Tips for in­creas­ing your re­tire­ment nest egg

THE SMART WAY TO PAY TAXES ON RE­TIRE­MENT SAV­INGS

Inc. (USA) - - CONTENTS - BY KATHY KRISTOF

TAX SEA­SON IS COM­PLI­CATED enough with­out your hav­ing to worry about re­tire­ment plan­ning. But if you want to max­i­mize your fu­ture spend­ing money, this is ex­actly the right time to re­view the taxes you’re pay­ing— or not pay­ing— on what you’re saving.

Just ask Phil Holt­house, co-founder of Los An­ge­les ac­count­ing firm Holt­house Car­lin & Van Trigt. You should never “let the tax tail wag the in­vest­ment dog,” he says, but that doesn’t mean you should ig­nore the is­sue, ei­ther. “No one wants to pay more than the law re­quires, but a lot of peo­ple do,” he says.

Struc­tur­ing your re­tire­ment ac­counts with taxes in mind can land you hun­dreds of thou­sands of dol­lars more in spend­ing power. And it can en­sure that you have the right amount of money at the right point in your re­tire­ment.

Prepar­ing fi­nan­cially for life af­ter work re­quires dif­fer­ent strate­gies over the course of your ca­reer. You’ll start in the early “poor but smart” stage, when tax breaks can help you save more, and even­tu­ally grad­u­ate to the “fab­u­lous 50s,” which many be­lieve are your prime sav­ings years: You’ll be earn­ing more and should have al­ready paid for big expenses, like your house and col­lege for the kids. To pay the least tax in each of these pe­ri­ods, you’ll need to di­ver­sify your sav­ings—and your tax bur­den—right now, so that you’re spread­ing out what you pay on it. In brief: Put some money into reg­u­lar bro­ker­age ac­counts, which are taxed on a more imme- di­ate ba­sis than re­tire­ment ac­counts; put some money into tax- de­ferred re­tire­ment ac­counts, such as tra­di­tional 401(k)s and SEP-IRAs, which al­low you to re­duce the in­come taxes you pay right now; and don’t for­get to put some money into tax-free re­tire­ment ac­counts, such as Roth IRAs, which al­low you to with­draw money later with­out pay­ing taxes on it.

How much to put where, and when, varies for ev­ery­one, of course, but this three-step primer can get you started on a smart re­tire­ment tax strat­egy.

STEP ONE Start out with tra­di­tional re­tire­ment ac­counts

Think 401( k)s, SEP-IRAs, and Roth IRAs. When you’re just get­ting your busi­ness off the ground, you prob­a­bly be­lieve you don’t have a lot of money to set aside for re­tire­ment. But ac­tu­ally, this is ex­actly when you should be tak­ing ad­van­tage of tax breaks for your re­tire­ment plan­ning. At this stage, in­vest­ing in a tax- de­ferred re­tire­ment ac­count like a 401(k) puts more

money in your pocket and al­lows you to boost your sav­ings rate.

Con­sider two hy­po­thet­i­cal 30-year-olds, John and Jane, who both earn $110,000 an­nu­ally and are in the 28 per­cent fed­eral in­come tax bracket. John con­trib­utes $1,000 a month to an or­di­nary bro­ker­age ac­count, for which he pays an­nual taxes on his in­vest­ment earn­ings. But Jane puts the same amount into a SEP-IRA, a re­tire­ment plan for self-em­ployed in­di­vid­u­als that al­lows her to deduct these con­tri­bu­tions from her tax­able in­come. So the fed­eral gov­ern­ment acts as if she had earned a lower in­come than John, which cuts her fed­eral tax bill by $3,360 an­nu­ally. (If she lives in a state that im­poses in­come taxes, her tax sav­ings are even greater.)

Jane can go a step fur­ther and put that $3,360 into a Roth IRA. (Such ac­counts are avail­able only if your an­nual in­di­vid­ual in­come is un­der $133,000 when sin­gle, or $196,000 when you’re mar­ried and fil­ing jointly.) When she even­tu­ally re­tires, she won’t have to pay taxes to with­draw money from that Roth IRA. And if she puts the same amount away every year, as­sum­ing av­er­age an­nual stock mar­ket re­turns of 8 per­cent, she could wind up with an ad­di­tional $640,000 or more in re­tire­ment sav­ings by age 65.

