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Earn By Saving: Tax-Advantaged Savings Vehicles

Sept. 18, 2012
Managing Money
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How are you saving to buy that beach house that you want to retire in? Putting an extra $100 here and there into your bank savings account will help you save but it’s not the smartest or most tax-advantageous way. You’ve worked hard to save for retirement so you want to make sure that Uncle Sam doesn’t take a big bite out of it each year.

Using tax deferred retirement accounts, such as individual retirement accounts (IRAs) and employee sponsored 401k plans, builds wealth faster and gives you tax advantages. Below is a comparison of the popular tax-advantaged retirement savings vehicles and factors to take into consideration with each vehicle:

Tax-advantaged Savings Vehicle: Traditional IRA Roth IRA SEP IRA Employee Sponsored 401k Plan
Consider if… You want your money to grow tax-deferred until you withdraw it in retirement. You’re interested in both tax-free growth and withdrawals. Roth IRA contributions are not tax-deductible. You’re a business owner, self-employed or an employee of a business with a SEP IRA. You want your employer to match a portion of the contributions you put into the plan (aka free money). The typical match is 50 cents on the dollar up to 6% of your salary.
Contribution Eligibility Anyone under 70½ Any age Anyone whose employer invites them to participate in a SEP Anyone whose employer offers a 401k plan
Maximum Annual Contribution For 2012:

  • $5,000 if under age 50
  • $6,000 if age 50 or older

No income limits

For 2012:

  • $5,000 if under age 50
  • $6,000 if age 50 or older

For single filers with income of less than $110,000 or joint filers with income of less than $173,000

For 2012:

  • Lesser of $50,000 or 25% of employee’s compensation
For 2012:

  • Lesser of $17,000 or 100% of compensation
  • Lesser of $22,500 or 100% of compensation if age 50 or older
Tax Advantages No taxes until you take distributions Tax-free when you take distributions No taxes until you take distributions No taxes until you take distributions
Distributions Taxable

  • Could include a 10% penalty if made before age 59½
Distribution of an original contribution is always tax and penalty free.

  • Any earnings and conversion dollars (from other retirement plans) are tax free after the IRS’ 5 year aging requirement has been met and you are 59½ or older.
  • Otherwise, you could incur a 10% penalty.

  • Could include a 10% penalty if made before age 59½

  • Could include a 10% penalty if made before age 59½
Required Minimum Distributions Mandatory at age 70½ Not required Mandatory at age 70½ When you retire or at age 70½, depending on the your employer

 Expert Commentary

Curtis Chambers, founder and managing member of the Chambers Financial Group, had this advice about retirement savings:

“It is good to start as soon as possible. However, the first step is building an emergency fund equal to six months living expenses. Once the emergency fund is complete, begin saving for retirement. By far the best way to start saving for retirement is through a 401k. The great thing about a 401k is it can be set up to automatically withhold a set percentage of your salary. Not everyone, however, has access to a 401k. But if you do, take advantage of it!”

Robert Margetic, President of Redwood Financial Advisors, Inc. and author of “How to Survive the Coming Retirement Storm”, had this advice about the importance of saving early:

“Deferring taxes builds more wealth. Earnings in IRAs and 401ks are tax deferred. For the same investments in a tax sheltered account versus a typical taxable bank or brokerage account, the tax deferred account will grow 1-3% faster over time.  2% growth over 30 years compounds to over 40% more money. These straight-forward but subtle concepts are key in building the wealth needed to retire.”

Chace Cannon, Investment Advisor at Cannon Capital Management, had this advice about employee sponsored plans: 

“The best vehicle for saving up for retirement is by using an employer sponsored plan. Generally with an employer sponsored plan you get a match which is essentially free money. Not only that, but you can contribute more money to your retirement each year through one of those plans than you can in an individual IRA. The best advice I can give to people who are part of an employer sponsored plan is to increase their deferral amount by 1% each year. So if you start at 1% the first year and work for 30 years, you would be contributing 31% at the end of that 30 years.”