Inflation, Taxes Erode Returns, Income

When considering how to preserve and build wealth, one factor to keep in mind is that inflation and taxes impact your returns and your income. Whatever return you, an independent woman, receive from your investments and whatever income you eventually receive from retirement accounts will be less than you think based on those two factors.

Both factors are unpredictable. That’s because no one knows what tax rates or inflation rates will be in the future. No one – not even the most experienced economist or most senior Federal Reserve official, can predict these rates, especially the farther you go out in the future.

Here’s the deal on how both of these elements can hurt you:

• Inflation erodes your investment returns: every day, inflation cuts into the returns that your investments provide. If the market has a bad year and your returns are negative, they are even worse because of inflation.
• Inflation eats away at your spending power: whatever funds you take out of your accounts in retirement, even if those are from a Roth IRA or 401(k) and are tax free or tax-deferred, inflation has been eating away at those returns for years.
• Taxes impact investment accounts: for your accounts in taxable accounts, you have to pay taxes on any income, dividends and capital gains, reducing your overall returns.
• Taxes hurt you in the future with your tax-deferred retirement accounts: when you take money out of a regular IRA or 401(k), you have to pay taxes on those distributions, reducing what you take home.

To drive this point home – how inflation and taxes can impact your returns and your income – here is an example. If you invested $10,000 and received an 8 percent return with an annual inflation rate of 3 percent, a state marginal tax bracket of 5 percent, a federal marginal tax rate of 25 percent and itemized deductions, the table below reveals how those factors cut into your returns.

Source: NASDAQ.com Tax & Inflation Calculator

And to further complicate the situation, the above table assumes an investment return of 8% each and every year. There are very few instances where I can use the word “guarantee,” but I can absolutely guarantee that you’re not going to experience an 8% return every year in the future. That’s why I “stress test” all my clients’ financial plans to account for future market uncertainty, but that’s a topic for another time.

That being said, it is the job of your financial advisor to use the best tools at his or her disposal to make some educated assumptions to help you maximize your resources so you can provide for yourself and your family and achieve your personal and financial goals. Just keep in mind that there are multiple variables when a financial planner helps you, as an independent woman, craft and implement a financial investment plan.

If you’re interested in learning more about how Wealthcare for Women can help you, sign up for my free e-course that details the secrets and simple solutions to successful wealth management for women. Or, you can contact me directly.

This article does not constitute a personal recommendation or take into account the particular investment objectives, financial situations or needs of individual clients. It is intended for illustrative, educational purposes only. Past performance does not guarantee future results. Illustrative data used in this article is from sources believed reliable but not verified independently by Wealthcare. Wealthcare Capital Management’s disclosure document ADV Part 2A can be found here.