For the past 7 years, George and Sue have deposited $10,000 in a retirement account with a simple interest rate of 4%. They plan to continue to make annual deposits for the next 15 years. Explain how their money will grow over time. Note: You do not need to extend their entire savings for 22 years in your explanation. Focus on the earning for the first several years and explain how their money will grow.

Accepted Solution

George and Sue's money will grow due to both to their contributions and the simple interest that they accrue. Simple interest means that the interest they receive will be applied to the principle, but not the interest that has been accrued. This means that for every $10,000 they put in, they will receive $400 dollars in interest every year, and this number will not change with time.

Right now, they've deposited 10,000 every 7 years for a total of 70,000 dollars. Their annual interest therefore is 400 * 7 = 2800. With every 10,000 dollars they deposit, the yearly interest will grow by $400. This is different from compounding interest, in which annual interest will grow by more than $400 dollars every year since the rate will be applied to principle and all accrued interest.