Skip to content

After-tax vs pre-tax return

By Jude Wallis

Every headline return is pre-tax. An 8 percent return taxed at 22 percent is 6.24 percent after tax, a drag of 1.76 points. Taxed at 37 percent the same 8 percent becomes 5.04 percent, a drag of 2.96 points. The investment did not change; the account it sits in did.

 After-tax returnPre-tax return
What it measuresThe investor's outcome.The asset's outcome.
At a 22 percent rate6.24 percent.8 percent.
At a 37 percent rate5.04 percent.8 percent, unchanged.
Depends onYour rate, your account type and the kind of income.The asset alone.
Where it is quotedAlmost nowhere. You compute it.Fact sheets, adverts and league tables.
What it makes comparableA taxable bond against a tax-exempt one.Two assets held in the same kind of account.
On this page

The drag is a share of the return, not of the pot

Tax at 22 percent takes 22 percent of the 8 points, which is 1.76 points, and leaves 6.24. That framing matters because the drag scales with the return: a strong year loses more points than a weak one, and a year with no return loses nothing. It is not a fixed haircut on the balance.

At a 37 percent rate the arithmetic is the same and the sting is larger: 2.96 points of drag and 5.04 percent left. The two after-tax figures differ by more than a full point on an identical asset, which is the whole argument for asking where an investment is held before asking what it returns.

The rate depends on what kind of income it is

One number cannot cover every case, because the tax code does not treat all returns alike. Interest is usually ordinary income. Qualified dividends and long-term gains have their own schedule. Unrealised gains are not taxed at all until they are sold, which is why a buy-and-hold position can carry a much lower effective drag than its nominal rate suggests.

So the rate to enter is the one that will actually apply to the return you expect, not your top marginal tax rate by default. How investments are taxed sets out which income falls where, and taxable against tax-exempt yield does the same comparison from the municipal bond side.

When the pre-tax number is the right one

Inside a tax-advantaged account, the pre-tax return is the return, because no tax event happens along the way. Comparing two funds held in the same taxable account also works fine pre-tax, since the same rate applies to both. The moment the comparison crosses account types or income types, the pre-tax figure stops being an answer. The after-tax return calculator and the tax-equivalent yield calculator handle the two directions of that conversion. This is educational material, not financial advice.

Worked examples

An 8 percent return at a 22 percent rate

An investment returns 8 percent and the tax rate on that return is 22 percent. What is the after-tax return?

  1. Tax takes 22 percent of the 8 points, which is 1.76 points.
  2. What is left is 8 minus 1.76, so 6.24 percent.

The after-tax return is 6.24 percent, with 1.76 points of drag.

The same return at a 37 percent rate

A higher-rate investor holds the same 8 percent investment and pays 37 percent on the return. What survives?

  1. Tax takes 37 percent of 8 points, which is 2.96 points.
  2. That leaves 5.04 percent after tax.

The after-tax return is 5.04 percent. Two investors, one asset, and more than a point of difference in outcome.

Common questions

Should I use my marginal or effective rate?

The marginal rate on the specific income, since the return stacks on top of what you already earned.

Does this apply to unrealised gains?

Not until they are sold. Deferring the event is itself worth something, because the untaxed amount keeps compounding.

Is a tax-exempt bond automatically better?

Only above a break-even rate. Compare its yield with the after-tax yield of the taxable alternative before deciding.

Is this financial advice?

No. It is educational material about converting a quoted return into an after-tax one.

Keep reading

This page is educational material, not financial advice. The figures come from the formula shown and assume the inputs you enter hold for the whole term. Your own rate, fees, taxes and timing will differ, so treat the output as arithmetic to check a decision against, not as a recommendation.