Taxes are one of the main things that can easily eat up your investment balances. American taxpayers are supposed to pay taxes on every income including interests received from your savings account and capital gains or dividends from your investments accounts.
However, when you invest in a qualified retirement plan, such as an IRA, Roth IRA, 401k, 457, 403b, the earnings are not taxable in the current year but instead are deferred during the distribution. The power of tax-deferred account is that it allows your retirement nest egg to grow even faster by letting you re-invest the taxes that you’re supposed to pay on the earnings in the current year back into your retirement account.
To see how powerful investing in a tax-deferred retirement account, let’s look at the following scenario:
For illustrative purposes, we assume that your monthly contribution is $100 and the hypothetical rate of return is 10%. In addition, we also assume the combined federal and state marginal tax rate is 27%. You see, using the scenario above, your money grows faster with the tax-deferred accounts. It may not seem a lot during the early years but after 30 years the balance in the tax-deferred account is $226,049, which is almost twice as much as the taxable accounts balance of $129,471. In fact, after 40 years, the balance in the tax-deferred account ($632,408) is at least twice as much as the balance in the taxable accounts ($285,666).
That is why you should try to invest and maximize the contribution in your retirement plans in order to achieve your retirement goals faster.
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