Well, the IRS will count interest as income. So if you put

Posted on: April 10, 2024 at 20:52:10 CT

$500,000 into a CD earning 5% you would have $25,000 in interest income that would go on your tax form, assuming it wasn't tax deferred. You would have to pay tax on your income, even if the value of the money you receive is less than it was when you invested it.

If there was a 10% inflation rate the value of your $525,000... the purchasing power, would be roughly the equivalent of what $472,500 could have purchased the prior year... so you lost ground financially.

But the government would say that you owe taxes on that $25,000 "income" you earned. If you had a 50% marginal tax rate on that income, you would have to pay the IRS an additional $12,500 in taxes because of the interest on that CD.

So after taxes, that CD would in essence be a $512,500 asset for you. But if inflation took 10% of the value away, it would now have the purchasing power that $461,250 would have had the prior year. You feel great that you earned 5% on your money, but in reality you are losing ground financially. You started with $500,000 in purchasing power, and a year later, after interest and taxes you are left with the equivalent of $461,250 purchasing power in the year you started.

You may feel like you are increasing your wealth, but in reality lost $38,750 in purchasing power.