Accrual Equivalent Return (AER)
The accrual equivalent return (AER) and accrual equivalent tax rate (AET) can be used to summarize the effects of any combination of tax rates and methods. The AER is the annualized single after-tax rate of return that, if compounded, would produce the same after-tax future value after considering all applicable taxes. This measure is used by investors to assess the impact of taxes on net returns. The lower (higher) the AER (AET), the higher the impact of taxes on net performance.
On this page, we discuss the accrual equivalent return formula as well as the accrual equivalent tax rate formula. An Excel spreadsheet is available at the bottom of the page that implements both formulas using a simple numerical example.
Accrual equivalent return formula
where n is the number of time periods (expressed in years) and FVAT is the future value after all taxes.
The accrual equivalent tax rate (AET) is the simple accrual taxation rate that if applied to the pre-tax return equates it to the AER. It is similar to the tax drag in that for a given situation, higher (lower) tax drag will translate as a higher (lower) accrual equivalent tax rate.
where r is the pre-tax return.
We conclude this discussion by considering a numerical example. The following table illustrates the necessary calculations to calculate both metrics. The spreadsheet used can be downloaded at the bottom of the page.
Notice in this example that the AET equals the tax rate. This is because the tax we apply is an accrual tax.
We discussed two measures that can be used to summarize the effects of any combination of tax rates and methods. In particular, we illustrated how to determine the AER and AET, which can be calculated using some very simple formulae.
Want to have an implementation in Excel? Download the Excel file: AER calculator