When it comes to your investing strategy, there are ways you can save on what you owe Uncle Sam by regularly investing for your future.
Make Retirement Savings a Priority
If you have access to a retirement savings plan such as a 403(b), 457(b), 401(k)) through your employer, make sure to take advantage of it. By contributing automatically each pay-period using pre-tax dollars, you'll reduce your taxable income and won't have to pay taxes on that money until you begin withdrawing it in retirement. If you have a 401(k), you may be able to boost your savings even more, because many employers will match contributions, usually between 2% and 8%. To take full advantage of this benefit, try to make contributions to get the full employer match, then work to contribute at least 10% of your pre-tax income and increase that amount over time if you can. Check with your employer for the specific details of their plan, if offered.
No Plan? Consider an IRA
If you don't have an employer-sponsored retirement plan, consider opening an Individual Retirement Account — or IRA — which allows anyone with earned income to save for retirement (maximum income rules can limit contribution amounts). If you're self-employed, you can use an IRA to create your own retirement plan. In addition, there are special rules that may allow a stay-at-home spouse to contribute to one as well. And unlike employer-sponsored plans, you have until tax day of the following year to make IRA contributions to reduce your taxable income.
There are two kinds of IRAs. The first is a Traditional IRA, which acts like a savings account with tax breaks, because your contributions reduce your taxable income and your contributions are able to grow tax deferred until you start withdrawing them come retirement time. However, because your contributions are earmarked for retirement, you'll incur early withdrawal penalties in addition to taxes if you withdraw funds before age 59 ½.
A Roth IRA uses after-tax contributions, allowing your contributions to grow tax-free. Your withdrawals can be tax-free too, if you follow the rules. Roth contributions won't help reduce your taxable income at tax time because you're using after-tax dollars. However, you'll get the benefit of growing your retirement savings tax-free and can withdraw your contributions at any time without incurring penalties. That means you have the option to use some of that money for other important life goals — such as putting a down payment on a home. However, the earnings you make on your investment can only be withdrawn when you are age 59 ½ or older and have had your Roth for five years or longer, otherwise, you will incur taxes and penalties. Some employer plans also offer a Roth option to make after-tax contributions that share many of the benefits of a Roth IRA, excluding the option to withdraw contributions without penalties. Check with your employer for the specific details of their plan if this option is offered.
Review Your Asset Allocation Strategy
If you haven't looked at how you invest in a while, reviewing your asset allocation strategy can help you take advantage of market opportunities. For instance, if you are younger, you can be more relatively aggressive with your investments because you have time on your side to weather any declines in the stock market. As you age, your investments may become more conservative to preserve your assets. But even if you take a more conservative approach, you can still invest wisely and earn higher returns. The key is to diversify your portfolio, so you have an appropriate mix of stocks, bonds and cash based on your individual risk tolerance and other personal factors. One easy way to diversify your portfolio is to invest in mutual funds and let professionals assist you.
This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.