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Money Smarts
Chapter 5 Money Smarts: Future Buying Power
Will a dollar buy as much next year as
it buys today? Inflation is the general rise in the
level of prices for goods and services over time. High rates
of inflation can greatly reduce the future buying power of
your savings. If the inflation rate is high, the buying power
of one dollar today may only be 65 cents ten years from now.
Taxes can also reduce the amount available
from your earnings because you generally must pay taxes on
those earnings. If you can delay paying taxes by using tax-exempt
or tax-deferred savings accounts, you will have more income
available each year to earn additional interest. Tax-exempt
income is income that is not taxed. Tax-deferred
income is income that will be taxed at a later date.
Go to the BusinessWeek Online
Personal
Finance Planning calculators. Scroll down to the Savings
Calculators and click on “How will taxes and inflation
affect my savings?”
Input the following values:
| Amount you have invested |
$2,500 |
| Years invested |
25 |
| Your savings rate |
6.00% |
| Your federal tax rate |
15.00% |
| Your state tax rate |
6.80% |
| Inflation rate |
3.00% |
Click on the “get your results”
button and answer the following questions.
- How much will your investment be worth after taxes, ignoring
inflation?
- What is the value of your investment after taxes and
after adjusting for inflation? By what amount does inflation
reduce the value of the investment?
- How much will your investment be worth if you don’t
have to pay taxes? How much will it be after adjusting for
inflation?
- Click on the INPUTS tab and change the inflation rate
to 5 percent. When compared to Question 2, how much will
a 2 percent increase in the inflation rate reduce the worth
of your investment after taxes?
- Is this a good investment if the inflation rate is 5
percent? Why or why not?
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