Taxes can put quite a bit of pressure on our lives. Let’s take a look at an example of how big of an impact taxes has on our overall financial plan.
Let’s assume I was the greatest financial advisor and could get you 100% Rate of Return. For simplicity sake let’s assume that you have given me $1 of your money to invest. At the end of the first year I have grown it to $2. That’s great! If I was able to provide you with 100% ROR (uninterrupted) over a 20 year period, what would that amount grow to? It would grow to approximately $1,051,000.
The majority of the population is subject to income taxes. Let’s assume that you will be taxed at the lowest marginal tax rate in Canada at 28%. At your first dollar of earnings, you will pay $0.28 in taxes leaving you with a balance of $1.72 rather than $2.00. After taxes, what amount will you are left with at the end of the 20 years? Most of you will be quite shocked by this; you will be left with approximately $51,000.
You see, the exponential power of compounding is working against you when your income is taxed, losing one million (over 20 years) to taxes at the lowest marginal tax rate in Canada!
The key take away from the forgoing is that when possible you should seek to invest in a tax free environment. Does this include retirement investment plans such as the RRSP? With registered savings plans (tax deferred plans) you will most likely pay full taxes when you go to take the money out, and most likely at a higher tax rate than when you put the money in!
Are you aware of the investment opportunities that offer tax free distributions?