Do you want to make money every time you add a contribution to your retirement account regardless of what you invest in? Of course you do — we all do! — and no, this isn’t a hot stock tip or sales gimmick to get you to buy a “how-to” special report. Hot tips and sales gimmicks might be fun, but they rarely pay off. This is just boring math. Fortunately, it’s easy math!
To get started, let us assume that taxes = lost money. Therefore, fewer taxes = more money. More money = higher returns. For this example, we will consider higher or lower returns as a function of completing a successful tax-management strategy with your money.
Let’s pretend you are in the 25% federal tax bracket today. Assume that when you retire, you will have less income and that you will be in the 15% federal tax bracket. This means any money you save into your retirement account today avoids paying tax at 25% and when you cash it out in retirement, it is at the lower 15% income tax. This scenario assumes you budget your withdrawals throughout your retirement years. That’s a 10% return on the money you put into the retirement account, AND you get all of the interest you earned on the initial 25% tax savings since the date of contribution at the 15% tax rate!
Now let’s pretend you are in the 15% federal tax bracket today and will retire in the 25% federal tax bracket. First, congratulations on your future financial freedom. Nice work! Second, consider a ROTH contribution. ROTH contributions are post tax, meaning that you pay the tax today at your current tax rate but get to take the money out after age 59.5 tax free! So you pay taxes at 15% now and get it back in the future along with every cent you’ve made on it tax free!
The US tax code is obviously a little more complicated than these simple examples, and that’s why financial advisors and CPAs are available to help. Please seek professional advice prior to initiating these types of strategies. S.E.E.D. is available to help you.