How Tax deferral works... (MUST READ)

In a previous post I mentioned how the real secret of Warren Buffet riches is tax deferral, so what is exactly tax deferral and how does it differ from tax evasion?

First things first, Tax deferral is legal while tax evasion is not.

With the first you still promise you are going to pay your capital gain tax in full (let`s say 20% like in Japan) by the the time you cash everything in, but you postpone this payment till the last minute.

Some of you might be thinking "but if in the end I am going to pay anyway what`s the difference? and why go through the hassle?"

The difference is that at the end of day you will be left with what`s pictured below...

Do you want them too? Then read on!

Let`s see how you get this extra cash with an example. Mark and Phil two colleagues at the same company, both with $100.000 to invest.

Phil gives his money to a local bank, where they promise a gross 9% of interests (9% from a Bank??? yeah right... but... let`s just say they can for example sake...) from which, each year the 20% capital gain tax is automatically detracted (even if you do stock trading using a local platform, when you sell the stocks and cash the money in, they take 20% off the gain automatically, no questions asked no other options).

Mark on the other hand gives the money to a good IFA (International Financial Adviser) and will pay the 20% at the very end, behold the amazing thing that happens below:



At Year 01 Phil starts with $100.000 and after 12 months, at 9% growth, he reaches $109.000, but he has to pay taxes so minus (-) 20% Capital gain tax he's left with $107.200

Thus Year 02 starts with $107.200 which at 9% = $116.830 - 20% CapitalGain Tax = $114.904
(note that every year the capital gain tax is calculated only on the amount of capital gain generated that year)

Year 03: $114.904 at 9% = $125.245 - 20% CapitalGain Tax = $123.176

Year 04: $123.176 at 9% = $134.261 - 20% CapitalGain Tax = $132.044

Year 05: $132.044 at 9% = $143.127 - 20% CapitalGain Tax = $141.689

So after 5 years Phil is sitting on $141.689, let`s see how Mark would be doing in case he decides to cash in his investment (which is growing tax free at the moment) after 5 years.
Due to the magic of compound interests he gets $56.568 of growth, ($156.568 total) and after paying 20% of capital gain tax he's left with 145.254, almost $4000 more in his pockets.

Although they are both tax compliant, by just being smart, Mark is going to Yodobashi Camera and get a 60" 4K TV "for free" ;)

Now, how much would the difference be after 10 years? $8000 I hear? NOT - EVEN - CLOSE

The difference after 10 years is a staggering $29.000!!!





Again here are the calculations:


Year 06 starts at $141.689 for Phil, at 9% = $154.441 - 20% CapitalGain Tax = $151.890

Year 07: $151.890 at 9% = $165.560 - 20% CapitalGain Tax = $162.826

Year 09: $162.826 at 9% = $177.480 - 20% CapitalGain Tax = $174.549

Year 10: $174.549 at 9% = $190.258 - 20% CapitalGain Tax = 187.116

Mark, with tax free growth reaches 245.135 if he decides to cash in, he pays his 20% and he's left with $216.108 a $29.000 difference even though they both paid 20% of taxes and are 100% compliant.

Now Mark can get a pretty decent car with the extra money...

You see where I am getting but let`s make one last projection to 20 years just for fun!

(you can skip below to see the results, I won`t tell anyone ;) )


Year 11 for Phil starts at $187.116 at 9% he gets $203,956 - 20% Capital gain tax, he's left with $200.588

Year 12: $200.588 at 9% = $218.640 - 20% CapitalGain Tax = $215,030

Year 13: $205.030 at 9% = $224.382 - 20% CapitalGain Tax = $220.511

Year 14: $220.511 at 9% = $240,356 - 20% CapitalGain Tax = $236,387

Year 15: $236.387 at 9% = $257.661 - 20% CapitalGain Tax = $253,406

Year 16: $253.406 at 9% = $276.212 - 20% CapitalGain Tax = $271.650

Year 17: $271.650 at 9% = $296.098 - 20% CapitalGain Tax = $291.208

Year 19: $291.208 at 9% = $317.416 - 20% CapitalGain Tax = $312,174

Year 20: $312.174 at 9% = 340.269 - 20% CapitalGain Tax = 334.650

So it`s time to retire, Phil looks at his pot and sees $334.650, he paid taxes every year, on the other end Mark reaches a gross total of $560.441 due to the exponential effect of (tax free) compound interests, he cashes in and pays 20% capital gain tax on the whole growth which sets him back a whopping $92.088, the good news is, he is left with $468.352, he paid his taxes just like Phil, and yet, he is $133.702 richer.

So, who do you want to be in your life, Mark or Phil?


P.S
I forgot to mention that at the very last year Mark changed his residence to a place where there are no capital gain taxes whatsoever (in the end you don`t know where you will be 20 years from now and you can decide for yourself...)


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