Savings, Taxes & Inflation Calculator
Understanding The Impacts of Inflation and Taxes on Your Savings
If you have a savings or investments you might be wondering how inflation & taxes can impact your returns. You wouldn't be alone, many people don't think about it, and they assume it doesn't have any effect on them either way. This article will explain what inflation does to your savings and investments. We will also talk about long and short term capital gains. We will also compare long term compounding returns that are taxed each year against one that doesn't get taxed. Finally, we will talk about some different savings plans that are available and how they compare at a high level.
Long-Term Capital Gains Versus Short-Term Capital Gains
The difference between long-term capital gains and short-term capital gains is the planned length of your investment time. Basically, long-term capital gains are investments that you plan to hold on to longer than a year span. For example, if you purchased 20 shares of stock at $100 a share and you sell them half of a year later for $125 per share, the $500 profit you made would be classed as short-term capital gains by the Internal Revenue Service (IRS).
This is extremely important to know because short-term and long-term capital gains are taxed very differently. Depending on which tax bracket you fall into, if you held on to the 100 shares of the stock we talked about above for more than a year, you could end up making more money if the stock price keeps trending upwards but you'll still pay less on this when it comes time to do your taxes.
The Short-Term Capital Gains Tax Rate
If you have short-term capital gains, this is taxed by the IRS as ordinary income. This means that any money you receive from your investments that you hold on to for less than one year has to be reported as taxable income when you submit your taxes. This means that if you have an annual salary of $59,000 and you have a short-term investment gain of $5,000, your taxable income would be $64,000. If you file as an individual, this could push you into a higher 25% tax bracket, and you would owe roughly $12,000 in income tax for the year. It is possible to reduce this amount by claiming tax credits and certain deductions.
2017 Short-Term Single Taxable Income Tax Brackets and Rates
|Rate||Taxable Income Bracket||Tax Amount Owed|
|10%||$0 to $9,325||10% of Taxable Income|
|15%||$9,325 to $37,950||$932.50 plus 15% of the Excess Over $9325|
|25%||$37,950 to $91,900||$5,226.25 Plus 25% of the Excess Over $37,950|
|28%||$91,900 to $191,650||$18,713.75 Plus 28% of the Excess Over $91,900|
|33%||$191,650 to $416,700||$46,643.75 Plus 33% of the Excess Over $191,650|
|35%||$416,700 to $418,400||$120,910.25 Plus 35% of the Excess Over $416,700|
|39.60%||$418,400 and Up||$121,505.25 Plus 39.6% of the Excess Over $418,400|
2017 Short-Term Married Filing Joint Taxable Income Tax Brackets and Rates
|Rate||Taxable Income Bracket||Tax Amount Owed|
|10%||$0 to $18,650||10% of Taxable Income|
|15%||$18,650 to $75,900||$1,865 Plus 15% of the Excess Over $18,650|
|25%||$75,900 to $153,100||$10,452.50 Plus 25% of the Excess Over $75,900|
|28%||$153,100 to $233,350||$29,752.50 Plus 28% of the Excess Over $153,100|
|33%||$233,350 to $416,700||$52,222.50 Plus 33% of the Excess Over $233,350|
|35%||$416,700 to $470,700||$112,728 Plus 35% of the Excess Over $416,700|
|39.60%||$470,700 and Up||$131,628 Plus 39.6% of the Excess Over $470,700|
The Long-Term Capital Gains Tax Rate
The Internal Revenue will tax long-term capital gains at drastically reduced rates, and they do this to encourage individuals and businesses to keep their investments in and not cash them out. The main difference between the long-term capital gains rate and the ordinary income tax rate can be up to 20%, and this is what applies to short-term capital gains. For individuals with long-term investments that fall into the 10% and 15% income tax brackets, they currently have to pay 0% on their investments. Even if the individuals find themselves in the 39.60% tax bracket only end up paying 20%.
To put it in perspective, assume that the $5,000 you earned in investment income from the example above was earned from a long-term investment that you had for more than 12 months. Your individual tax bracket will be in the 25% range, but this would just be on the $59,000. You would owe around $10,793.25. However, you would only have to pay 15% on your capital gain amount, which totals out to $720. This means that instead of owing $12,021.25, you would owe $11,301.25 on the same amount of income earned. The higher your investment income is, the wider this gap gets.
