Most of us are familiar with the concept of tax-deferral. We know that we will have to pay taxes on the money in our retirement plan or annuity policy, but only when we take it out. We know that taxes will be due on any gains in our stocks, but only if we sell. The fact that we can defer paying taxes to a time in the future that we decide makes most of us feel pretty good. Feeling good is worth something, but how much? Are the financial benefits of tax deferral worth enough to forgo the pleasure of spending our money now?
Before we answer these questions, let’s try and understand why tax deferral works. The reason tax deferral works is all due to compounding. We know that compounding funds at a higher rate for a longer period can work wonders on our finances. It takes about 12 years to double our money at a compounded annual rate of 6%. At a compounded annual rate of 4% it will take about 18 years. Paying taxes on our earnings annually is equivalent to compounding at a lower rate of return. And as we know, a lower rate of return extends the amount of time our funds must be invested to earn the same amount of money.
This power of tax deferral gained from compounding increases with the amount of tax deferred and the length of time the deferral is maintained. When applied to an individual stock, the power is based on the capital gains tax that is due on any sale. When applied to a tax-deductable contribution to a retirement plan or annuity, it is derived from your individual income tax rate. Let’s put this into numbers using the current 15% capital gain rate and a 28% individual income tax rate.
Future value of $1,000 invested at 6% applying a 15% capital gain tax
|
Years to Liquidation |
No Tax |
Tax-Deferred (Tax Paid at the end of period) |
No Deferral (Tax Paid Annually) |
|
10 |
1790.00 |
1672.00 |
1644.00 |
|
20 |
3207.00 |
2876.00 |
2704.00 |
|
30 |
5743.00 |
5031.00 |
4447.00 |
Future value of $1,000 invested at 6% applying a 28% individual income tax rate
|
Years to Liquidation |
No Tax |
Tax-Deferred (Tax Paid at the end of period) |
No Deferral (Tax Paid Annually) |
|
10 |
1819.00 |
1590.00 |
1539.00 |
|
20 |
3310.00 |
2663.00 |
2369.00 |
|
30 |
6023.00 |
4616.00 |
3646.00 |
With average market returns and no major change in taxes, most of you will have to wait a minimum of ten years to reap the rewards of a tax deferral investment strategy, not counting the individual quirks of each plan, or policy. Only you can decide if the potential gain and the time your money is unavailable is worth it.
Anderson Griggs & Company, Inc., doing business as Anderson Griggs Portfolio Management is a registered investment adviser with the US Securities & Exchange Commission. Pursuant to laws and regulations Anderson Griggs also maintains notice filing with several individuals state regulators including North and South Carolina. Anderson Griggs only conducts business in states and locations where it is properly registered or meets state requirements for advisors. This commentary is for information purposes only and is not an offer of investment advice. We will only render advice after we deliver our Form ADV Part II to a client in an authorized jurisdiction and receive a properly executed investment Management Agreement. Any reference to performance is historical in nature and no assumption about future performance should be made based on the past performance of any Anderson Griggs Investment Objective, individual account, or index. The authors of publication are expressing general opinions and commentary. They are not attempting to provide legal, accounting, or specific advice to any individual concerning their personal situation. Anderson Griggs Portfolio Management's office is located at 113 E. Main St., Suite 310, Rock Hill, SC 29730. The local phone number is 803-324-5044 and nationally can be reached via its toll-free number 800-254-0874.