Question

Your bank has two checking account options, one pays tax-free interest at a rate of 3% per annum and the other pays taxable interest at a rate of 4.5% per annum. You are currently in a 24% marginal tax bracket. If you converted the tax-free interest rate to the comparable taxable interest rate you would find that:

Answer 1

Answer:

The comparable tax rate is 3.95%, thus you should choose the 4.5% taxable account option.

Step-by-step explanation:

In order to convert the tax-free interest rate of 3% per year to the comparable taxable interest rate, one should consider that 3% is the interest rate after the marginal tax discount. If you are at the 24% marginal tax bracket, the comparable rate is:

$r*(1-0.24)=0.03\\r=\frac{0.03}{0.76}\\r=0.0395\\r=3.95\%$

The comparable tax rate is 3.95%, thus you should choose the 4.5% taxable account option.