For as long as men have ruled other men, taxes have been a necessary way of life. They fund the government and provide the civil services that we depend on in our everyday lives. But as important of a notion as that is, no one likes paying them. It’s something that we just have to do … but not always. If you’d like to hang on to your money, then look no further than your retirement accounts to find the best tax saving investment – your IRA and 401k.
Why a Retirement Account is the Best Tax Saving Investment:
The biggest advantage to using your IRA, 401k, and other retirement accounts is this:
- Tax sheltering
By putting your money into a tax sheltered savings account, the U.S. gives you the special privilege of deferring your tax payments until you finally withdraw the money in retirement. Although this sounds minor, it really is quite a powerful incentive!
Here is an example:
The current IRS savings limits are $17,500 for a 401k and $5,500 for an IRA. Suppose we have two people in the same tax bracket (about 25%):
- Person A takes the money they get from their paycheck and puts the equivalent of this money into a regular taxed brokerage account.
- Person B designates the money to go straight into their tax sheltered savings account. This means the money gets deducted from their paycheck from their gross pay before taxes are taken out, and they get a tax deferred adjustment for the contributions made to a traditional IRA.
Now let’s suppose both invest in identical investments that bring in the same 8% return. Who do you feel will make the most money after 30 years and by how much?
How Much More You Gain with Tax Savings:
Wow! By not having to pay taxes on both the principle (the money you put in) and the capital gains (the amount of money that the stocks grew), you could almost finish with DOUBLE what you would have! That should be some pretty powerful motivation.
Remember – You Still Have to Pay Taxes:
One thing to keep in mind is that you will eventually have to pay taxes on the retirement account money once you finally take portions of it out to live on. With the taxed accounts, you won’t have to pay taxes on the money you take out because you already paid taxes on it once.
This is the other side of the coin and can be a pretty significant consideration if you plan to be in a higher tax bracket when you are older. For example: Let’s say in 30 years that you are significantly richer then than you are now. (Congratulations!) With that said, would you rather pay 25% in taxes or 35% in taxes?? In this case, there may have been some advantage to paying taxes on the money earlier in life rather than later. This is where a Roth IRA may help.
However, let’s get back to one more advantage of having tax saving investments. Person A even after they retire will have to pay taxes on the investment growth even if he doesn’t use his money for retirement. Person B will pay taxes only on the money they take out while everything else will continue to grow tax free. Again, that can be pretty significant in terms of making your money last for the rest of your life!
Take advantage of the best tax saving investment and put your retirement accounts to work for you. You can’t really afford not to!
Image courtesy of FreeDigitalPhotos.net
Ryan @ RLD Investments says
There are a lot of options out there for the astute investor. I’ve found while I explain things and advise people is that it isn’t too difficult for them to understand, they just never learned. I am a big advocate for teaching people about what their options are, not just telling them what to do. Great post.
Oh, I believe retirement can really be daunting and hence long term plan works best in having a retirement account. Considering the advice from my father I have been trying to assess what will be my income requirement at that point of time, all about assets, plan out a balanced portfolio which will not disturb my income from market upspring and allow me to keep up with inflation and even consider applying for supplementary health insurance, etc.