Consequences of Retirement Tax Strategies
Whichever option you have selected, are you certain that it is the best choice for your retirement? There are a number of strategies when used that can help you take advantage of tax laws. So which one is right for you? Read on before you decide.
Strategy #1 – Paying taxes on retirement income as it is received.
When you invest your money in a traditional IRA or employer 401k, you are doing so with pretax dollars. You receive a tax advantage by reducing your net income, you pay less in income tax. When you begin to take disbursements from your IRA or 401K, you will begin to pay taxes on that money.
By saving for your retirement this way, you have the ability to invest more money and potentially increase your portfolio at a greater rate because there is more money in the account. It is also presumed that your tax rate would be lower at retirement therefor the amount of money you pay in taxes would be less. Alternatively, if you have done this, you could pay more in taxes at the time of disbursement due to a larger amount of money coming to you.
Strategy # 2 – Investing for retirement with money that has already been taxed.
Investing your funds in a Roth IRA or Roth 401k allows you to avoid taxes in the future. With funds such as these, you will pay taxes on the amount of money you deposit. The income you receive from these investments is then income-tax free.
If you are in the belief that tax laws are going to change and not to your benefit, then this strategy might look appealing to you. Paying taxes on your contributions now could save you money in the long run as well if you believe that your investments are good and will increase greatly in the years to come.
Is one tax strategy better than the other?
Diversification is a buzzword that will never die and that is because it is applicable in so many ways. Not only do you want to diversify the direction for money is sent (stocks, bonds, real estate) but you may also want to diversify the types of accounts you are holding. The best strategy may be that of using both in concurrently with each other.
Tax laws do and probably will change between now and when you retire. There is the possibility that they will change in your favor but what if you are wrong? Placing all of your money into an IRA could be a large risk and one you may not want to take.
It would probably be less risk to you to invest for your retirement in multiple avenues, including Roth IRAs, 401ks and other revenue streams. Retirement income is far too important to risk by investing in only one type of fund.