2017 Individual Long-Term Capital Gains Tax Rate and Tax Brackets
|Marginal Tax Rate (Tax Bracket)||Long-Term Capital Gains Tax Rate|
|10%||0% Tax Rate|
|15%||0% Tax Rate|
|25%||15% Tax Rate|
|28%||15% Tax Rate|
|33%||15% Tax Rate|
|35%||15% Tax Rate|
|39.60%||20% Tax Rate|
Putting it All Together
If you can resist the temptation to pull your short-term investments for a year, it is in your best interest to keep them invested. You will have the chance to make more money on your long-term investments, and you will be taxed less when it comes time to pay in on your annual income taxes. Short-term investments are an option for someone who doesn't mind paying more on their taxes, but ideally, you want long-term investments.
2017 Breakdown of the Individual Capital Gains Tax Rates
|Income||Tax Bracket||Short-Term Capital Gains Rate||Long-Term Capital Gains Rate|
|$0 to $9,325||10%||10%||0%|
|$9,326 to $37,950||15%||15%||0%|
|$37,951 to $91,900||25%||25%||15%|
|$91,901 to $191,650||28%||28%||15%|
|$191,651 to $416,700||33%||33%||15%|
|$416,701 to $418,400||35%||35%||15%|
|$418,401 and Up||39.60%||39.60%||20%|
2017 Breakdown of the Married, Filing Jointly Capital Gains Tax Rates
|Income||Tax Bracket||Short-Term Capital Gains Rate||Long-Term Capital Gains Rate|
|$0 to $18,650||10%||10%||0%|
|$18,651 to $75,900||15%||15%||0%|
|$75,901 to $153,100||25%||25%||15%|
|$153,101 to $233,350||28%||28%||15%|
|$233,351 to $416,700||33%||33%||15%|
|$416,701 to $470,700||35%||35%||15%|
|$470,701 and Up||39.60%||39.60%||20%|
What Type of Account Compounds Over a Long-Term and is Not Taxed?
If you decide to invest in a Roth IRA account, this account will compound over a long-term without being taxed. As an added perk, once your Roth IRA is distributed, it is tax-free and penalty-free as long as the five-year aging requirement has been met. This can be met by the individual turning 59 and a half years old, a death, disability, or buying your first home. Compounding is a powerful tool to have at your disposal. Once you have made gains on your initial balance, you can potentially start making gains on your gains, and this snowballs into a larger and larger amount.
An Example of Compounding Interest on a $1,000 Investment
|Time Frame (Years)||$1,000 Grows To||Gain for the Previous 5 Years|
|In 5 Years||$1,611||$611|
|In 10 Years||$2,594||$983|
|In 15 Years||$4,177||$1,583|
|In 20 Years||$6,728||$2,551|
|In 25 Years||$10,385||$3,657|
|In 30 Years||$17,449||$7,064|
|In 40 Years||$45,259||$27,810|
|In 50 Years||$117,391||$72,132|
What Type of Account Compounds Over a Long-Term and is Taxed Annually?
A Certificate of Deposit (CD) is a popular long-term account that is taxed each year. This option is used by investors who want to have a steady investment that isn't related to the fluctuations of the stock market. Your bank, credit union, or lender will issue you a CD, and they offer an interest rate on any money you deposit into this account in return for you leaving the money in the account for a preset period of time. This is usually two, three, or five years.
You can take this interest and put it into another account, or you can take it and reinvest it in your CD. This interest is considered by the IRS to be taxable on both a Federal and state level. At the end of each tax year, the investor will get a form that details how much interest their CD investment earned. This amount will be taxed as interest income instead of short-term capital gains. For example, if the individual is in the 25% tax bracket and their CD interest amount is $300, they will owe $75 in interest tax for that year.
Tax Efficient Savings Plans
Now that you're thinking about different savings accounts, we'll review several so you can make an informed decision when it comes time to choose your account for your savings to maximize your return,
A 401(k) plan is a retirement savings plan that is sponsored by your employer. You save and invest a portion of each of your paychecks, and your employer will match your contributions.
