Investing for Retirement: Why Taxes Matter

Posted on: August 15th, 2018

The Tax Cuts and Jobs Act of 2017 made sweeping changes to federal income taxes and corporate tax rates — but what does it mean for your retirement accounts? The tax benefits of retirement accounts such as 401(k)s and IRAs are mostly unchanged by the new tax plan. That means you can keep on saving in your retirement accounts and enjoy the same tax benefits as before.

There are some minor changes regarding IRA conversion rules, which may apply if you have converted from a traditional IRA to a Roth IRA. If you have questions about the tax implications of IRA conversions, you should review your situation with a tax professional.

Tax-Advantaged Retirement Accounts

Federal tax policy provides tax advantages for retirement accounts such as traditional and Roth IRAs and 401(k) and other employer-sponsored retirement plans. Among the tax advantages available for retirement savings are:

  • Pretax or tax-deductible contributions. Benefit: You can save more with less pinch on your wallet. If you’re in the 25 percent tax bracket, a $100 pretax contribution costs you only $75 in take-home pay.
  • Tax-deferral on account earnings. Benefit: Your account has the potential to grow faster than a taxable account earning the same rate of return. If you’re in the 25 percent tax bracket and invest $100 a month in each of two accounts — one taxable and one tax-deferred — both earning an 8 percent return, after 20 years the tax-deferred balance will grow to $59,304 while the taxable one reaches only $46,440.*
  • Tax-free distributions (available with Roth accounts). Benefit: As opposed to tax-deferred retirement accounts, from which withdrawals are taxed as ordinary income, you’ll owe no tax on distributions from Roth accounts if certain conditions are met.**

What’s Best for You?

In order to choose which tax advantages are most beneficial, you need to consider another factor: tax rates. Your current tax bracket and your tax bracket in retirement both influence the relative value of each potential tax break. And that’s where some major uncertainty enters the picture.

When you retire, your tax rate will depend not only upon your income, but on what action Congress takes now and in the future (depending on how long you have until retirement). Over the past 40 years, the top income tax rate has varied from 28 percent to 70 percent.***

Make the Right Moves

To help control your tax bill in retirement, you may want to have assets in a variety of accounts that will produce different tax consequences when they are converted to income. For instance, you may have assets that are tax-free, taxed at capital gains tax rates (which are generally lower than income tax rates) or taxed at ordinary income tax rates.

Your Seaside Client Advisor can discuss the advantages of different kinds of accounts with you and help you develop an investment strategy that suits you. Call or stop by for an appointment today.

This financial institution does not give tax advice. Consult your tax advisor for information specific to your situation.

* Rate of return is for illustration only and does not represent the return of any actual investment. Your returns will vary. Taxes will be due upon withdrawal from a tax-deferred retirement account. Premature withdrawals (prior to age 59½ or age 55 from an employer’s plan if leaving your employer) may be subject to a 10 percent tax penalty, as well (does not apply to 457 plans).
** Qualified distributions are those made after you’re age 59½ and have held the account at least five years. Ordinary income taxes and a 10 percent penalty apply to premature withdrawals.
*** Source: Tax Policy Center

Investment products:
• Not federally insured
• Not a deposit of this institution
• May lose value

Compare Tax-Advantaged and Taxable Accounts

Type of Account Contributions Current Returns Withdrawals
Traditional IRA No tax* No tax Ordinary income tax
Roth IRA Ordinary income tax No tax No tax
401(k) No tax No tax Ordinary income tax
Roth 401(k) Ordinary income tax No tax No tax
Taxable account Ordinary income tax Type of tax varies** Capital gains tax

* Contributions to a traditional IRA may be tax-deductible depending on income and your or your spouse’s participation in an employer-sponsored retirement plan. See your tax advisor.
** Tax rates vary by type of return: short-term capital gains are taxed as ordinary income; dividends and long-term capital gains are taxed at their own rates.

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