Everyone hears about “the magic of compounding” and nobody feels it in their account. Run the numbers to the end and there are two reasons — the horizon is too short, and tax takes a cut every year.
1. What it's worth. On $1,000 at 5%, compounding beats simple interest by $2.50 at year two — and by $1,821.94 at year thirty. Compounding is invisible early and steep late.
2. Where it leaks. Tax takes a cut every year. At Korea's 15.4% deducted annually, $856.31 of that $1,821.94 is gone by year thirty — nearly half — because what is taken never earns interest again.
3. What to do. CFPB splits saving from investing by time, not by return: five years. Money you need within five years belongs in savings, where the lower return is a condition, not a penalty. And compare after tax, not before.
What follows works both through. CFPB's own page stops at year two, where the whole advantage is $2.50 — too small to feel like anything.
“Compound interest is when you earn interest on the money you've saved and on the interest you earn along the way.”
The example — $1,000 at 5% becomes $1,050 after one year ($50 of interest) and $1,102.50 after two ($52.50).
“Increasing the compounding frequency” is named as one way to “help your savings grow even faster.”
— Consumer Financial Protection Bureau, How does compound interest work? (reviewed October 19, 2023)
The problem is that $2.50 at year two looks like the whole of compounding. So we took the same example and ran it out to thirty years.
What it becomes at 30 years
| Period | Compound | Simple | Difference |
|---|---|---|---|
| 1 year | $1,050.00 | $1,050.00 | $0.00 |
| 2 years (where CFPB's example ends) | $1,102.50 | $1,100.00 | $2.50 |
| 5 years | $1,276.28 | $1,250.00 | $26.28 |
| 10 years | $1,628.89 | $1,500.00 | $128.89 |
| 20 years | $2,653.30 | $2,000.00 | $653.30 |
| 30 years | $4,321.94 | $2,500.00 | $1,821.94 |
The arithmetic. Compound = 1,000 × 1.05n; simple = 1,000 + 1,000 × 0.05 × n. We kept CFPB's own conditions — $1,000 principal, 5% a year, compounded annually — and changed only the period. Since the source stops at year two, everything from year three on is our calculation.
And tax takes a cut every year
The table above assumes no tax. In reality tax comes out each time interest is paid, and what leaves cannot earn interest the following year. That is how tax eats compounding.
We verified the rate against source text. The interest row of Korea's National Tax Service withholding-rate table reads “other interest income — 14%” (ordinary deposit and savings interest falls here). The commonly quoted 15.4% is explained as that plus 1.4% local income tax, but local income tax does not appear in that table. The figures below use 15.4% (14% verified + 1.4% assumed).
— National Tax Service (Korea), Filing Guide > Corporate Filing > Withholding Tax > Basic Information > Rates — “Withholding Tax Rates,” residents and domestic corporations
Note that the worked example is American (CFPB, dollars, 5%) while the tax rate is Korean. We are stating that plainly — the point is to show how tax erodes compounding as a structure, not to model the after-tax return of a US account.
| Period | No tax | 15.4% taken annually | Reduction |
|---|---|---|---|
| 5 years | $1,276.28 | $1,230.17 | −$46.11 |
| 10 years | $1,628.89 | $1,513.31 | −$115.58 |
| 20 years | $2,653.30 | $2,290.10 | −$363.20 |
| 30 years | $4,321.94 | $3,465.63 | −$856.31 |
Over thirty years, $856.31 of the $1,821.94 that compounding earned over simple interest — close to half — disappears into tax. That is part of why “the magic of compounding” feels weaker in an actual account than on paper. Run your own after-tax comparison in the interest calculator.
The rate taken each year never changes, yet the share it costs you grows with time.
