Mistake number one is paying taxes on the same dollar more than once. Albert Einstein was quoted as saying, “compound interest is the eighth wonder of the world”. But Albert never lived under our current tax system. Today we have what our politicians call a progressive tax system; the easiest way to say, “the more we make, the more they take”.
Nevertheless, most people think that compound interest is a good thing, and it would be if we lived in a perfect tax-free world. Trouble is, we don’t. If you think about certificates of deposit, taxable bonds, mutual funds, real estate, money markets and individual stocks, to name a few, all of these certainly can grow an compound to sizable amounts of cash. The problem is, as these accounts grow and compound, so does the government’s fair share call taxes. Let me show you what I mean.
In the perfect world of compound interest, $1O,OOO earning 5% over a 30 year period, grows to a little over $43,000.
But don’t get too excited. The government has something to say about this magical compounding.
With any kind of growth, it becomes our patriotic duty to share with the IRS even if it means paying taxes on money that’s already been taxed. But that’s not all we need to take this one step further. The money we pay taxes with creates another wealth-eroding problem called lost opportunity cost.
What is lost opportunity cost or LOC? It is the understanding that we not only lose the dollar, but would also lose the interest we could’ve earned if we had to avoid the cost.
So how do you avoid all these taxes and the lost opportunity cost? Two ways: First, find financial products and strategies that allow you to defer taxes. Secondly, you deal with the original tax upfront and avoid future taxes altogether.
As always, talk to your financial advisor about your best options.