The 7 costly mistakes your clients make, Pt. 1: Paying taxes on the same dollar more than once
By Tony Walker
It has been said that Albert Einstein once referred to compound interest as the “eighth wonder of the world.” If that’s true, then obviously ole’ Albert never lived under our nation’s present tax system.
You see, in the US of A, we are guided by what the politicians affectionately refer to as a “progressive” tax system. Simply put: The more we make, the more they take.
Nevertheless, most Americans are following the herd in thinking that compound interest is a good thing — and it would be if we lived in a perfect tax-free world. But we don’t.
Certificates of deposits (CDs), taxable bonds, mutual funds, real estate, money markets and individual stocks (just to name a few) can certainly grow (compound) to sizable amounts of cash. The problem is, as most of these accounts grow and compound, so does the government’s fair share — called taxes. Let me show you what I mean.
As you can see, the growth of the CD at 5 percent, compounded over the course of time, is quite “magical” indeed. But hold on, because the government has something to say about all this magical compounding. With any kind of growth, it now becomes your “patriotic duty” to share the magic with the IRS — even if this means paying taxes on money that’s already been taxed (not a good thing). But the nightmare is not over. Take a look at what happens to the money (the taxes due on our money) that is now gone forever.
You see, whenever we have a cost (taxes each year), we also create another wealth-eroding problem called lost opportunity cost (LOC). LOC simply implies that whenever your clients incur a cost — taxes, insurance premiums, interest, fees, etc. — they not only lose the dollar, but they lose the interest they could have earned had they avoided the cost. The effects of LOC on our illustration reveal the horror of compounding interest, especially in a taxable account. So how do your clients avoid all of these taxes and LOC?
There are two options: 1.) You find financial products and strategies that allow your clients to defer the taxes (thus eliminating the LOC), or 2.) You have your clients deal with the original tax up-front and avoid future taxes altogether.
Bottom line: Be sure you help monitor your clients’ taxes each year. By lowering their taxes, you are also lowering their LOC, which in turn gives your clients more money to use and enjoy at no additional risk or out-of-pocket expenses to them. Talk to your clients about all of their options. You’ll be glad you did, and your clients will most likely pay less taxes as a result.