From Here to Financial Happiness

Day Sixty One Worth the Wait

Yesterday, we discussed the importance of both funding retirement accounts and limiting the amount you trade in your regular taxable account. In many cases, these two strategies are simply delaying the day of reckoning: When you make withdrawals from most retirement accounts and when you sell a profitable investment that's held in your taxable account, you have to pay taxes.

Still, the longer you can delay paying those taxes, the more money you stand to make. Think of it this way: If you have money sitting in a traditional 401(k) plan or you have a stock in your taxable account that's been a profitable investment, the taxman has a claim on a slice of your money. But if you can put off paying the taxman his share, you can use that money to earn additional gains for yourself.

How valuable is this tax deferral? Consider a husband and wife. They both invest $1,000 in the same investment, but he buys it in a taxable account and she purchases it in a traditional, tax‐deferred retirement account that doesn't offer an initial tax deduction. Over the next 40 years, the investment climbs 6% a year.

The husband pays taxes on his entire 6% gain every year at a 24% rate. The wife also pays taxes at 24%, but she doesn't pay taxes on her gain until she cashes in her retirement account, 40 years after she made the initial investment. Result? The husband amasses $5,951, while the wife walks away with $8,057, or 35% more.

To add to our wealth, we should focus ...