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Finance: What is Aftertax Yield? 8 Views


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Description:

What is After Tax Yield? After tax yield is simply how much an investment makes (or yields) after taxes have been paid. This term refers to bond yield; bonds are taxable as federal income, so after tax yield varies due to differences in tax brackets.

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Transcript

00:00

Finance a la shmoop... what is after-tax yield, well we'll presume you [Yield definition on 100 dollar bill]

00:08

know what standard yield is yeah okay so you have a stock trading for a

00:12

convenient exactly 20 bucks a share it pays a quarter a share four times a year

00:17

is a dividend or a dollar a year total in dividends its dividend yield is one

00:23

over twenty or five percent right you buy share for 20 bucks you get a dollar a

00:28

year back but you the investor pay tax on that buck a share of sweet hot

00:33

dividend love if you're a 35 percent bracketed taxpayer that is you pay 35 [35% taypay circled]

00:38

percent tax on the last dollar of your income well then you only keep 65 cents

00:43

on each dollar of dividend income that you receive and yes we note that there

00:47

is both federal and state and you know sometimes other taxes that go in here [List of taxes on sticky note]

00:52

like the Obamacare flavors or other county taxes but in total we're just

00:57

saying let's make up a story here that if you pay 35 percent tax on that buck

01:01

then your real after-tax yield is a lot less than the 5 percent the company

01:06

distributes to you, you calculate your after-tax yield by replacing that

01:11

"gross" dividend of a buck with a 65 cents of dividend that you keep [After-tax yield calculation]

01:16

after-tax in the numerator like that and then that 20 bucks you paid per share of

01:21

gently-used pacemakers dot-com stays in the denominator down there it looks like

01:26

this 65 cents divided by 20 bucks and that's 3.25 percent that

01:31

is 3.25 percent is your after-tax yield so that's as it applies [Man discussing after-tax yield to stock]

01:36

to stocks what about as it applies to bonds well in a way this calculation

01:41

matters a lot more because there's an entire industry in muni-bonds which pay

01:45

lower total rates of interest but which are generally insulated from paying [Person holding a muni-bond]

01:49

taxes so in a way muni bonds compete against fully taxable corporate bonds

01:54

for your bond investing dollar well tax rates for qualified dividends

01:58

meaning they're qualified for the various deductions from equity

02:01

investments are usually meaningfully lower than ordinary income rates so

02:06

let's look at the individual paying 35 percent marginal tax on long [Magnifying glass focuses on womans face]

02:10

term investment gains well they're likely paying something close to 50% tax

02:14

on ordinary income so we have a tale of two bonds foam depot corporation whose

02:19

bonds pay 7% and we're in the muni-city muni bonds which pay 4% which is better

02:25

the two bonds are of identical credit risk and if you're Joe hard-worker high [Hoe hammering a roof]

02:30

tax payer and supporter of government pork then which of these two bonds gives

02:34

you a better after-tax yield well if you pay 50 percent ordinary income tax then

02:40

you're 7% on that corporate is half or 3.5% after-tax that's the after-tax

02:46

yield got it and your muni bond carries no tax liability to you so the 4%

02:51

gross is the four percent net as well answer well go with the muni bond

02:56

and you two will be you know in the muni [Man discussing muni-bond after-tax yield and hat lands on his head]

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