The Power of Tax-Deferral
When it comes to growing assets for retirement, especially in today's volatile economic environment, you want to take advantage of every break you can get. One of these breaks is through the use of a tax-deferred vehicle, such as a 401-k, IRA, or 403-b plans, etc. How do these plans work? Quite simply, any growth inside them is sheltered from taxation in the accumulation phase. You don't pay the taxes until you begin to take the money out and spend it. This becomes a huge advantage over time.
For example, let's look at a person, age 45 who has $100,00 in a 401-k. She's in a 25% tax bracket. Let's assume this person contributes nothing else for 20 years, and that she averages an 8% return over that same 20 year period. At age 65, in a normal non-tax-deferred account that money would have grown to over $306,000.
But since she was in a 401-k, all of her earnings continued to grow without being taxed. Now the value is well over $466,000, an increase of $145,000. As tax strategies go, this is a good one.
What's the downside to using these tax-deferred vehicles? There are limits as to how much you can contribute to them each year. So what's a person with a very healthy investment budget to do?