Choosing a tax-deferred account?

Question

This was a money saving tip from MD Cooperative Extension... "If you save just $2.74 a day and invest it in a tax-deferred account that just matches the historic return of the the stock market, you would have more than $1 million after 40 years." With a search I found the historic return of the stock market is 10-12% but I don't know what kind of account to invest in. Are there accounts with a fixed interest rate of at least 10%, that are tax-deferred, and that I can make small contributions toward on a regular basis? Any advice it appreciated!

Answer 1

Traditional IRA takes pretax $$ and grows. Money is taxed when you withdraw the money many years later.

Roth IRA takes posttax $$ and grows. Then, when you retire and withdraw that money, it's all tax free.

For most people, this is the best way to go for their first $4000 of money since it grows unencumbered. But, you'll have to decide for yourself whether you think your tax rate'll be higher or lower at retirement.

For you, it probably makes more sense to do a ROTH IRA if your current tax rate is low or close to 0% right now.

Hope that helps!

Answer 2

There are no 10% fixed accounts out there!! Perhaps, during the Jimmy Carter 14% inflation days there were some that were 10% but that didn't last but several years and the 14% inflation ate away at the savings to boot.

"Tax-deferred" is something like a 401k, 457, or IRA, for example. You aren't taxed on the gains until you withdraw the money.

The 10-12% historically you learned is the stock market (generally gauged against a standard such as the S&P 500) average over time. Over the years, through all of the ups and downs, the market averaged 10-12% per year. Some years a lot more, some a lot less - but you get your average.

As far as what account to invest in... can't answer. That depends on your personality type and tolerance for risk. A total stock market index (S&P 1500, for example) is a way to be aggressive as safe as possible (open to debate, yes). Good luck.

Answer 3

Another way of looking at this is to fix your investment into funds that are tied to the Stock market. Their are funds which buy a small portion of each share and then the returns are exactly those of the market.

These are called indes funds and can be purchaed through almost any stockbroker.

The amount of your coffee - plain no cream- every day for a year amounts to $1,000.00. The $1,000 00 tax deferred ( assume a tax rate of 15% would cost you outof pocket $850.00). The account when matured ( 40 years) would then be taxed at your then current tax rate. Presumably at a higher tax rate than now. It may be prudent to invest in a Roth IRA - where the funds are after-tax, costing the full $1,000.00 now, but the interest and principle accrue tax free over the life tof the account.

A comparrison of the results should be reviewed. Assume the
same return for each option; You can either assume the same investment amount, or assume that the Roth would have the 780.00 amount investe while the tax-deferred account would have the full $1,000.00. IF you assume the same amount for both then the Roth IRA would be the clear winner. If you assume you invest the net amount then the taxdeferredwould accumulate a higher amount. This amount would then be taxes at a higher rate in the later years when you withdraw your funds. You would also consider the inflation effect of the funds. That is as the years go and inflation continues then future dollars are worth less than current dollars, that is they would buy less. When taking all these factors into consideration it usually works out that the ROth is better.

The main thing is not to lose sight that you need toinvest, and starting small and adding to it on a regular basis would bring great rewards no matter which investment vehicle isused.

I don't think the actual rate of return for the stock market has performed at 10% oiver the long term. I beleive historically it ismore like 6%. (10% perhaps in the last 10 years).

A similar calculation was done that suggested that the Indians got the better deal for the Island of Manhattan. It was "sold" to the settlers for somebeads and trinkets with a value of approx 34.00 in historic dollars. If that $34.00 was invested in a simple compounding saving account from that time ~ 1500. a.d. At 6% per year the account would be worth more than the value of the land now. Somewhere in the billions.

Answer 4

A tax deferred account is something like an IRA or 401(k).

Your employer might offer a 401(k). Any financial institution can open a IRA for you (most will allow you to establish a systematic savings program).

I don't know of any investments that are offering a fixed return of 10% to 12%. In order to earn 10% to 12%, you'll need to invest in the stock market (i'd suggest a diversified portfolio of stock mutual funds).