Understanding Asset Allocation is critical for building and protecting your wealth. In my previous posts on Options Trading and Capital Gains I outlined some of the factors that can impact wealth generation from active investments. Simply, if you are planning to trade for a profit through either a regular Stock trade or derivative of this such as an Option Trade then after you get through all the hurdles of actually picking a winner, you want to keep hold of the profits too!
Here is where Tax Advantaged Accounts come into play, there are several options out there and if you are employed you should absolutely max out the allowed contributions to these plans, and if you are self employed you should pick the best one for your company based upon its size and structure, i’ll post on that in the future.
Regular Employee Account – 401(k), 403(b) these are both quite traditional plans, the latter offered to those working in the educational sector. You can allot the following in 2013:
- up to $17,500 in elective salary deferrals,
- plus up to an additional $5,500 in “catch-up contributions” if the 403(b) participant is age 50 or older,
- and total contributions (employee’s salary deferrals plus employer’s matching contributions) cannot exceed $51,000.
An example we used was when Mrs Saverocity was working as a teacher on a salary of $40K with a 403(b) and 401(k) with matching contributions that maxed out at 10%/3% what that meant was that if she put in $4K they would match it by $1,200 per year, adding to her income! We then topped up the amount tucked into these retirement accounts by filling the 403(b) to the limit, so around another $12K per annum into that. That meant that at tax time when reporting her salary instead of it being $40K it was $24K which made quite the difference to our tax bill!
As you can see if we had just put the full $17k into the 403(b) we wouldn’t have got the free $1,200 from her employer, that matching level is quite low too, and your company may match even more, don’t leave a penny on the table!
The money in your 401(k) and 403(b) will sit there, hopefully appreciating until your retirement years, and at that time you withdraw from the account. The funds are Tax Deferred which means you get a tax deduction on the way into the account, but have to pay on the way out. Withdrawls from the account in retirement will be taxed as regular income. It is worth considering that since you will no longer be working your regular income will be considerably lower and most likely in a different Tax Bracket from today.
Traditional IRA Limit of $5,500
If you aren’t covered by a 401K plan at work you can consider a Traditional IRA, the only thing to note is that the limits are lower and you have to have earned the income contributed to the plan in the year. Also, on the upper end of the scale it phases out as a deduction once your salary hits $59K Single Filing Status and $95K Joint Filing Status – however it is a rare occasion indeed where a person earns that salary level and does not get a plan from their employer.
The Traditional IRA works very much like the 401K in that the funds have a deduction on the way into your account and are taxed as income when you retire.
Roth IRA
A Roth IRA is different from a Traditional IRA and the 401K in that the funds grow Tax Free! But, they aren’t deducted on the way in 🙁 however, if you consider the amount of growth that can occur of the 30 years of being in the retirement account that could be a much better deal for you on the other end when it is time to pull money out of the account.
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