This is an annualized after-tax return of 7.81 percent. Deferring the payment of capital gains taxes increased the expected after-tax return from 7.60 percent to 7.81 percent. This reduced the effective tax rate to 21.9 percent. Extending the example to 10 years produces an expected after-tax return of 8.03 percent, an effective tax rate of 19.7 percent. A 25-year holding period produces an 8.47 percent expected after-tax return, an effective tax rate of 15.3 percent. Deferral reduces the impact of capital gains taxes. Disposal The previous example assumed that the investor would sell at the end of the horizon. What if the investor did not sell? There are only four ways an investor can dispose of a security: Sell it, give it to an heir while the donor is alive, give it to an heir upon the donor's death, or give it to a charity. Only selling requires immediate payment of capital gains tax. If the asset is transferred to an heir while the donor is alive, the heir assumes the existing cost basis of the asset. If the asset is given to charity or held until death, capital gains taxes are avoided. Many wealthy investors will not consume much of their wealth, and therefore many of their assets may be disposed of by death or charitable giving. We will use the term bequest mode to describe the situation in which an investor expects to eventually dispose of an asset in a way that does not require the payment of capital gains taxes. This is the alternative to liquidation mode in which an investor is managing an asset with the expectation that it will eventually be sold. In this case, capital gains taxes can be deferred but ultimately must be paid. Referring to the tax options described earlier, an investor in liquidation mode may employ the timing option to defer capital gains tax and thus achieve a greater after-tax return. An investor in bequest mode can derive more benefit from the timing option by combining it with the disposal option. A buy-and-hold strategy can be particularly powerful when an investor is operating in the bequest mode. The after-tax expected return of the index fund is 9.2 percent in the bequest mode regardless of holding period. There is ongoing taxation of dividends while appreciation is not taxed. The effective tax rate is only 8 percent. This assumes that all appreciation TABLE 29.2 Expected Growth in Market Value and Cost Basis       Income Cost Market Year Dividend Tax Basis Value 0     100.00 100.00 1 2.00 0.80 101.20 109.20 2 2.18 0.87 102.51 119.25 3 2.38 0.95 103.94 130.22 4 2.60 1.04 105.50 142.20 5 2.84 1.14 107.21 155.28