Why After-Tax Yield Matters When Comparing Savings Rates
When comparing savings accounts, CDs, and bonds, the headline interest rate (pre-tax) does not tell the full story. Your actual return depends on how much of that interest you keep after paying taxes. The after-tax yield is the number that really matters for your financial planning.
How After-Tax Yield Is Calculated
After-tax yield = Pre-tax rate × (1 − your tax rate on interest). If you earn 5% in a CD and your combined federal and state tax rate on interest is 30%, your after-tax yield is only 3.5%. The higher your tax bracket, the larger the gap between pre-tax and after-tax returns.
Tax-Advantaged Alternatives to Consider
Municipal bonds (munis): Interest is generally exempt from federal income tax and often from state taxes if you live in the issuing state. This makes them especially attractive for high-bracket investors. Compare the muni yield to your after-tax yield from a taxable account to find the better option.
I Bonds: US Treasury inflation-protected savings bonds with interest exempt from state income tax, and federal tax can be deferred until redemption. Limited to $10,000 per person per year.
Tax-Equivalent Yield Formula
Tax-equivalent yield = Tax-free yield ÷ (1 − your tax rate). This tells you the pre-tax yield a taxable investment would need to match a tax-free alternative. Useful for comparing munis to CDs or savings accounts.
Frequently Asked Questions
Most US states tax interest income. A few states (like Texas, Florida, and Washington) have no state income tax. Check your state's tax rules to calculate your true after-tax return.
Consider holding interest-bearing assets in tax-advantaged accounts (Traditional IRA, Roth IRA, 401k). Hold munis in taxable accounts and save higher-yield taxable bonds for tax-deferred accounts.
* Calculated on a simple interest basis. Actual returns may vary for compound interest products.