As part of the portfolio management, we strive to make sure clients understand the huge tax advantages of properly preparing for retirement. Many investors lose out on the advantage of maxing out their contributions to their 401(k)’s and IRAs. A simple reallocation of funds to the proper Tax-Advantaged Retirement Accounts can create substantial current year tax savings and years upon years of tax-free earnings.
Most of allowed contributions to Tax-Advantaged Retirement Accounts have two advantages:
- Any money set aside into a tax-advantaged retirement account can usually be deducted from the current year’s taxable income depending on certain restrictions. By doing this, an investor is able to invest pretax dollars instead of post-tax dollars (typically 30% less after paying federal and state income taxes). In addition, the investor’s reduced taxable income should lead to a lower tax bill.
- The money in a Tax-Advantaged Retirement Account grow tax free. Any income or capital gains from the underlying investments are generally not taxed until retirement and upon distribution of the accumulated assets. Instead, the contributions are invested and grow tax-free over time. Upon retirement, the distribution from these accounts is taxed at ordinary income. Since most retirees have less income, the tax rate in retirement tends to be lower than during an individual’s peak earning years.
In addition, the repeated use of these tax-advantaged strategies over the long term has the potential to benefit from the Power of Compounding.