Question

Assume that Congress is considering several new tax provisions to encourage savings. Each of the proposed structures allows an individual to invest up to $18,000 of annual earnings in a savings plan which allows no current deduction. Which structure employs the time period variable to provide a tax incentive to save?

Answer 1

The structure using the time period variable for encouraging savings is similar to 401(k)s or IRAs, where funds grow tax-deferred and taxes are only paid on withdrawal in retirement.

Step-by-step explanation:

The tax structure that employs the time period variable to provide a tax incentive to save does so by encouraging individuals to invest their money for a long period before it is taxed. This structure operates similarly to 401(k)s and Individual Retirement Accounts (IRAs), where contributions are made with pretax income, and the assets within the account grow tax-deferred until retirement. This means that the taxes on the earnings are not paid until the money is withdrawn after retirement, ideally at a lower tax bracket due to a reduced income, thus offering a significant tax incentive to save. The power of compound interest also plays a critical role in this process. If, for example, a person starts saving early, the money invested accrues interest upon interest over the years, leading to a more substantial growth of the saved funds.