings Bonds: Currently offering 8.05% per annum (linked to NSC rate plus 35 basis points). Interest is fully taxable at slab rate. These are government-backed and carry zero credit risk, making them one of the most relevant benchmarks for TEY comparison.
Corporate Bonds and NCDs: Vary widely by credit rating and tenure. AAA-rated corporate bonds typically offer 7.5 to 9% for medium tenures. Interest is taxable at slab rate.
Government Securities (G-Secs): 10-year G-Sec yield is approximately 6.5 to 6.8% as of April 2026, reflecting the RBI’s rate-easing cycle. Interest is taxable at slab rate.
Debt Mutual Funds (post April 2023): Earning 7 to 8% nominally, but all gains taxed at slab rate regardless of holding period. Effectively treated the same as FDs for tax purposes for new investments.
9. Worked Examples with Indian Context
Example 1: Tax-Free Bond vs RBI Floating Rate Bond
Ananya is a salaried professional with an annual income of Rs 28 lakh. Her marginal tax rate under the new regime is 30% (plus 4% cess = 31.2% effective).
She is comparing two instruments:
- Option A: Tax-free bond (NHAI, AAA-rated) available in secondary market at a YTM of 5.5%
- Option B: RBI Floating Rate Savings Bond at 8.05% (fully taxable)
TEY of Option A:
TEY = 5.5% / (1 - 0.30) = 5.5% / 0.70 = 7.86%(Using base 30% rate as is standard for exam purposes)
After-Tax Yield of Option B:
After-Tax Yield = 8.05% x (1 - 0.30) = 5.635%Conclusion: The RBI bond’s after-tax yield of 5.635% exceeds the tax-free bond’s 5.5%, and its TEY of 8.05% exceeds the required TEY of 7.86%. For Ananya, the RBI bond is marginally better after tax, despite both instruments carrying sovereign-grade safety.
However, if cess is included (effective rate 31.2%):
TEY = 5.5% / (1 - 0.312) = 5.5% / 0.688 = 7.99%The RBI bond at 8.05% still clears this threshold, but only barely. This illustrates how sensitive the TEY comparison is to the precise tax rate used.
Example 2: Tax-Free Bond vs Fixed Deposit
Ramesh earns Rs 35 lakh per annum and is in the 30% tax bracket. He compares:
- Option A: Tax-free bond with YTM of 5.5%
- Option B: SBI FD at 7.0%
TEY of Option A:
TEY = 5.5% / (1 - 0.30) = 7.86%After-Tax Yield of Option B (FD):
After-Tax Yield = 7.0% x (1 - 0.30) = 4.9%Conclusion: The tax-free bond’s after-tax yield of 5.5% is higher than the FD’s after-tax yield of 4.9%. The FD would need to offer at least 7.86% to match the tax-free bond. At 7%, it falls short.
For Ramesh, the tax-free bond is the better choice despite having a lower headline yield.
Example 3: Investor in 10% Tax Bracket
Priya is a freelancer with income of Rs 9 lakh. Her marginal tax rate under the new regime is 10%.
Same comparison: Tax-free bond at 5.5% vs FD at 7.0%.
TEY of Tax-Free Bond for Priya:
TEY = 5.5% / (1 - 0.10) = 5.5% / 0.90 = 6.11%After-Tax Yield of FD:
After-Tax Yield = 7.0% x (1 - 0.10) = 6.3%Conclusion: For Priya, the FD’s after-tax yield of 6.3% is higher than the tax-free bond’s 5.5%. The tax-free bond’s TEY of 6.11% is below the FD’s 7%, meaning the FD is the better choice for a 10% bracket investor.
This example makes a critical point: tax-free instruments are not automatically superior. Their advantage grows with the investor’s tax bracket. For lower-bracket investors, taxable instruments with higher nominal yields can be the better choice.
10. TEY with Surcharge: High-Income Investors
For investors with income exceeding Rs 50 lakh, surcharge applies on top of the base tax rate and cess. Under the new regime:
- Rs 50 lakh to Rs 1 crore income: 10% surcharge on income tax
- Rs 1 crore to Rs 2 crore income: 15% surcharge
- Above Rs 2 crore income: 25% surcharge (capped under new regime)
Under the old tax regime, the surcharge rate was as high as 37%, which resulted in an effective tax rate of 42.74% for individuals in the highest income tax slab of 30%.
