Question

A certain savings account has a 3% effective annual rate of return on which 35% income tax is paid. If the annual inflation rate next year is 3.5%, what is the annual after-tax real rate of return?

Answer 1

Effective annual rate of return on saving account = 3%

After-tax annual rate of return on saving account = 3%*(1-0.35)

= 1.95%

Inflation rate = 3.5%

Calculating the Real rate of return using Fishers Equaton:-

After-Tax Real rate of return = [(1+After-tax annual rate of return)/(1+Inflation rate)] - 1

After-Tax Real rate of return = [(1+0.0195)/(1+0.035)] - 1

After-Tax Real rate of return = -1.4976%

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