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Taxable vs Tax-Deferred Investment Calculator

Estimate Your Savings With Tax-Deferred Investments

This tool will help you figure the future value and annualized yield differences between investments which are taxable vs tax-deferred.

Description Amount
Amount invested ($):
Expected annual rate of return (%): (Get Current Rates)
Years invested:
Marginal tax rate (%):
Percent of growth that is taxable (%):
Results Taxable Tax-deferred
Future value:
Annualized yield:

Current Savings Rates

 

What You Need to Know About Taxable vs. Tax-Deferred Investments

Wouldn't you like to keep more of the money you work so hard for, and give less of it to the government? If so, you've come to the right place. Our convenient calculator will show you how a tax-deferred investment can increase your take-home pay.

A good example of a duty-deferred account is the 401(k) plan, and yet the latest statistics show that less than 25% of Americans who are eligible for a 401(k) retirement account take advantage of it.

The main attraction of such a plan is that you pay less income tax, so let's look at the nice piece of change you could put into your own pocket instead of Uncle Sam's. In our example, "John" makes $2,000 a month and wishes to put 10% into a 401(k) account every month.

By entering this information, as well as John's income tax rate of 28%, we find that contributing $200 a month to the 401(k) will cost John only $144 each month. If he moves $144 into the account from each monthly paycheck, his take-home pay is reduced from $1,440 to $1,296. But John's reward for squirreling away that $144 a month is to see his savings grow by $200 a month, which is basically like a $56 bonus for paying it forward.

The Tax Benefits Are Undeniable

However, many people are skeptical of any worthwhile savings because (as they keep repeating) you'll have to pay dues on the money when you withdraw it later on down the road. That's true, but there are good reasons to defer the taxes:

  1. The amount of money you contribute to your savings plan is not taxed - by state or federal agencies - in the year it's deferred.
  2. You are not taxed on your savings plan earnings until you withdraw those earnings.
  3. Since most people plan on making withdrawals from their savings plan only after they reach retirement, and you will most likely be in a lower due bracket by then, you will save considerably on the taxes you pay on that money.

Also, keep in mind that you'll only pay dues on the amount you withdraw from your tax-deferred accounts, while the remainder in these accounts continues to grow and compound.

Exponential Function.

However, there are two disadvantages to keeping your money in deferred accounts. Firstly, if you make any withdrawals before age 59 ½, you'll be hit with hefty early withdrawal penalties, namely the 10% early withdrawal penalty fees. If you expect you'll need the money within a few years, it's not wise to invest in a retirement plan.

Secondly, capital gains might be taxed at a higher rate in a deductible IRA than in a standard taxable account. This is because they're subject to the regular income tax rates that can go as high as 39.6%; funds held in a taxable account top out at a maximum rate of 28%.

Capital Gains Tax Rate

When you sell an investment for a profit, it's called a capital gain on investment. Just like your regular income, these profits are taxable, albeit at a different rate than your salary. Your capital gains tax rate in 2014 depends on:

  • Your overall taxable income
  • How long you've held the investment
  • Whether you took losses to offset some or all of your capital gains

Short-term gains are assets owned for less than a year and a day, and they're taxed at your normal income tax rate.

Long-term gains are assets you've owned for more than a year and a day, and (as of writing this, in 2014) they're taxed as follows:

  • Overall income in the 10% - 15% tax bracket - your long-term capital gains due rate is 0%
  • Overall income in the 25% - 35% tax bracket - your long-term capital gains due rate is 15%
  • Overall income in the 39.6% tax bracket - your long-term capital gains due rate is 20%

Traditional IRA vs. Roth IRA

The money you deposit in your traditional IRA isn't taxed until you withdraw the funds decades later. If you made $30,000 last year and $5,000 of it was placed in an IRA, you'll only be required to pay income tax on $25,000 of your yearly earnings. Plus, your contributions will continue to grow duty-free. Only after age 59 ½ will the money be taxed (at your regular income tax rate).

The fee structure and tax breaks for a Roth IRA are quite different. Your contributions to a Roth IRA are never deductible, so if you made $30,000 and socked $5,000 away in a Roth IRA, you'd still be paying taxes on the entire $30,000.

However, when you withdraw your funds from a Roth IRA, neither the funds nor any earnings will be taxed. Of course, you can't start withdrawing until you reach age 59 1/2, and the Roth IRA has to be open for at least five years. In the end, you get all that money, and all you have to do is... wait.

While both the traditional IRA and the Roth IRA let you amass small fortunes by paying taxes as you go, the former blindsides you with a big tax bill on those profits. The Roth IRA, on the other hand, offers no surprises in the end. In other words, you never pay taxes on your gains with a Roth IRA.

Conclusion

Deductible IRAs, 401(k)s, 4093(b)s, and similar due-deferred retirement plans provide the best after-tax results for most investors - if the funds are not withdrawn early and do not incur the early withdrawal penalty tax.

Most investors have funds in both taxable and tax-deferred accounts, and many others own both stocks and bonds. It is advisable to keep your lower-returning bonds in taxable accounts and your higher-returning stock funds in tax-deferred accounts.

Even if the capital gains fee rate is reduced by 50%, a deductible IRA will still be the best bet for most investors who are saving for retirement.

Glossary

  • Expected Annual Rate Of Return: the annual after-tax rate of return you expect to make on your investments. The actual rate depends on the types of investments you've chosen. For example, the Standard & Poor's 500 report for the last decade had an annual compounded rate of return of 7.3% (including reinvestment of dividends).
  • Years Of Contribution: the number of years you plan on making contributions.
  • Years Of Withdrawal: the number of years you plan on making withdrawals, which are assumed to be made at the beginning of the term.
  • Existing Balance: the existing balance on the accounts.
  • Contributions: this is your periodic contribution, also assumed to be made at the beginning of the term.
  • Frequency Of Contributions: you have the option of monthly, quarterly, or yearly, made at the beginning of the term.
  • Frequency Of Withdrawal: the same options - monthly, quarterly, or yearly, made at the end of the term.
  • Tax During Contributions: to get your estimated marginal tax rate, consult the 2014 IRS federal income tax tables.