Asset Accumulation

What Is Asset Accumulation?

Asset accumulation is building wealth over time by earning, saving, and investing money. It can be measured by the total dollar value of all assets, by the amount of income that is derived from the assets, or by the change in the total value of the assets over a period of time.

Understanding Asset Accumulation

Asset accumulation typically refers to the acquisition of financial assets that represent value or yield income. The income may include interest payments, dividends, rents, royalties, fees, or capital gains.

These assets derive their value through a contractual claim rather than a tangible quality. Examples of non-physical financial instruments include stocks, bank deposits, and bonds.

For businesses, asset accumulation can also, less commonly, refer to the accumulation of the tangible means of production, such as factories or research and development, as well as physical assets, such as real estate.

Asset Accumulation and Retirement

Retirement plans today are the most common method of asset accumulation for individual investors. In the United States, retirement plans are typically classified as either defined-benefit or defined-contribution plans.

A defined-benefit plan is essentially a pension plan. Asset accumulation decisions are largely handled by pension fund administrators, who collect money, make investments, and reinvest returns. There are no separate accounts for individual participants.

In a defined-contribution plan, each participant has an account, and asset-accumulation decisions, including how much to save and how to invest or reinvest, are handled by the participants. Individual retirement accounts (IRAs) and 401(k) plans are defined contribution plans.

Some types of retirement plans, such as cash-balance plans, combine features of both defined-benefit and defined-contribution schemes.

Tax Breaks to Encourage Asset Accumulation

Retirement plans in the U.S. have meaningful tax breaks that are designed to encourage asset accumulation. In the case of traditional IRAs and employer-sponsored 401(k) plans, the money contributed to the retirement account is not taxed as income at the time that it is contributed, up to annual limits.

In employer-sponsored plans, the employer also receives a tax deduction for any amounts that it contributes as part of its employee compensation package. This is known as a pre-tax contribution, and the amount allowed varies significantly among retirement plan types.

Another significant tax advantage in traditional IRAs and 401(k) plans is that the money in the account grows through investing without being taxed on the annual growth. Once the money is withdrawn, it is taxed as income for the year that it is withdrawn.

The Roth Alternative

Roth IRA and Roth 401(k) plans are an alternative to these traditional plans.

In the Roth plans, the tax advantages are essentially reversed: Contributions to the accounts are made in income that has already been taxed, while withdrawals after retiring are tax-free.