Tax-Advantaged Retirement Investment Planning
Tax-advantaged retirement savings plans
You may have the opportunity to make investments into both individual retirement accounts (IRA) and into employer or self-employed tax-advantaged retirement plans, such as a 401k, 403b, 457, Keogh, Simple, or other employer sponsored retirement plan. In general, if your net wage and salary earnings after living expenses will provide enough free cash flow, most retirement investment advisers would recommend that you make the full contributions each year into both individual retirement accounts and employer tax-advantaged retirement investment plans throughout your years of employment up to when you retire.
Even when you find that your annual contributions to such individual and employer sponsored retirement plans would not reduce your current annual income subject to current income taxation, very often it still makes long-term retirement financial planning sense to make these IRA and employer plan contributions, since future appreciation of your tax-advantaged assets would be sheltered from ongoing taxation.
Academic studies also indicate that it usually only takes a few years of non-taxed investment growth within tax-advantaged retirement plans to overcome the 10% federal penalty for withdrawals before age 59 and 1/2. For the vast majority of people, it tends to be unlikely that they would need emergency access to these tax-advantaged assets in the few year period before their tax savings would reach the break-even point versus this potential early withdrawal penalty. Thus, from a variety of points-of-view, maximizing available tax-advantaged plan contributions year after year tends to be a better lifetime financial planning strategy.
Tax-advantaged retirement savings plan rules are complex
The complexity of US income tax rules related to individual retirement account and defined contribution employer sponsored retirement plans simply cannot be understated. The highly complex and confusing retirement investment tax mess that Congress has developed over time for US citizens to cope with is simply idiotic. Nevertheless, it is what it is, and all you can do is to try to understand the rules and to optimize your retirement investment strategy within these rules.
The best way to understand these topics yourself is to download Publications 560 and 590 from the IRS website. These tax publications are long and involved, so grab some coffee and dedicate a few hours to the task of learning about US retirement plan taxation. Grab some aspirin, if needed, but keep at it.
This can be a very valuable expenditure of your time, particularly if you have ever asked these questions: “how much do I need to save for retirement?” or “how long will my money last in retirement?” It does not take much reflection to realize that the answer to these questions would depend greatly upon whether your retirement savings account assets are “pre-tax” or “after-tax.” The pre-tax or after-tax income tax status of your retirement portfolio can make a huge difference in determining how much to save for retirement!
For those of you who are self-reliant and would like to find the answers for yourself, you really need an automated retirement savings calculator and retirement income calculator with sophisticated saving for retirement calculator functionality including fully integrated lifetime retirement tax calculator capabilities. (Here is a hint: poke around on the blue pull-down menu bar of this website, and you will find just what you need right here. The VeriPlan retirement planning software integrates, automates and hides these complex US tax-advantaged retirement investment plan rules, allowing you to stop guessing and to focus on making more optimal lifetime financial planning decisions.)
Traditional tax-advantaged employer sponsored plan and IRA contributions versus Roth retirement account investments
The multi-page article that follows provides information that will allow you to understand better the trade-offs between “traditional” and “Roth” tax-advantaged retirement accounts. Understanding the trade-offs between traditional IRA and 401k retirement contributions versus Roth 401k retirement plan contributions and Roth IRA contributions requires automated analysis of all the factors over one’s lifetime that impact this decision. Back-of-the-envelope calculations can easily be simplistic, incorrect, and deceptive. This decision can only properly be made with the assistance of a comprehensive retirement plan calculator tool.
If you do not have access to an IRA retirement calculator, 401k retirement calculator, or other retirement fund calculator that can do this analysis for you, you really should acquire such a retirement planning software tool. The dollar amounts involved can be very large over a lifetime, and the best retirement calculator can help you to determine the advantages of one choice over another. Following uninformed instincts and assumptions could lead you to pursue a highly sub-optimal retirement savings plan, and over your lifetime you might accumulate many, many thousands of dollars less than you could have saved with a more optimal tax-advantaged retirement investment strategy.
Generally, for the projected lifetime financial circumstances of the majority of Americans, a retirement plan calculator tool would develop lifetime projections indicating that it would be more advantageous to make contributions into traditional tax-advantaged retirement accounts rather that into Roth tax-advantaged retirement accounts. This tends to be true, whenever a person saving for retirement can take advantage of the current tax deductibility features of traditional tax-advantaged IRA, 401k and other retirement account investments. However, note that when retirement savers cannot a) take advantage of current tax deductibility to reduce their current taxable income and b) their earned income and cash flow still allows for some level of retirement plan contributions, then Roth contributions are preferred, if the tax rules allow the person to make Roth retirement plan contributions.
While a sophisticated and automated retirement plan calculator tool usually indicates that retirement savers should prefer to make traditional retirement plan contributions (versus Roth contributions) to reduce current taxable income, you should monitor the situation each year to understand the rules in effect in a particular tax year. Unfortunately, while tax-advantaged retirement plan account rules are already complex, some of the rules have been shifting from year to year. You need to keep paying attention to maintain an optimal tax-advantaged retirement savings plan strategy.
The following pages of this multi-page retirement financial planning article will provide some very useful information allowing you to understand better the trade-offs between “traditional” and “Roth” tax-advantaged retirement accounts. A subsequent article also discusses the estate planning and inheritance advantages of Roth retirement savings accounts, which can be very substantial, if your assets are likely to out-live you.
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About the author
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