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Tax Deferral: How Much Is It Really Worth?
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Imagine you make $2,000 at work and decide to invest it in the stock market. First, you'll have to pay income tax, let's say 25%, on your $2,000. That leaves you with $1,500. If you invest that and earn a 10% annual return, you'll make $150 in one year.
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Now imagine investing the $2,000 all at once in your tax-deferred DC plan instead. After one year with a 10% return, you'll have earned $200. By investing in your tax-deferred account, you wind up $50 ahead.
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That might not seem like much, but $50 adds up over time, especially when it's allowed to earn interest. For instance, after 20 years you earn $34,865 more by investing $2,000 a year in your tax-deferred DC account than in a taxable account (assuming a 10% annual return). Over 30 years the difference is even greater: $99,196.
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Of course, you wind up paying taxes on the money you invest whether you invest in your DC account or in a taxable account. However, by waiting to pay those taxes, you allow all of your money to work for you, meaning you make more in the long run.
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