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How taxes can reduce your investment returns

The following example illustrates the effect of taxes on investment returns in a long-term account.

Let's say two people invested in the same mutual fund, but one invested through a 401(k) plan and the other invested in a taxable account.

To make the comparison fair, the ending balance in both accounts assumes the money was withdrawn and taxed at the appropriate tax rate. The taxable account was adjusted for the taxes owed on the growth—the capital gains rate of 15%; yearly distributions were taxed as they were realized.

This hypothetical example assumes an annual contribution of $4,000 (adjusted to $2,880 for the taxable account) and an 8% annual total return, 3% of which came from income (and was taxed annually at 15% in the taxable account). It is not representative of any particular investment.

Benefits of tax-deferred investing

The tax-deferred account grew to $1,036,226, or $880,792 when adjusted for taxes. The taxable account grew to $841,913, or $771,789 when adjusted for taxes.

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