- Beneficiary and Eligibility. To be eligible for a 401(k), your employer must offer this service. Many employers will enroll you automatically, but if they don't, contact your Human Resources office and ask. You are the beneficiary for this account type. If you're married and you die, your spouse automatically becomes the beneficiary. You can also name a separate beneficiary.
- Investment Options. There are two different account types you can choose from, but your employer may only offer one. There are caps on how much you can invest each year, and in 2015-2016 you were capped at $15,500.
- Tax Advantages. Your wages are invested before taxes are taken out, and your taxable income drops by the more you contribute. You'll pay income taxes when you withdraw your funds on your contributions and earnings.
529 Savings Plans
A 529 Savings Plan is a savings plan that is sponsored by the state or a state agency, and it is used for college funds. The money in this fund can be used for tuition, books, and any other related expenses. Each state has these plans, and anyone over 18 can invest in one.
- Beneficiary and Eligibility. As long as you have a valid social security number, a valid United States mailing address, and you are over 18, you are eligible to open a 529 account. There are no income restrictions for this plan either. If you want to be a beneficiary, all you need is a valid social security number and to be over 18. You can even set up an account and name yourself the beneficiary.
- Investment Options. There are a few different account types you can choose to invest in. The age-based strategy invests in more conservative things as the investor ages. The custom investment lets you pick from Individual, Static, Age-Based, or Bank Deposits.
- Tax Advantages. Any funds that are put into this account are Federal income tax deferred, and they may also be eligible for several state tax deductions. Once the money is distributed for college expenses, it is considered to be tax-free by the Federal government.
Defined Contribution Plans
A Defined Contribution Plan works by you choosing how much you want to contribute out of your paycheck, and you employer will put the money into an account for you. This contribution happens through a payroll deduction.
- Beneficiary and Eligibility. As long as you have a steady job and your employer offers this type of account, you will be eligible to invest in it. You are named as the beneficiary on this account, and if you're married and something happens to you, your spouse will be slid into this spot. You also have the choice of naming another individual beneficiary.
- Investment Options. Your investment options depending on your employer. You will usually be given a few options to choose from, and once you pick one, the payroll deduction will start. Your employer may also choose to match any contribution you make into the account. You can also choose to use stocks, bonds, and CDs instead of cash contributions.
- Tax Benefits. This account is subject to both Federal and State taxes on an annual basis. You will also pay taxes when you withdraw the money in your retirement. However, most retirees are in a lower tax bracket, so you'll end up paying less if you withdraw it later than you would normally.
A Roth IRA is a retirement fund account, and you can contribute at any age as long as you have a steady income. These types of accounts make the most sense for investors who think their individual tax rate will be higher during their retirement than it was when they were working.
- Beneficiary and Eligibility. Roth IRAs have income eligibility limits, so if you make too much money, you won't qualify for this account. Your gross income must be less than $118,000 annually, and you can contribute a maximum of $5,500 per year. You are the beneficiary of the account unless you name someone else.
- Investment Options. You can invest in this account until you go over the maximum income limit, then you will have to roll it over into a traditional IRA.
- Tax Advantages. As long as you follow all of the IRS's rules for this account, it is entirely tax-free. There is no up-front tax deduction on this account, and your withdrawals are also free of taxes.
A traditional IRA account is one of the most common types of retirement account you can have. You contribute a portion of your paycheck into this account, and your employer will match it. It is a good idea to put the maximum amount in each year, so you don't leave money sitting unused.
- Beneficiary and Eligibility. If you choose to use this account, you are the beneficiary. If you're married and you die, your spouse will automatically be moved into the beneficiary position. You also have the option to name an additional beneficiary. To be eligible for this account, you have to have a steady job that takes taxes out of your paycheck.
- Investment Options. You can choose to invest cash into your IRA account, but you do have the option of other investment choices as well. You can pick things like bonds, CDs, stocks, or mutual funds.
- Tax Advantages. This account and whatever contribution you put into it is taxable with both Federal and State taxes. Your withdrawals after you retire are taxed at the ordinary tax rate, and if you find yourself in a lower tax bracket, you'll end up paying less overall.
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