For a very high-income investor facing a 42.74% effective tax rate (old regime):
TEY of 5.5% tax-free bond = 5.5% / (1 - 0.4274) = 5.5% / 0.5726 = 9.61%A taxable instrument would need to offer 9.61% to match a 5.5% tax-free bond for this investor. That is a very high bar in the current interest rate environment. For ultra-high-income investors, tax-free bonds become exceptionally attractive even at seemingly low yields.
11. TEY and the PPF: A Special Case
PPF earns 7.1% per annum with EEE tax status. For TEY purposes, the calculation is straightforward:
TEY of PPF for 30% bracket investor:
TEY = 7.1% / (1 - 0.30) = 10.14%A taxable instrument would need to offer 10.14% per annum to match PPF’s after-tax return for a 30% bracket investor. That is exceptionally high by any fixed-income standard in India’s current environment, which explains why PPF remains one of the most recommended instruments for high-income savers who can use the old tax regime and claim the Section 80C deduction.
However, PPF’s TEY advantage must be weighed against its 15-year lock-in period and the annual investment limit of Rs 1.5 lakh. It is not a complete solution for large-scale fixed-income allocation. The TEY analysis must always be paired with a liquidity and tenure assessment.
12. Limitations of Tax-Equivalent Yield
TEY is a useful tool but it has specific limitations that a financial planner must keep in mind.
TEY ignores tenure and liquidity: A tax-free bond with a 10-year residual maturity and a 3-year FD cannot be compared purely on TEY. The investor’s liquidity needs and tenure preferences matter independently of yield.
TEY ignores credit risk: A tax-free bond from a government-backed entity and a corporate NCD from a lower-rated issuer may have different TEYs, but the NCD carries higher credit risk. Yield comparison must always be accompanied by a credit risk assessment.
TEY ignores reinvestment risk: TEY assumes the tax-free yield will persist. In practice, if a tax-free bond matures or is sold and rates have changed, the reinvestment yield may differ.
TEY does not account for capital gains: While interest on tax-free bonds is exempt, selling bonds before maturity triggers capital gains tax. Short-term gains under 12 months are taxed at slab rate, and long-term gains above 12 months are taxed at 12.5%. A TEY comparison based only on interest yield overlooks the tax cost of an early exit.
TEY assumes a static tax bracket: If an investor’s income changes, their marginal tax rate changes, and so does the TEY of every tax-free instrument in their portfolio.
13. TEY in Portfolio Construction and Financial Planning
For a CFP professional, TEY is a practical tool in two specific planning situations.
The first is debt portfolio construction for high-income clients. When a client in the 30% bracket has surplus funds to allocate to fixed income, TEY analysis quickly identifies whether tax-free bonds, PPF, or taxable instruments offer the best risk-adjusted, after-tax return for the client’s specific tenure and liquidity needs.
The second is tax regime comparison. Under the old tax regime, many deductions are available including PPF’s Section 80C benefit, which effectively enhances its TEY further by reducing taxable income upfront. Under the new tax regime, Section 80C deductions are not available, which changes the PPF’s effective TEY for clients who have switched regimes.
A financial planner building a debt allocation recommendation must always run the TEY calculation for the specific client’s tax bracket and regime before finalising the instrument mix.
14. Comparison Table: Tax-Free vs Taxable Instruments India (2026)
| Instrument | Nominal Yield | Tax Treatment | After-Tax Yield (30% bracket) | TEY Required to Match |
|---|---|---|---|---|
| Tax-Free Bond (secondary) | 5 to 5.5% YTM | Interest fully exempt | 5 to 5.5% | 7.14 to 7.86% |
| PPF | 7.1% | EEE: fully exempt | 7.1% | 10.14% |
| RBI FRS Bond | 8.05% | Fully taxable at slab | 5.635% | N/A (taxable) |
| SBI FD (1-3 yr) | 6.5 to 7.5% | Fully taxable at slab | 4.55 to 5.25% | N/A (taxable) |
| G-Sec (10-yr) | 6.5 to 6.8% | Fully taxable at slab | 4.55 to 4.76% | N/A (taxable) |
| AAA Corporate Bond | 7.5 to 9% | Fully taxable at slab | 5.25 to 6.3% | N/A (taxable) |
| Debt MF (post 2023) | 7 to 8% | Slab rate (no LTCG) | 4.9 to 5.6% | N/A (taxable) |
15. Key Exam Points
- TEY Formula: Tax-Free Yield divided by (1 minus Marginal Tax Rate). This is the pre-tax yield a taxable instrument must match.
- Reverse Formula (After-Tax Yield): Taxable Yield multiplied by (1 minus Tax Rate). Converts a taxable yield into its post-tax equivalent for direct comparison.
