You worked hard for your money. Tax-advantaged accounts can help you save more of it.
In November 1789, Benjamin Franklin wrote to Jean-Baptiste Le Roy, his French scientist and friend, about the recently revised government in the United States. He stated that, “Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.” Nearly 230 years later, Franklin’s sentiments hold true. Indeed, the constitution remains in-place, but only death and taxes are assured.
Death and taxes are inevitable. They can be postponed, but never eliminated. It’s true that we can delay our expiration date, but even eating healthy, exercising and living a less stressful life has its limitations. The circle of life will eventually overpower the fountain of youth. Additionally, the government is going to take their cut of your income one day; however, unlike death, you can not only postpone them but also decide when you would like to pay them.
As a financial advisor, one of the easiest ways I see people delay taxes is by contributing to a tax-deferred savings account. By saving in a tax-deferred account like an Individual Retirement Account (IRA) or employer-sponsored retirement plan, such as a 401(k), 457 or 403(b) plans, you get to save for your future while reducing your tax burden today: truly a win-win.
Example of How Tax-Deferral Works
Let’s say you save $5,000 in a tax-deferred savings account (like a 401(k) plan or an IRA account) during the year. That contribution will lower your annual taxable salary by $5,000. If you topped out in the 24% federal income tax bracket, this $5,000 contribution would save you $1,200 in Federal taxes.
$5,000 X 24% (Your Hypothetical Top Tax Bracket) = $1,200 Savings.
All things being equal, the more money you save in a tax-deferred account, the more you reduce your taxes today. But that is not all!
Not only can you reduce your taxes, but your savings can grow tax-deferred. Your investment returns will be free to compound, and no taxes will be imposed until after you withdraw money from your tax-deferred account (hence the name tax-deferred). Contributing to a tax-deferred account is like eating broccoli and exercising… it not only delays the inevitable, but also provides added benefits in the meantime.
Tax Exempt Savings Accounts
In the movie, the Curious Case of Benjamin Button, Benjamin lives his life in reverse – starting out as an old man in a nursing home and ending as an infant. Tax-free savings accounts are the Benjamin Button of retirement accounts. Your taxes are paid upfront (when you make the contribution), but there are absolutely no taxes later (if you follow the withdrawal requirements).
By saving in a tax-free account like a ROTH (IRA) or employer-sponsored retirement plan such as a Roth 401(k), or Roth 403(b) account, you pay taxes now while eliminating your future burden. Your contributions and investments in Roth accounts grow tax free, unleashing the full power of compound interest (growing returns with absolutely no future tax burden).
Benjamin Franklin is best known as the only Founding Father who signed all three documents that freed America from Britain, but he was also an avid believer in the power of compound interest. It was his ideas that inspired me to write the 3 Simple Steps to Become a Millionaire. Therefore, I suspect Mr. Franklin would have appreciated the opportunity to save in these tax-advantaged accounts had they been available over two centuries ago. To that extent, I highly recommend that you consider the benefits of these savings accounts and what they can do for you. Let’s just say that anytime I have followed in the footsteps of Mr. Franklin, it has certainly helped me save and grow my own Benjamins.
Your Tax Advantaged Accounts Checklist
How can you get started with these tax advantaged accounts? Here is a simple starting checklist:
Check with your employer. Most companies offer tax advantaged plans, such as a 401(k), 457 or 403(b). If you are a small business owner, you could consider opening a SEP-IRA or Solo 401(k).
Ask if your company offers an employer match! Many companies will match a portion of your contributions – take advantage of this free money by contributing, at minimum, up to the match-amount or percentage!
If your company doesn’t offer these benefits, open up your own tax-advantaged account i.e. Individual Retirement Account (IRA) or Roth IRA and begin contributing.
If you would like to discuss how you can use these tax advantaged accounts can help grow your own wealth, you are welcome to shoot me an email or give me a call anytime.
Thank you for reading!
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