Today I want to share with you some very powerful stuff about saving your taxes and protecting your wealth.
I bet you heard the phrase “In this world nothing can be certain, except for death and taxes.”
Would you agree that paying taxes to the “Uncle Government” is least enjoyable yet required contribution we make?
However, there’re ways to save on your taxes and protect your wealth!
I want to start a conversation today on how not only to grow your wealth… but protect it too, through retirement planning from the tax standpoint.
I know it’s not as “sexy” as might be investing in cryptos, or publicly traded space-exploration stocks or pre-IPOs companies.
But if you want to save a ton by strategically planning your investments in various investing accounts (aka brokerage accounts), keep reading and pay attention to this strategic planning.
Taxes and fees are two important factors to keep in mind when you do any financial planning.
So, before you decide to invest your money into some promising ideas and causes you support, while growing your financial net worth, you’ve got to protect what you already have.
Here’s the thing… The super-rich use ALL available legal “loopholes” to save fortunes on taxes…
Why not you and me?
Please note that I’m going to use the names of brokerage accounts used in the U.S.
However, there’re equivalent accounts in other countries, just with different names (for example, a superannuation plan in Australia and New Zealand, a RRSP in Canada, and a pension scheme in the U.K.).
So, please do some research for retirement accounts if you live outside of the U.S.
Disclosure: Everything I say here is meant for general tax purposes only and doesn’t cover every aspect of retirement accounts… So, please consult with your accountant or tax adviser regarding your specific financial situation.
OK, now that I got the legalize out of my mind, we can get started. LOL
There’re 3 types of investing accounts used by individuals who invest in traditional stock market assets like stocks, mutual funds, ETFs, etc.:
1. Taxable accounts
2. IRAs (Individual Retirement Accounts)
3. ROTH IRAs
Taxable accounts are used to invest your after-tax money and pay capital gain tax when you sell your holdings.
IRA accounts are used to invest pre-tax money and pay ordinary income tax when you sell your holdings and take money out.
ROTH IRAs (aka tax-free IRAs) are used to invest your pre-tax money BUT you never have to pay ANY tax when you sell and withdraw your money.
The logical question is: Why would anyone ever use anything other than a Roth IRA?
The short answer is “Because each type of accounts has its pros and cons.”
So, let’s look at some advantages and other considerations associated with these three major types of investing accounts.
1. Taxable Investing Account
Why would you choose a taxable investing account?
Because a regular taxable brokerage account might end up owing far less in taxes than a traditional IRA.
Surprised?
Here’s WHY it might be happening: Long-term capital gains rates – which apply to investments held for at least one year – currently max out at 20% (with an additional 3.8% Medicare surcharge that applies to high-income people).
If you’re a buy-and-hold investor (meaning, you hold your positions for more than a year), that could make a taxable account a pretty good choice.
Let’s do a quick math: Let’s say you grabbed a bargain stock at $1 per share and held it thru its ups and downs, not selling it, until it reached $1,000…
And once you decide to sell it, the most you would owe Uncle Sam is 23.8% of your profits.
As opposed to the same investment inside a traditional IRA where you would be subject to ordinary income rates – which currently go as high as 37% plus 3.8% surcharge for high-income people.
In addition, with Traditional and ROTH IRAs, you have additional restrictions on when you can withdraw your money.
For instance, if you withdraw before you turn 59½, you’ll owe an additional 10% early withdrawal penalty on the proceeds.
2. Individual Retirement Accounts (IRA)
When you use Traditional IRAs:
- You contribute pre-tax money and can save on your current taxes by lowering your taxable income
- Your contributions and earnings will be subject to taxation upon withdrawal, not when you sell and keep the proceeds on the account
- You must stop contributing and begin withdrawing money at age 70½ – it’s the rule.
In general, according to the research, a single investment held for a long time is best in a Roth IRA, then in a taxable account, and last in a traditional IRA.
However, if you receive and withdraw regular income from your investments – for example, regular stock dividends – or like to trade (buy and sell frequently), you lose the advantage of lower capital gains rate on Long-term capital gains that we pay on taxable accounts and will have to pay regular federal income tax every year, which will eat up a substantial portion of your investments’ profits.
So, for various income investments and/or more frequent trading, either Traditional IRAs or ROTH IRAs are superior to a taxable brokerage account.
Because by using Traditional IRAs you defer taxes and by using ROTH IRAs you eliminate taxes, therefore, allowing your money to continues compounding over many years (especially if you set up “reinvest dividend and interest” option on your accounts).
Also, Traditional IRAs have no income restriction for contributions, though the tax deductibility can be affected by your Modified Adjusted Gross Income (MAGI) and whether you’re covered by a retirement plan at work.
3. ROTH IRA Accounts
Here’s how and why to use Roth IRAs:
- You contribute after-tax money, therefore, don’t get any upfront tax-savings benefit
- Your investment gains will never be taxed, as long as you meet the ROTH IRA guidelines: no withdrawal until the age of 59½ and an account established for at least five years.
- You can continue contributing money to your ROTH IRA as long as you have earned income, regardless of your age.
- You never have to make minimum withdrawals, like it’s required for the Traditional IRA at 70½
Note that you can contribute to either IRA accounts until the Tax Day of the following year (usually April 15 in the U.S.).
The contribution amounts to IRAs are regulated.
For example, in 2021, the regular annual contribution limit for either IRA is $6,000 and $7,000 for age 50-plus.
Remember that you can’t max out both – Traditional and Roth IRA – in the same tax year.
Your total contributions to all IRA accounts – not counting rollovers from your employer retirement accounts like 401K – must fall within the range I mentioned above.
Note that you can contribute to a Roth IRA ONLY IF your Modified Adjusted Gross Income (MAGI) falls within certain levels (usually, very low income levels).
However, many rich people use a legal “backdoor” strategy, which involves converting a traditional IRA to a Roth IRA and paying taxes in the process.
This “backdoor” strategy allows you to fund your Roth IRA with as much money as you want no matter how high your income may be.
The Bottom line: Save on Taxes, Protect Your Wealth
When it comes to picking between a traditional IRA and a Roth IRA, the biggest factors are
· Your current income
· The tax rates you’re being subjected to (federal, state, and local tax rates)
· What is your expectation for your income and tax rates in the future
As you know, life is unpredictable: tax rates change, laws related to IRAs can be altered at any time.
That’s why personally I use all 3 different types of investing accounts – including both Traditional and Roth IRAs – to hedge against unexpected.
And if you diversify your retirement’s assets like I keep suggesting to you over and over again, using different kinds of investing accounts will protect your wealth even further.
Hit “reply” and let me know if you got any value from this newsletter – any insights, AHAs and action items.
And if you’d like to ask me some specific questions about your financial situation, schedule a 30-min complimentary consultation with me asap (because I currently have VERY limited availability for these calls).
Make sure to read my next week’s email where I’ll share with you another “loophole” used by the super-rich to save fortunes on taxes.
To your Health, Wealth and Freedom! ?
P.S. If you want to participate in my upcoming free trainings, make sure you apply to join the Wealth Building For Powerful Women FB group ASAP, where the new trainings will take place.