- TEY is bracket-specific. The same tax-free instrument has a different TEY for every investor depending on their marginal tax rate.
- Under the new tax regime for FY 2025-26, the 30% rate applies to income above Rs 24 lakh. Income between Rs 20 and 24 lakh is taxed at 25%. Budget 2026-27 made no changes to these rates.
- Tax-free bonds in India are no longer issued in the primary market. No new issuances have occurred since 2016. Bonds are available only in the secondary market, often at 15 to 20% premium, reducing YTM to approximately 5 to 5.5%.
- PPF’s TEY for a 30% bracket investor equals 10.14%. A taxable instrument would need this yield to match PPF on an after-tax basis.
- For very high-income investors under the old tax regime with 37% surcharge, the effective tax rate can reach 42.74%, dramatically increasing the TEY of tax-free instruments.
- TEY does not factor in tenure, credit risk, liquidity, or capital gains on early exit. Use it alongside other analysis tools, not in isolation.
- For SIP-based debt investments, TEY is less relevant because returns come as capital gains (not interest), and the tax treatment is different from interest income.
- A 4% cess applies to all income tax. Effective marginal tax rates including cess are: 5% bracket (5.2%), 10% bracket (10.4%), 20% bracket (20.8%), 30% bracket (31.2%).
16. FAQs
What is Tax-Equivalent Yield and how is it calculated in India? Tax-Equivalent Yield is the pre-tax yield a taxable instrument must offer to equal the after-tax return of a tax-free instrument. The formula is: TEY equals Tax-Free Yield divided by (1 minus Marginal Tax Rate). For example, a 5.5% tax-free bond has a TEY of 7.86% for a 30% bracket investor, meaning a taxable instrument must yield at least 7.86% to be equally attractive.
Is Tax-Equivalent Yield the same for all investors? No. TEY depends entirely on the investor’s marginal tax bracket. A 30% bracket investor gets a much higher TEY from a tax-free bond than a 10% bracket investor. Tax-free instruments are most valuable for investors in the highest tax brackets where the tax saving is greatest.
Which tax-free instruments are available in India in 2026? The main tax-free fixed-income instruments in India are: PPF (7.1%, EEE status, 15-year lock-in), tax-free bonds from government entities like NHAI, REC, and PFC available on the secondary market (YTM approximately 5 to 5.5%), and SGB interest income subject to the usual slab rate but capital gains at maturity are exempt.
Should a 10% bracket investor prefer tax-free bonds over FDs? Generally no. For a 10% bracket investor, a tax-free bond at 5.5% has a TEY of approximately 6.11%. If the FD offers more than 6.11%, the FD is the better after-tax choice. Most FDs currently offer 6.5 to 7.5%, which exceeds this threshold. Tax-free bonds add the most value for investors in the 25 to 30% brackets.
What is the TEY of PPF for a 30% tax bracket investor? PPF earns 7.1% per annum and is fully exempt from tax. Its TEY for a 30% bracket investor is: 7.1% divided by (1 minus 0.30) = 10.14%. A taxable instrument would need to offer 10.14% to match PPF’s after-tax return for this investor, which is not achievable with any safe fixed-income option currently available in India.
Does TEY include the 4% health and education cess? It depends on the context. For a precise calculation, the effective tax rate including cess should be used. For a 30% bracket investor, the effective rate including 4% cess is 31.2%, giving a slightly higher TEY. In exam questions, use the rate specified in the question. Where not specified, the base slab rate (without cess) is typically used unless otherwise indicated.
17. CFP Exam Quick Recap
- TEY Formula: Tax-Free Yield divided by (1 minus Marginal Tax Rate)
- After-Tax Yield Formula: Taxable Yield multiplied by (1 minus Tax Rate)
- TEY is bracket-specific: higher bracket = higher TEY = more advantage from tax-free instruments
- New regime FY 2025-26: 30% applies above Rs 24 lakh; 25% for Rs 20 to 24 lakh; 20% for Rs 16 to 20 lakh
- Tax-free bonds: no new issuances since 2016; secondary market YTM of 5 to 5.5%; TEY is 7.14 to 7.86% for 30% bracket
- PPF TEY for 30% bracket: 10.14% (one of the highest TEYs among safe instruments)
- RBI FRS Bond at 8.05% is taxable; its after-tax yield for a 30% bracket investor is 5.635%
- Always compare instruments on after-tax yield, not nominal yield
- TEY does not account for credit risk, tenure, liquidity, or capital gains on early exit
- 4% cess makes effective rate for 30% bracket: 31.2%