It’s not important how much you make but how much you keep.
That’s why you need to take advantage of every legal and practical opportunity to reduce your tax bill and put your investible dollars into tax-free or tax-deferred products.
Our U.S. tax code allows you to save and invest to fund your retirement in accounts that are tax-advantaged. Anyone who is legally employed and earning an income can contribute to their employer-sponsored 401K (up to $18,000 for 2015) and also independent Retirement Accounts – IRA’s (up to $5,500). There are special catch-up provisions if you are over 50 (An additional $6,000 for 401(k) and an additional $1,500 for IRA).
You have a choice of 2 types of IRAs, a Traditional IRA or a Roth IRA. The Traditional IRA is tax deductible, while the Roth is not. The amount you contribute is deducted from your gross income and will reduce your tax bill. It will also increase the cash you have on hand.
Both of these accounts will grow on a tax-deferred basis. Your capital gains on assets held in 401K or Traditional IRA accounts are not taxed year to year. It makes sense not to give your yearly capital gains to the government. Instead, you can keep it in your account for tax-deferred compounded growth. When you make withdrawals, you will be taxed as earned income based on what your tax bracket is.
A person with a modified adjusted gross income (MAGI) of less than $129,000 to contribute to a Roth IRA, but anyone who earns an income can contribute to a Traditional IRA.
Early withdrawals are subject to penalties as these are both meant to be retirement accounts. The current retirement age in the U.S. is 59.5 years. Anyone younger will be subject to early withdrawal penalties. Early distributions or withdrawals may be subject to a 10% penalty of the amount withdrawn. A 10% penalty for a Roth IRA will apply for early distribution, but since the moneys contributed were after tax with no deduction, only the penalty applies.
The 10% penalty may be exempt due to death and disablement of the account holder. In that case the disabled person or surviving beneficiary will not have to pay the penalty for early withdrawal.
Each year you do not make use of these tax-advantaged accounts to the maximum, is a lost opportunity that cannot be recovered so don’t put it off. The savings you will lose may be substantial.
To make sure you are taking advantage of every tax investing opportunity you can, contact your tax adviser immediately.
If you have any questions or concerns about your tax situation related to investments, please call us.