CFPB draws the line at five years
So what separates saving from investing? In CFPB's educator material the dividing line is time, not return.
| Item | Saving | Investing |
|---|---|---|
| Purpose | “Short-term financial goals such as a vacation or a down payment on a car” | “Long-term financial goals that may take five or more years to achieve” |
| Horizon | Up to five years | Beyond five years |
| Risk | Bank and credit union products are federally insured up to $250,000 | “Investments aren't insured, and you could lose some or all of the money you invested because of market changes” |
| Access | “Easy access to the money” | Less readily accessible |
| Return | “Usually are relatively low” | “May earn a larger financial return” |
The split is not “which is better” but “when will you need the money.” Moving a deposit you need in three years into investments because the return looks better is, by this framing, filing it in the wrong column. Deposit insurance limits differ by country — check your own separately.
“Five years” comes from a US agency's educator material. Read it less as a hard boundary and more as a number standing in for the principle that the closer you are to spending the money, the less its principal can be allowed to move.
Here are CFPB's four items, placed on either side of the line.
So the order is
| Step | What | Basis |
|---|---|---|
| ① Fix the spending date first | Within five years, or after? | CFPB text |
| ② Within five years → save | The low return is not a penalty but a condition | CFPB text |
| ③ Look after tax | Tax leaves annually, and what leaves never earns again | Our calculation |
| ④ Beyond five years → investing territory | But “you could lose some or all of the money” | CFPB text |
| ⑤ If you carry debt, compare first | Repaying a loan is closer to a certain return | Pay down vs save |
Questions this raises
Why do installment and lump-sum deposits pay differently?
An installment plan puts money in month by month, so the final contribution earns only one month of interest. At the same headline rate, a lump-sum deposit earns more. Compare the actual figures in the deposit maturity calculator.
Does compounding frequency matter?
CFPB names “increasing the compounding frequency” as a way to grow savings faster. But no daily/monthly/annual comparison appears in the source. The calculations above use annual compounding.
So should I invest?
CFPB's line is about horizon, not encouragement. The same material states plainly that investments “aren't insured, and you could lose some or all of the money you invested.” This article is information, not investment advice.
I have debt — should I still save first?
In the CFPB experiment, over 90% of participants put some savings toward the debt. The full comparison is in paying down versus saving.
Compounding is nearly invisible at the start. Where CFPB's example ends, at year two, the whole advantage is $2.50. Run the same conditions for thirty years and it is $1,821 — and tax takes close to half of that.
Sources
- Consumer Financial Protection Bureau — How does compound interest work? (reviewed October 19, 2023). Source for the definition, the $1,000 at 5% example ($1,050 and $1,102.50), and “increasing the compounding frequency.” The example on that page stops at year two.
- Consumer Financial Protection Bureau — Comparing saving and investing (educator guide) (Spring 2023). Source for “short-term financial goals such as a vacation or a down payment on a car” versus “long-term financial goals that may take five or more years,” the $250,000 federal insurance, “investments aren't insured…”, and “returns on savings products usually are relatively low.”
- Consumer Financial Protection Bureau — Experiment suggests people pay down debt but keep savings cushion (January 26, 2021). Source for the “over 90 percent” figure quoted in the FAQ above.
The tax rate comes from the National Tax Service (Korea), “Withholding Tax Rates” page (Filing Guide > Corporate Filing > Withholding Tax > Basic Information > Rates), the “residents and domestic corporations” table — “other interest income 14%.” Local income tax does not appear in that table.
Where to check further
- Korean deposit rates and the Korean protection limit. The 5% here is CFPB's illustrative figure and the $250,000 is US federal deposit insurance. Korean rates are comparable product by product on the FSS “Financial Products at a Glance” site, and the Korean limit is covered in our deposit protection article.
- When the tax is actually deducted. The after-tax table assumes it comes out of each year's interest. Many products tax once at maturity instead, which changes the result — check the product disclosure for the interest payment cycle and the taxing point.
- The basis for the 1.4% local income tax inside 15.4%. The NTS withholding table confirms only 14% on interest income. The Wetax local income tax guide is where to cross-check the rest.
Written as of July 2026. The definitions and the dividing line come from CFPB source text; the figures from year three on, and the after-tax calculations, are ours under the stated assumptions. If you also carry debt, see paying down versus saving; for changing loan terms, refinancing. This is general information and not investment or financial advice.
