See Greater Profits By Reducing Your Investment Taxes: Part 5

Here’s another round of invest tax tips!

Taxes on Retirement Accounts

Retirement accounts have different tax rules than brokerage accounts. In addition to the ones explained below, investment taxes also apply to any other account where you’re controlling an investment as part of a retirement plan.

The following types of retirement accounts are charged investment taxes:

  1. 401ks. A 401k account is a type of account where money is deducted from an employee’s paycheck and put into a retirement fund for the future. This type of pension plan is established in the company’s name. Keep in mind that 401k plans vary greatly.
  • Depending on the program, an employee’s contribution into a 401k plan is often matched by the person’s employer.
  • The money contributed by the employee can be made on a pre-tax or post-tax basis, depending on the specific plan. Either way, the investment earnings are tax-deferred.
  • As of 2022, the annual contribution to a 401k plan is limited to $20,500.
  1. IRAs. The term IRA can stand for both Individual Retirement Account and the broader term Individual Retirement Arrangements. IRAs can be considered a trust or custodial account set up for an individual or their beneficiary.  
  • IRA accounts are offered to individuals through financial institutions. These accounts are popular with people who are not covered by an employment-based retirement plan, such as a 401k.
  • There are several different IRA accounts you can explore. They include: Traditional IRAs, Roth IRAs, SIMPLE IRAs, SEP IRAs (which we will further discuss next) and Self-Directed IRAs.
  • Depending on the type of IRA, you may be eligible for a tax credit on some or all of your contribution. Generally, your earnings from an IRA account are not taxed until they are distributed to you upon retirement.
  • As of 2022, the annual contribution to an IRA is limited to $6,000 for those under age 50 and $7,000 for those over 50. All contributions must be from your income.  
  1. SEP Plans. SEP stands for Simplified Employee Pension. Although considered a type of IRA, an SEP is really a variation. An SEP can be invested the same way as any other IRA. Contributions to a SEP are deductible and can lower a taxpayer’s income tax liability. 
  • SEP contributions are made into a Traditional IRA account established in the employee’s name instead of to a pension fund set up in the company’s name.
  • SEPs target small business owners and allow them to provide retirement benefits for themselves and their employees. All employees must receive the same benefits under an SEP plan. 
  • This type of retirement plan can also be used by self-employed individuals with no employees.
  • These funds are taxed at an ordinary income tax rate, as long as withdrawals are not taken until after the age 59 ½. 
  • As of 2022, the annual contribution to a SEP Plan is limited to $61,000, or 25 percent of the employee’s salary, whichever is lower.

The benefit of these retirement accounts and others is as long as you keep money in your retirement plan, you don’t owe taxes.  

If you reinvest your income in a brokerage account, it would still be taxable. However, if you reinvest your investment income with a retirement plan you don’t have to pay taxes during that year.

The flip side of retirement plans is you’re only allowed to use that money for retirement, which means you’re supposed to keep the money in there until you’re at least 59 ½ years old.

If you take out money before then, the IRS charges an extra 10 percent penalty, which really impacts any gains you’ve made. So, you have to be careful.

Setting up and using a retirement account is really the best way to grow your money for your future retirement. Just make sure it’s not your only source for money. Balance out retirement accounts with an emergency fund or some other account you can access before you turn 59 ½.

Keep in mind you can really get burned by that early withdrawal penalty. If you just keep everything in the one account and you have to access it early, it will destroy your annual return.

“A lot of the money in the stock market is really our national retirement plan, for better or worse.”

~Ron Chernow

Thanks for reading! Stay tuned for more next week.

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