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Understanding the Benefits of Tax Code

We know it doesn't often feel this way, but the IRS actually affords us some benefits in our tax code. 

Quick disclaimer here-we are not CPAs or Tax Professionals.  Now that that's done....

The IRS allows investors some incentives.  They include the following:

  • Pre Tax Contributions
  • Tax Deferred Growth
  • Tax Free Distributions

How about if you've got all three! That would be awesome, and you could enjoy those benefits from the comfort of your jail cell as that would be tax fraud!  However, certain vehicles afford you 2 of 3. 

For example, a common retirement tool is a 401(k).  With a 401(k) you get to make pre tax contributions to lower your effective tax rate for that single year.  You also get to enjoy tax deferred growth each year and not have to pay capital gains taxes when the account value goes up.  However, a 401(k) does not afford you tax free distributions in retirement.  Any money taken out to spend and enjoy will be taxed at your ordinary tax rate at that time.  So when you get your quarterly statement showing you have $400,000 in your 401(k), don't get too's not all yours. 

So what else can you do to take advantage of incentives that a 401(k) doesn't?  Good question because you can't put in more than $18,000/year into a 401(k) (if you are under age 49).  And if you are saving at least 20% of your income like we recommend, you're going to have to identify additional investments.  For example, if you are earning $300,000 and saving $60,000 of it, that means you have to find a spot for the additional $42,000.  (statistics as of 2015)

Roth IRAs, Roth 401(k)s, Permanent Life Insurance and Real Estate are some of the additional saving or investing vehicles that differ in their tax treatment and could be used, if integrated properly, in to your overall financial plan.

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