STEP TWO As you get older and richer, add a tax­able bro­ker­age ac­count

It may sound coun­ter­in­tu­itive, but you should put more money into tax­able ac­counts as your wealth in­creases. For ex­am­ple, Holt­house ad­vises his clients to put ad­di­tional sav­ings in a non­re­tire­ment bro­ker­age ac­count when they’re older and earn­ing more. Don’t stop con­tribut­ing to tra­di­tional re­tire­ment ac­counts, of course—but rec­og­nize that they come with some draw­backs that reg­u­lar in­vest­ment ac­counts don’t have. And that makes it wise to have both.

Specif­i­cally, you’re sub­ject to tax penal­ties if you with­draw money too soon—or too late—from tax- de­ferred re­tire­ment ac­counts. Un­cle Sam usu­ally im­poses penal­ties on non­re­tire­ment with­drawals be­fore age 59 ½ and for fail­ing to make with­drawals by your early 70s.

Even if you start tap­ping your re­tire­ment ac­counts right on sched­ule, you’ll have to pay or­di­nary in­come taxes on what­ever you take out of them. (This ap­plies to all so-called qual­i­fied re­tire­ment plans, in­clud­ing 401(k), 403( b), IRA, SEP-IRA, and Keogh ac­counts.) Those fed­eral tax rates can climb as high as 39.6 per­cent, depend­ing on how much in­come you re­port in any given year, in­clud­ing what you pull from these re­tire­ment ac­counts. But with a non­re­tire­ment in­vest­ment ac­count, you are taxed only on your earn­ings, not on the prin­ci­pal you orig­i­nally in­vested—and your gains are gen­er­ally taxed at lower rates than or­di­nary in­come. Cap­i­tal gains rates top out at 23.8 per­cent for the high­est-in­come fil­ers, and can drop to zero for those whose fed­eral in­come is

taxed at rates of 15 per­cent and lower.

STEP THREE Re­mem­ber to di­ver­sify your as­sets, not just your ac­counts

As­set al­lo­ca­tion is the art of de­cid­ing how much of any given in­vest­ment—stocks, bonds, cash, real es­tate, etc.—you should hold. That’s best done with a fi­nan­cial plan­ner, who can match your risk tol­er­ance and time hori­zon with the right in­vest­ments. As­set lo­ca­tion is the art of putting those as­sets in the right type of in­vest­ment and re­tire­ment ac­counts.

Jack Sharry, ex­ec­u­tive vice pres­i­dent of fi­nan­cial soft­ware provider LifeYield, says you can boost af­ter-tax re­turns by 1 to 2 per­cent­age points an­nu­ally by get­ting those lo­ca­tions right. His gen­eral ad­vice:

Put most of your stock in­dex funds in the likes of sav­ings and bro­ker­age ac­counts, which are tax­able now. They en­joy lower cap­i­tal gains taxes and tend to throw off min­i­mal in­come (from dividends) each year. These ac­counts also al­low you to deduct cap­i­tal losses when the mar­ket drops, and will re­sult in your pay­ing less tax when you pull money out to spend in re­tire­ment.

Put bonds, REITs, and other in­vest­ments that yield reg­u­lar in­ter­est in­come in re­tire­ment ac­counts, such as 401(k)s and IRAs, which de­fer tax un­til with­drawal.

Put higher-risk and po­ten­tially higher-re­turn in­vest­ments—think small­com­pany and emerg­ing-mar­kets stocks— in Roth ac­counts, which al­low you to with­draw money tax-free. Be­cause these in­vest­ments have the po­ten­tial to earn the most, you want to min­i­mize the taxes you’ll pay on them.

There’s no one right an­swer for all of this. But spread­ing around your re­tire­ment in­vest­ments, and spac­ing out the taxes you pay on them, can ef­fec­tively hedge your saving strat­egy— and en­sure that you have enough money for ev­ery­thing you want to do in re­tire­ment.

“A lot can change over the decades be­fore and dur­ing re­tire­ment, so I don’t stress too much about get­ting this ex­actly right,” Holt­house says. “But even get­ting it di­rec­tion­ally right can save you a ton of money.”

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