How do I calculate after-tax returns and why does it matter for private clients?

Question

AcadiFi · Accepted Answer

After-tax return measures what the investor actually keeps after federal, state, and local taxes are deducted from investment income and realized gains. For taxable investors (individuals, non-qualified accounts), after-tax return is the only economically meaningful metric — pre-tax reported returns can be misleading if tax efficiency varies significantly.

Calculation components for a taxable period:

(1) Interest income × (1 − ordinary income tax rate)

(2) Qualified dividends × (1 − qualified dividend rate)

(3) Short-term capital gains × (1 − ordinary rate)

(4) Long-term capital gains × (1 − LTCG rate)

(5) Unrealized gains generally deferred (not taxed until realization)

Worked example: Thornwood Wealth manages a $1,000,000 portfolio for a client in the 37% federal bracket, 6% state.

- Interest income: $20,000 (taxed at 37% + 6% = 43% = $8,600 tax, keep $11,400)
- Qualified dividends: $15,000 (taxed at 20% + 6% = 26% = $3,900 tax, keep $11,100)
- Realized LTCG: $30,000 (taxed at 20% + 6% = 26% = $7,800 tax, keep $22,200)
- Realized STCG: $10,000 (taxed at 43% = $4,300 tax, keep $5,700)
- Unrealized gains: $45,000 (no current tax, deferred)

Pre-tax return: ($20K + $15K + $30K + $10K + $45K) / $1M = 12.0%

After-tax return: ($11.4K + $11.1K + $22.2K + $5.7K + $45K) / $1M = 9.54%

The 'tax drag' of 2.46% annually compounds dramatically over decades.

Key insights:

(1) Tax efficiency matters — index funds and ETFs typically have lower turnover and fewer realized distributions than actively managed mutual funds, producing better after-tax returns even if pre-tax returns are similar.

(2) Asset location — place tax-inefficient assets (bonds, REITs) in tax-advantaged accounts (IRAs, 401ks); tax-efficient assets (broad index equities) in taxable accounts.

(3) Tax-loss harvesting systematically — selling losers to offset gains can add 0.5-1.0% annually.

(4) Wash sale rules — cannot repurchase substantially identical security within 30 days of harvesting loss.

(5) Step-up at death — unrealized gains in taxable accounts pass to heirs at stepped-up basis, so holding winners long-term maximizes this benefit.

CFA Level III private wealth management makes after-tax return the central metric, with substantial exam coverage.

How do I calculate after-tax returns and why does it matter for private clients?

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