Guide
Taxes and Compound Interest (Basics)
Taxes can reduce the return that compounds—often called “tax drag.” Here’s a simple gross vs net illustration and how to test it.
Published: March 12, 2025 · Updated: December 21, 2025 · By FinToolSuite Editorial
Important notice
Educational only; not tax, legal, or financial advice. Tax treatment varies by country, account type, provider, and individual situation. Examples are illustrative; real returns vary; investments can go down as well as up. Speak to a qualified tax professional for personal guidance.
Try the calculator
Run gross vs “net” rate scenarios to see how tax drag affects the ending balance.
Open the calculatorQuick answer
Tax drag means taxes reduce the return that compounds. A lower net rate compounds to a smaller ending balance. Test net rates in the calculator.
What tax drag means
Depending on account and country rules, taxes can apply to interest, dividends, or capital gains. If taxes are paid along the way, the balance available to compound can be lower than the gross figure. Timing of taxes (ongoing vs at sale) also changes the path.
Illustrative example (gross vs net)
Starting amount: £10,000. Gross return assumption: 5% per year. Time: 20 years. Case A: 5% gross with no tax drag (for illustration). Case B: net 4% after an illustrative “tax drag.” This is an illustration of compounding, not a tax estimate.
| Rate | Ending balance (approx.) | Difference |
|---|---|---|
| 5% gross (illustrative) | ~£26,500 | — |
| 4% net after “tax drag” (illustrative) | ~£21,900 | ~£4,600 lower |
Illustration only—use your own assumptions in the calculator.
What affects taxes (country-neutral)
- Account type (tax-advantaged vs taxable)
- Type of return (interest, dividends, gains)
- Holding period and transaction frequency
- Provider reporting and local rules
How to model taxes in a calculator
A simple approach is to test a “net” rate (e.g., slightly lower than gross) to see the directional effect. Or run two cases: one with your gross assumption, one with a reduced net rate. This is an approximation, not tax advice.
Open the calculatorSalary After Tax: plan contributions
Take-home pay affects how much you can save each month. Check your net pay here:
Salary After Tax CalculatorCommon mistakes
- Assuming pre-tax returns are what you keep.
- Mixing up interest vs capital gains treatment (varies by country/account).
- Over-precision when rules and rates change.
FAQ
What is tax drag?
It’s the reduction in compounding because taxes lower the return or balance along the way.
Do taxes reduce compound interest growth?
Yes, if taxes apply, the net return is lower and the compounded balance can be smaller.
Are taxes paid every year or only when I sell?
It depends on local rules and account type; some returns are taxed annually, some at sale.
Does account type matter?
Yes. Tax-advantaged vs taxable accounts can have different rules.
How can I estimate taxes in a simple calculator?
Use a slightly lower “net” rate as an approximation, or run gross vs reduced-rate scenarios.
Why do different countries have different outcomes?
Rules, rates, and account types vary by country; outcomes differ accordingly.
Does reinvesting returns change tax treatment?
It can, depending on local rules and account type. This overview stays general.
Should I talk to a tax professional?
Yes, for personal decisions and local rules, a qualified tax professional can help.
Run gross vs net in the tool
Compare a gross return and a slightly reduced net return to see how tax drag changes the ending balance.
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