Why Investing Throughout Your Life is the Ultimate Retirement Gift
Throughout life, there’s a constant tug-of-war between time, energy, and money. Early careers might have ample time and energy to chase ambitions, but financial resources can be scarce.
Conversely, our time is stretched thin in the middle of our careers due to work and other commitments. As we enter our elder years, we may lack the necessary energy to pursue other passions despite the time and money at our disposal.
The point is, for each life stage, different priorities and considerations can make it challenging to reach our goals. But we end up doing them anyway. Similarly, we’ll always have a reason to push back on saving or investing. And while it does matter when you start, tax strategies are always available to help you make the most of your investment, regardless of age.
Too often, investors underestimate the significant impact that taxes can have on their overall returns. It’s an often-overlooked factor that can tilt the scales in your favor or work against you.
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Tax-Efficient Investing for Different Life Stages
Young Professionals: Starting on the Right Foot with Tax-Efficient Investments
If you’re in your 20s, congratulations! You’re early in the game. With so much time on the horizon, you’ll want to do it right the first time.
You’re fresh out of college and just starting your career. It can be intimidating to invest, especially when you have student loans to pay. You may even think of pushing it back. After all, you have all the time in the world, right?
The thing is, your responsibilities won’t be going away. They’ll only evolve as you age. You may be paying for loans now, but the next thing you know, you’re paying for diapers and childcare. With the amount of time you have, saving now means earning interest on interest (i.e., compound interest).
We recommend prioritizing contributions to a Roth IRA or Roth 401(k) if you’re in a lower tax bracket. In these accounts, the contributions are made after tax. You won’t receive an immediate tax deduction, but your future withdrawals upon retirement will be tax-free. Paying taxes on your contributions now can be advantageous, as you are likely to pay lower taxes now than in the future when you are earning more.
Later, if you anticipate moving into a higher tax bracket, consider a traditional 401(k) or IRA. Contributions to these accounts are made using pre-tax funds. This results in an immediate tax advantage, as the contributed amount is not subject to income taxes until it is withdrawn in retirement.
Mid-Career Investors: Balancing Tax Efficiency with Financial Goals
Mid-career investors find themselves juggling financial priorities. The balancing act between your personal financial goals and the kids’ education, coupled with the pressure of retirement. Reducing your tax burden through smart investment strategies is a key advantage you shouldn’t overlook.
You’re now a high-earning individual who has reached the contribution limits for your 401(k) and IRA. However, you may still have ample opportunity to increase your savings.
1. Health Savings Account (HSA)
Consider establishing a health savings account (HSA). This type of account has a three-tiered tax benefit:
- It allows for contributions with pre-tax funds.
- Offers tax-free growth on investments.
- Permits tax-free withdrawals for healthcare expenses in retirement.
2. 529 College Savings Plan
Your extra money can also go into your child’s 529 college savings plan. The tax benefits of these plans vary depending on your residence. Some states offer deductions for contributions, while others provide tax credits. Furthermore, eligibility criteria may vary, with certain states limiting eligibility to parents and others allowing any contributor.
- In Arizona, individuals can claim tax deductions of up to $2,000, while married couples filing jointly can claim up to $4,000.
- In Nebraska, single filers can deduct contributions to a 529 plan up to $5,000, and married filers can deduct up to $10,000.
- In Wisconsin, the deduction is up to $3,860 per beneficiary per year, regardless of filing status.
Our investment tax professionals in Arizona, Nebraska, and Wisconsin can provide more information on your state’s eligibility rules.
Seniors and Retirees: Preserving Wealth and Optimizing Tax Efficiency
Many think they’ve reached the finish line upon retirement and come unprepared for the long haul.
As a senior or retiree, preserving your wealth and optimizing tax efficiency are top priorities. Here are some important considerations to help you:
1. Required Minimum Distributions (RMDs) and Tax Implications
Funds in your employer-sponsored plans won’t lie in waiting for when you need to withdraw them. Since these accounts contain pre-tax contributions, the IRS will be itching to collect taxes due on these funds. Thus, from the time you reach a certain age, you must take out yearly RMDs. Failure to comply with RMD rules can lead to expensive penalties. However, you can work around this requirement and delay the RMDs or exclude these funds from your taxable income.
First, you can continue working past 73 to delay distributions from your current job’s 401(k). You can also avoid taxes on withdrawals if you roll over your savings into a Roth IRA, where your money can stay and grow tax-free. But this means you’ll have to pay taxes on these funds since they’re pre-tax funds.
Another option is to utilize qualified charitable distributions (QCDs). With QCDs, you can directly transfer up to $100,000 annually from your IRA to a qualified charity. With this, you not only satisfy RMD requirements but also exclude these funds from your taxable income.
2. Withdrawal Sequencing
Your Social Security benefits may be subject to higher taxes if your income exceeds certain thresholds. Withdrawal sequencing can help manage your income levels and reduce the impact on your Social Security benefits.
Initiate withdrawals from your taxable investment accounts first. Although these withdrawals may be subject to capital gains tax, using these funds initially allows for continued growth and tax benefits for your tax-deferred retirement accounts. This should be followed by traditional tax-deferred and, lastly, Roth.
3. Long-Term Care and Tax Considerations
Depending on the type of care, senior living can cost from $3,100 (independent living) to $4,995 (memory care) monthly and $30 per hour for in-home care. With this, you need to plan for long-term care, and having a good grasp of the tax consequences can aid in effectively controlling expenses.
You can deduct some long-term care expenses if they meet certain criteria. Keep detailed records of qualifying medical expenses, including nursing home costs, in-home care expenses, and necessary medical supplies. Additionally, you can deduct long-term care insurance premiums as a medical expense. Just keep in mind that the premiums, plus other medical expenses, cannot exceed a specific threshold.
Let Your Investments Work Harder for You
As you continue your financial journey, explore and implement tax-efficient investing strategies. It’s not just about the numbers. It’s about keeping more of what you earn and enabling your investments to work harder for you.
Work with a qualified financial advisor or tax professional to examine your investment strategy more closely. They can provide personalized advice and guide you toward the strategies that best align with your financial goals and risk tolerance.