How to Calculate After-Tax Yield

Taxes can take a huge bite out of your investment returns.

Taxes can take a huge bite out of your investment returns.

After-tax yield is the amount an investment pays after deducting taxes. It is often used as a reference point to help compare taxable with tax-free investments, such as municipal bonds. For investors in a high tax bracket, an investment's after-tax yield can be significantly less than the pre-tax yield. After-tax yields drop even more for investors in high-tax states, such as California and New York.

Determine the tax characteristics of your investment. Most securities that pay interest or dividends, including stocks, savings accounts, certificates of deposit and corporate bonds, are taxable. U.S. Treasury securities are exempt from state taxes. Municipal bonds, issued by state and local governments, are usually exempt from both federal taxes and state taxes in the state of issue.

Record the type and amount of interest you receive annually from the investment. For example, if you own a $1,000 corporate bond that pays 5 percent annual interest, you will receive $50 per year in taxable interest.

Record the purchase price of your investment. This price should include all costs to obtain the investment, such as commissions or sales charges.

Look up your federal tax bracket. Your tax bracket is a function of your taxable income, as determined on your federal tax forms. Tax brackets are subject to change annually but are readily available in the financial press. For example, if you are married filing jointly in 2012 and make over $338,350, you are in the highest tax bracket of 35 percent.

Look up your state tax bracket. Most states charge an income tax on top of the federal income tax. Your state's taxing authority will be able to provide you with your current year's tax bracket, based on your income. Most states will have their own website providing this information.

Add your federal and state tax rates. For example, if you are in the highest federal and state brackets and you live in California, your combined tax rate would be 35 percent plus 9.3 percent, for a total of 44.3 percent.

Multiply the amount of interest you receive by your combined tax rate. For example, if you earn $50 in interest and are in a combined tax rate of 44.2 percent, multiply 50 times .442, for a result of 22.1. This is the total amount of tax you pay.

Subtract your taxes from your interest payment. If your taxes are $22.10 on a $50 in interest payments, the net amount of interest you receive after taxes is $50 minus $22.10, or $27.90.

Divide your net after-tax interest payment by the total cost of your investment. This will be your net after-tax yield. For example, if your net amount of interest after taxes is $27.90, and you paid $1,000 for your investment, your after-tax yield is 2.79 percent.

Video of the Day

Brought to you by Sapling
Brought to you by Sapling

About the Author

After receiving a Bachelor of Arts in English from UCLA, John Csiszar earned a Certified Financial Planner designation and served 18 years as an investment adviser. Csiszar has served as a technical writer for various financial firms and has extensive experience writing for online publications.

Photo Credits

  • Digital Vision./Digital Vision/Getty Images