Taxable vs. Tax-deferred
How many of us would like to find a way to control the taxes on investments? Do you understand that a portion of your portfolio, and the interest you earn, is taxed each year - regardless of whether you spend those earnings or not?
To help understand the net effect of taxes on portfolios, we have designed the marketing piece “Is Your Money Working as Hard as it Could?” This taxable yield chart shown below illustrates the difference in taxable and tax-deferred rates of return for today’s income tax brackets.
Securing tax-deferred growth can be enough to increase yields over non-deferred accounts. For example, an investor in the 32% income tax bracket who purchases a tax-deferred product with a rate of 2.75% would require a taxable rate of 4.04% to equal the same amount of after-tax growth?
Let’s see how taxable vs tax-deferred works over a timespan.
Using the rule of 72 we look at compounding returns over a given period of 36 years. The rule of 72 starts by dividing 72 by the annual return rounded up to the whole number, the result is approximately how long it takes to double your money using compounding interest.
An investment with a 6% annual compounding return will double approximately every 12 years.
Let’s look at the example of a 6% annual growth rate of both a taxable account and a tax-deferred account. In the taxable account, we take out 2% of the annual return to account for taxes, accommodating a 33% tax bracket. While the tax-deferred account will not be taxed until the money is taken out.
The taxable investment has an ending account value of $400,000 while the tax-deferred has an ending value of $800,000, but taxes have not been paid yet.
First, let's look at the lump sum withdrawal implications of the tax-deferred account.
This leaves us with $400,000 after taxes in the taxable scenario and $569,000 in the tax-deferred account.
Since retirees are often looking for guaranteed lifetime income, let's walk through how an annual withdrawal of 5% would look.
After accounting for taxes, we still see more income in the tax-deferred account.
With more income annually, as well as a larger lump sum amount, the benefits of tax-deferral are evident.
Download our taxable yield chart here:
For more tips on how to position tax-deferred investments, give us a call at 877 595 9325 or click on the button below
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