Most people view taxes as unavoidable... They're inevitable, like death, right?
That thinking leads many people to ignore the huge benefits gained from investing through tax-sheltered accounts. But in an effort to protect us from its own taxes, the government graciously allows individuals to invest through several tax-deferred accounts.
The main examples are an individual retirement account ("IRA") and a 401(k). In the next two essays, I'll explain how these accounts work... and how they can provide you with instant returns that will compound your wealth for many years to come.
Today, I'll cover the huge benefits offered by opening an IRA...
An IRA lets you park your cash and compound your wealth tax-free.
You don't have to pay taxes on capital gains, dividends, or interest income for any stocks, bonds, or funds you hold within an IRA. (If nothing else, this makes for simple accounting come tax time.) Even better,
you make contributions to a traditional IRA withpre-tax dollars (up to a certain level of income).
For instance, say you make $100,000. With a marginal tax rate of 25%, you would owe roughly $16,857 a year in taxes (depending on a lot of other assumptions). So you'll take home $83,143. If both you and your spouse make the maximum annual IRA contributions of $5,500, you'll adjust your taxable income to $89,000. Your tax bill will drop to $14,107. You end up taking home $74,892... but you also set aside $11,000.
Another way to look at it:
You get $11,000, but it only cost you $8,251. That's an immediate 33% return on your investment, which you then compound for decades.
The only downside is that you can't withdraw your money until you reach 59 and a half years of age. If you do withdraw before then, you have to pay the taxes due on it plus a 10% penalty.
After 59 and a half, your withdrawals are taxed as ordinary income. If you withdraw $50,000 a year, that will count toward your annual income. You'll be taxed accordingly. And when you reach 70 and a half, you must start making the minimum required withdrawals.
In short, if you don't have an IRA now... open one immediately!
Opening an IRA is as easy as opening any other brokerage account. You can do it with any brokerage. When registering, you simply select an IRA as the account type.
When you file your taxes at the end of the year, the forms include a line to enter any IRA contributions. It's as simple as that. By skipping taxes, you've already made a huge investment gain.
And that 33% boost on your initial capital will save you tens of thousands of dollars over just a decade or two of retirement savings.
Don't leave that free money on the table...
Here's to our health, wealth, and a great retirement,