Power of Compounding and Tax Deferral
Written By: Clif Albino in New Berlin, WI
Let’s say you have two uncles. One is Jarvis who just passed away and left an inheritance of $100 K. The other uncle is Sam, who always demands money. A fun little math aid will show how well the money is being managed. Take 72 and divide by the interest rate. That shows the number of years for the money to double. It is not perfect but it is close. At 8%, money doubles every 9 years. Therefore, in 18 years, the account would have $400 K. Remember time is your friend so don’t squander it but tax deferral can be your second best friend. The resultant difference in these two interest rates could be compared to the money demanded by Uncle Sam. When tax deferral is part of the plan design, you have additional growth. The longer interest accumulates the more impressive the buildup. So, stop paying the tax and give it some time. It’ll be amazing. Think triple compounding…. Interest on principle, interest on interest, and interest on the money that would have gone to Uncle Sammy.
Albert Einstein said, “compound interest is the eighth wonder of the world. He who understands it, earns it… He who doesn’t… pays it.” Let’s use a trivia question to make this more apparent. What happens when a dollar is doubled every year for 20 years? The answer is well over a million dollars is generated! That is correct. I had to get a calculator the first time I heard that. Don’t feel bad there was an accountant at one of my seminars that did not believe it. Everyone would like that plan, but it only exists at cocktail parties. Assuming it was possible and the growth was taxed at 28% every year, it gets more interesting and depressing. The account value after tax and after 20 years would be less than $100,000. Nobody can double the value of an account every year. But Uncle Sam will be there to demand some, if you let him. By avoiding the tax you are essentially getting free money. Saving for 20 or 30 years is common and may only be the accumulation phase in the planning process. The distribution phase may be at least another 20 years. We are talking about at least 40 years of money management.
Millionaires’ biggest financial regret is not putting in place a regularly reviewed personal financial plan earlier in life. Now is the time to explore the possibilities and map out the realities. You can get started by calling Clif at 262-893-9853 or e-mail him at ClifAlbino@AlbinoAndAsociates.com.
About the Author: “As A Chartered Financial Consultant with 25 years of experience, I design tax-free retirement plans that have less expense than mutual funds, better returns than the S & P 500 and income 25% to 40% greater than a 401K. My goal is to get you as close to the 0% tax bracket as possible.”
To learn more from Clif, visit his website: www.ClifAlbino.com.
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3 Comments
Great article on compound interest Cliff. Compound interest on the deferred tax dollars is a simple, powerful and under-covered topic.