Take Advantage of IRA & 401(k) Tax Benefits

January 8th, 2008  |  Published in 401K, Roth IRA

When it comes to investing, the tax benefits of IRAs (both Roth and Traditional) and 401(k)s can’t be matched, as long as you use them properly. So, it always pays to make sure that you’re not putting tax advantaged investments into those accounts (unless that’s the only place you’re investing) because you generally can’t take advantage of them twice. While a little confusing, let me explain with an example.

Let’s say you invest in a bond that is federal income tax free. For our example, you are earning 3.9% APY from this federal income tax free bond and you invest a tidy little sum of $10,000. After the first year you have made yourself a nice $390 profit. If you kept this in a regular brokerage account and realized those gains, you wouldn’t owe any federal income taxes on those funds. In fact, if you are in the 25% tax bracket, you would’ve had to have earned 5.2% APY from a non-federal income tax free bond in order to get that equivalent yield.

Now let’s take the case in which you invested that money in a Roth IRA. After the first year, you get your $390 and you still pay no taxes on the realized gain. It’s the same thing right? Wrong because in the Roth case you could’ve invested in a 4.0% APY bond, non-federal tax free, and made more because of the tax advantaged status of the Roth IRA. See what I mean? Instead of being forced into finding a 5.2% federal income tax free bond because you have to pay taxes, anything above 3.9% is fair game in a Roth (you have to wait until retirement to withdraw it penalty free though).

So, be sure to take advantage of the tax advantaged nature of IRAs and 401(k)s in your investment decisions.

  

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