A math teacher didn’t believe this calculation
You’re learning a lot about taxes, but maybe you’re not convinced taxes are a big deal. I feel ya. Maybe you’re right. Maybe taxes aren’t such a big deal.
Let’s run through a quick little example.
Imagine you had an investment that doubled in value every single year. First of all, that would be amazing! But let’s say you had this investment. The first year, you start off by investing $1. By the start of the second year, you would have $2, then $4, $8, $16, etc. Let’s say this doubling went on for 20 years.
Take a guess at how much you’d have invested at the end of 20 years?
A cool million bucks!
But what does this have to do with taxes?
Nothing yet. Patience. Okay, now let’s add taxes. Let’s say that every year there was a 33% tax on the growth in the account. Whatever money you had after taxes would still double each year.
Without the 33% tax, the account was over $1 million in 20 years. With the 33% annual tax, how much would the account be worth at the end of 20 years?
Well, 33% is a third, so most people guess about $700,000 or so, but that’s actually a bit too high. Then people will say something crazy, like $500,000. But even that’s a little too high. Can you see how taxes eat away at your wealth? Instead of being a cool millionaire at the end of 20 years, you have less than half that amount because of a 33% tax. And think about this: a 33% tax isn’t even that high. The highest federal income tax is almost 40%, and that doesn’t even include any state tax you might owe.
So, yes, taxes are a big deal indeed. If you aren’t aware of them or aware of strategies to minimize them, you could be paying a lot more than you should.
Okay, so how much would the account actually be worth at the end of 20 years with a 33% tax on the growth each year?
Don’t believe me? It’s true. You’d only have an account worth $28,000 at the end of 20 years. That’s the power of taxation. It can rob you of your money and leave you with much, much less than you’d have otherwise.
Your goal shouldn’t be to read all 80,000 pages of the tax code, or to even file your own taxes. Your goal should be to understand how insidious taxes are to building wealth and to make sure you have people on your team who are obsessed with minimizing your taxes.
Well, I guess the good thing is that there are only a couple of different kinds of taxes, right?
The proceeding blog post is an excerpt from Get Money Smart: Simple Lessons to Kickstart Your Financial Confidence & Grow Your Wealth, available now on Amazon.
About the Independent Financial Advisor
Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.