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Revision as of 17:53, 5 May 2013 by Assumer (talk | contribs) (Added a description of the final total row.)
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Looking for opinions on adding this section to

Advantages of tax deferment

Tax deferment is the process of paying the taxes you owe on an investment in a future year, instead of the current year. It may not be clear why deferring taxes is a good idea, especially if you expect to be in the same tax bracket in the future. For an example, refer to Table 1, in which the taxes you owe on an investment return are paid in year 5, compared to annually.

This example compares a hypothetical investment of $10,000 in a vehicle (such as a bond or CD) returning 6% annually for 5 years. The investor is assumed to be in the 25% tax bracket both during the investment and the withdrawal stage. A tax-deferred account (such as a non-deductible traditional IRA) waits until the investor withdraws the funds, and then taxes are paid on the entire, cumulative, amount of gains. In a taxable account, the 25% tax is paid each year on the gains for that given year. It can be seen that deferring the taxes yields a final, after-tax amount of $12,537 for this hypothetical investor, while paying taxes each years yields a final, after-tax amount of $12,462.

It should be noted that tax-deferred accounts may have additional benefits (such as a deductible IRA), which this comparison ignores in an attempt to make a more apples-to-apples comparison.

Table 1. Tax Deferment
Year Return   Taxable   Tax-Deferred
Tax Rate Return Taxes Total Tax Rate Return Taxes Total
0 - - - - $10,000 - - - $10,000
1 6% 25% $600 $150 $10,450 - $600 - $10,600
2 6% 25% $627 $157 $10,920 - $636 - $11,236
3 6% 25% $655 $164 $11,412 - $674 - $11,910
4 6% 25% $685 $171 $11,925 - $715 - $12,625
5 6% 25% $716 $179 $12,462 25% (of total return) $757 $846 $12,537
Total 6% 25% $3,283 $821 $12,462 25% $3,382 $846 $12,537

Start with $10,000. After year 1, you will have $150 less total return after taxes (compared to the non-taxed amount of $10,600). Going into year 5, you will be starting with a higher amount ($12,625) if the taxes were deferred than not ($11,925). In year 5 (the year where the taxes have been deferred to) you will end up with a higher starting amount, which shows that deferring taxes is the best approach. In both cases, you pay the tax (25%) on the total return (25% * $3,282 = $821, 25% * $3,382 = $846) but in the tax-deferred example, you were able to accumulate more of a return before taxes had to be paid.

List of Tax-Deferred Accounts

Do we want this section?

  • Traditional IRA
  • I-Bonds
  • 529

Editor's note: Did I do these calculations correctly? --Assumer 08:14, 26 March 2013 (CDT)

How do I put more of a "break" between the taxable and tax deferred columns? Like a double vertical bar? --Assumer 08:14, 26 March 2013 (CDT)

You can get a lot more complicated as shown here: wikipedia:Help:Table#Setting borders, but one simple approach is to insert a non-break space (&nbsp;) see wikipedia:List of XML and HTML character entity references. Tables usually ignore spaces, but non-break spaces force the insertion. Note the column spans the table. --LadyGeek 21:12, 26 March 2013 (CDT)

How do I add a break before the final