The Tax Benefits Millennials Should Know about Retirement Plans

Retirement Benefits Millennials Should Know

This is the third installment of a four-part series that addresses concerns Barron’s raised in its September 20th issue about why millennials are NOT investing for retirement.

Time in the stock market outweighs the benefit of almost every other factor about investing. That’s why this is so important. Timing the market and hot stock picks are less beneficial than time in the market. Our advice, especially millennials who have the benefit of time on your side, is to invest early and often.

One of the findings highlighted in Barron’s was that “54 percent [of millennials] are unaware of the tax benefits of retirement plans.” There’s a reason why there’s a whole industry that helps the rich and corporations avoid taxes. Taxes, both personal and corporate, reduce revenues, both personal and corporate, that can otherwise improve your financial situation.

This being the case, reducing your taxes in as many ways as possible is wise. There are numerous ways to reduce taxes, such as investing in tax-advantaged investments and reducing or avoiding spending on goods and services tied to taxes. Another way is to put your income into tax-advantaged accounts.

In part two of this series, we discussed the various types of retirement accounts. In part three, we’ll discuss the tax benefits of those retirement accounts.

Individual Retirement Accounts (IRA)

Traditional IRA Features:

• Tax-deferred growth account
• Maximum annual contribution limit of $5,500 if under the age of 50, $6,500 if over the age of 50
• Taxes are paid at withdrawal and may include a 10 percent penalty if withdrawals occur before age 59 ½

Tax Benefits:

• Lower tax liability – Contributions may be tax deductible, which reduces current income tax liability, depending on whether
• you participate in an employer-sponsored retirement plan,
• file your taxes as single, married and jointly or married and separately, and
• certain income thresholds
• Tax-Deferred Growth – Contributions grow tax-deferred; taxed at withdrawal, which will likely be at a lower tax rate in retirement and increase compound interest benefits

Roth IRA Features:

• Account grows tax-free
• Maximum annual contribution limit of $5,500 if under the age of 50, $6,500 if over the age of 50
• No taxes are paid at withdrawal unless the withdrawal occurs before age 59 ½, at which point taxes and a 10 percent penalty may be charged

Tax Benefit:

• Tax-free retirement income – Roth IRA contributions are taxed prior to being deposited, investment growth is tax-free and taxes aren’t charged at withdrawal – taxes and a 10% percent penalty may be charged if withdrawals occur before age 59 ½

To determine which IRA is appropriate for you, read last week’s post and talk to an accountant or investment professional.

Pensions

401(k) Features

• Tax deferred, employer-sponsored retirement account
• Maximum annual contributions of $18,000, plus employer match
• Contributions are made with pre-tax dollars
• Taxes are paid at withdrawal and may include a 10 percent penalty if withdrawals occur before age 59 ½

Tax Benefit:

• Lower tax liability – Contributions are tax-deferred, which reduces current income tax liability
• Tax-Deferred Growth – Contributions grow tax-deferred; taxed at withdrawal, which will likely be at a lower tax rate in retirement and increase compound interest benefits

403(b) Features:

• Tax deferred, employer-sponsored retirement account
• Maximum annual contributions of $18,000, plus employer match
• Contributions are made with pre-tax dollars
• Taxes are paid at withdrawal and may include a 10 percent penalty if withdrawals occur before age 59 ½

Tax Benefit:

• Lower tax liability – Contributions are tax-deferred, which reduces current income tax liability
• Tax-Deferred Growth – Contributions grow tax-deferred; taxed at withdrawal, which will likely be at a lower tax rate in retirement and increase compound interest benefits

Small Business Accounts

SEP IRA Features

• Tax deferred, employer-sponsored retirement account
• Typically used by self-employed individuals and their employees
• Maximum annual contributions is the lesser of 25 percent of the employee’s wages or $53,000
• Contributions are made with pre-tax dollars
• Taxes are paid at withdrawal and may include a 10 percent penalty if withdrawals occur before age 59 ½

Tax Benefit:

• Lower tax liability – Contributions are tax-deferred, which reduces current income tax liability
• Tax-Deferred Growth – Contributions grow tax-deferred; taxed at withdrawal which will likely be at a lower tax rate in retirement and increase compound interest benefits

SIMPLE IRA Features

• Tax deferred, employer-sponsored retirement account
• Typically used by small businesses that cannot afford the costs of a 401(k) plan
• Maximum annual contributions limit of $12,500
• Contributions are made with pre-tax dollars
• Taxes are paid at withdrawal and may include a 10 percent penalty if withdrawals occur before age 59 ½

Tax Benefit:

• Lower tax liability – Contributions are tax-deferred, which reduces current income tax liability
• Tax-Deferred Growth – Contributions grow tax-deferred; taxed at withdrawal, which will likely be at a lower tax rate in retirement and increase compound interest benefits

Though the contribution limits to these retirement accounts vary the tax-free (growth) retirement income benefit of the Roth IRA is the main difference between them. The benefits to reduce or defer taxes, however, cannot be overstated. This should be enough incentive for any #moneyconscious millennial.

As we mentioned last week, open either a Traditional IRA or a Roth IRA. Learn what type of employer-sponsored retirement plan is available to you, and open it as soon as possible. Contribute as much as you can to both accounts, so as to not let your savings and investments cause you to refrain from creating an emergency savings account or cause you to use credit cards. Also, always take advantage of whatever employer match is available to you. This is free money that adds huge returns on your retirement investments.

Get started as soon as possible to take advantage of the time you have in your favor. With ongoing, regular contributions, you’ll see your retirement accounts grow in no time.

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