New York Retirees: This Bond ETF Pays Income Neither the IRS Nor Albany Can Tax

New York has some of the highest individual income tax rates in the country, particularly once New York City taxes are included. That’s one reason investors in high-tax states need to think about more than a bond fund’s headline yield. What matters for retirement spending is how much of that income you actually get to keep.

It’s also why an entire category of state-specific municipal bond ETFs exists. Rather than owning municipal debt from across the country, these funds concentrate on bonds issued within a particular state, potentially allowing residents to receive income exempt from both federal and state income taxes. For New Yorkers, one option is the iShares New York Muni Bond ETF (NYF).

NYF doesn’t have the highest nominal yield you’ll find in fixed income. Its current 30-day SEC yield is 3.79%. But for a New York resident holding the ETF in a taxable brokerage account, comparing that figure directly with a taxable corporate or Treasury bond yield misses the primary reason to own it.

How New York Municipal Bonds Work

When you buy a bond, you’re essentially lending money to the issuer in exchange for interest and the eventual repayment of principal. The tax treatment of that interest depends considerably on who’s doing the borrowing. Corporate bond interest is generally taxed as ordinary income at the federal level and by New York. U.S. Treasury interest is subject to federal income tax but generally exempt from state and local income taxes.

Municipal bonds can go one step further. Interest from qualifying municipal bonds is generally exempt from federal income tax. When a New York resident owns qualifying bonds issued within New York, that income can generally also be exempt from New York state and local personal income taxes.

There are two broad categories of municipal bonds. General obligation bonds are backed primarily by the taxing power of the issuing government. Revenue bonds instead depend on income generated by a particular project, facility, or other revenue source.

That gives NYF exposure to debt from a range of issuing authorities. These can include the state itself as well as cities, counties, school districts, transportation authorities, water and sewer systems, housing agencies, hospitals, universities and other public or quasi-public entities.

A 3.79% Yield Could Be Worth 7.84% Taxable

NYF charges a 0.09% expense ratio and currently has a 3.79% 30-day SEC yield. That might not immediately grab your attention when taxable bond funds can offer higher headline yields. The more useful figure for a New York investor is the tax-equivalent yield.

Tax-equivalent yield estimates how much a taxable bond investment would need to yield for you to retain the same amount of income after taxes. Because NYF is a state-specific municipal bond ETF, iShares calculates its estimate using the highest applicable federal and New York individual income tax rates.

On that basis, NYF currently has an estimated tax-equivalent yield of 7.84%. In other words, an investor subject to those assumed marginal tax rates would need a comparable taxable investment yielding approximately 7.84% to match the after-tax income from NYF’s 3.79% tax-exempt yield.

That’s particularly interesting when you look at the credit quality you’re getting. Approximately 58% of NYF’s portfolio is rated AA. Reaching a nominal yield approaching 8% in the taxable bond market would generally require accepting substantially more credit risk than that.

Of course, 7.84% isn’t everyone’s personal tax-equivalent yield. The advantage depends on your federal, state and potentially local marginal tax rates. The calculation becomes less compelling as your tax bracket falls, and the tax exemption provides little reason to hold NYF inside an IRA or other tax-advantaged account.

Contact [email protected] for any questions or corrections.