If you look at the traits of successful people, often you will notice they appear to be a bit pessimistic. They focus on the downside or in other words, what happens if things go wrong. This is not as dumb and depressing as it sounds. Part of your personal financial plan is how to earn or accumulate more money. The other is how to keep that money. This should be considered before the accumulating it part.
What do I mean by this? Lottery winners are the perfect example. How many stories have you seen about big lottery winners losing it all after a few years. Or maybe the talented sports person who signed a multi-year, multi-million dollar contract who gets injured and can then barely afford to live. These are examples of people who didn’t focus on how to keep their money.
If you can investment with pre-tax dollars the end result is significantly better.
Regardless of your income, there are always things pulling at those funds. Taxes, mortgages or rent, insurance, food and more. Look at all those items regularly and see if you are getting value for money.
For this article, let’s focus on one strategy for taxes. Obviously you can’t just stop paying them. However, you can make sure you are not paying more than necessary. As an employee it’s not as easy. Depending on your employer you may be able to divert some money to savings as pre-tax dollars. This can make a huge difference over the long term when put into tax effective products.
By way of example, if you decide you can afford to save $190 each month. An OECD report says the average US single person tax rate for 2019 was 24%. Therefore you would have to earn $250 to have this $190 to save. The $250 is called pre-tax dollars. Again some assumptions have to be made so let’s go 8% for the earning rate. This is the average annual rate of return for the S&P 500 since inception back in 1926.
As you can see, simply investing pre-tax money means about another $90 000 ($372 590 – $283 136 after 30 years. Or in percentage terms, just under an extra 32%.
An extra $90 000 was not achieved by working harder or more hours. It could have been from exactly the same job. Lifestyle was not altered either. In both examples, the net amount you have left after savings is the same. It is simply taking advantage of the laws that allow you to either invest with pre-tax or post-tax dollars.
Obviously there have been some simplifications made for the example and your individual tax position will affect things. The concept is the same though. If you can investment with pre-tax dollars the end result is significantly better.
By the way, the example above doesn’t just relate to tax. If you think you can save $190 a month, that is great. If you can stretch a bit more and save $250 a month then you can see that’s an extra $90 000 earned. Not to mention the extra $21 600 after 30 years.