Taxes are a major drag on building wealth.
For example, take the median federal tax burden. It's about 11%. That means for every dollar you make, you keep only $0.89.
What if every American could keep that 11% and combine it with a personal savings rate of just 4%? They'd be saving 15% a year.
And if you make an above-median income, your taxes get much higher than 11%.
Plus, even after you pay income taxes... state sales taxes... property taxes... and add to your savings... you still have to pay additional taxes on your investments. Capital gains, interest, and dividends all create taxable events.
Many folks pay a third – or even half – of their earnings to the government in some way or another...
Retirement accounts are an easy way to avoid these onerous taxes.
And recently, the IRS announced that it's going to let you put away a little extra money...
In November, the IRS increased IRA contribution limits from $5,500 to $6,000. In addition, contribution limits to 401(k)s, 403(b)s, and some government plans are also getting an increase – from $18,500 to $19,000.
This is good news for all the savers out there.
When you use a pre-tax income vehicle like an IRA or 401(k), you get to park your cash and compound your wealth tax-free.
From that point on, you won't have to pay taxes on capital gains, dividends, or interest income for any stocks, bonds, or funds you hold in your IRA. (If nothing else, this makes for simple accounting come tax time.)
Even better, you make contributions to a traditional IRA with pre-tax dollars.
For instance, say you make $100,000. Assuming a marginal tax rate – that's your normal income tax – of 24%, the IRS says you would owe roughly $18,289 a year in taxes (depending on a lot of other assumptions). So you'll take home $81,711.
Let's say that this year, both you and your spouse make the maximum allowable annual IRA contributions of $6,000. You'll adjust your taxable income to $88,000 ($100,000 minus two $6,000 contributions). Your tax bill drops to $15,409. You end up taking home $72,591... but you also set aside $12,000. So instead of $81,711 of net worth, you've got $84,591. That's an extra $2,880...
Another way to look at it: You get $12,000, but it only cost you $9,120. That's an immediate 32% return on your investment, which you then compound for decades.
As an added bonus, the IRS also raised income phase-outs on the Saver's Credit.
This credit matches a portion of what you put into your IRA up to $2,000 (or $4,000 if you're married), as long as your income isn't above a certain level.
The credit amount is also based on your household earnings. For example, in 2019, a married couple earning between $41,501 and $64,000 earns a tax credit equal to 10% of their IRA contribution.
That's the highest your income can go before you're phased out of the Saver's Credit entirely. In 2018, the limit was only $63,000.
The tax credit gets bigger for lower income levels. If a married couple makes $38,500 or less, the credit is 50% of their contribution. (In 2018, they had to make $38,000 or less to receive this credit.)
Remember that ultimately, how much you save will be the difference between a lifetime of poverty... or one of wealth.
With two 401(k)s and two IRAs, a married couple interested in saving aggressively can save $50,000 a year without paying income taxes. That's a savings of tens of thousands of dollars that you earned and get to keep, and that you can spend later in life on whatever you'd like. And by investing that money, you can compound your earnings quickly. Before you know it, you'll have wealth and riches to enjoy in your retirement days.
Getting there just got a little bit easier. The IRS is giving you a chance to keep more of your hard-earned cash out of its reach. So take full advantage of it...
Share this article with the people you care about. And if you haven't already, start saving in a retirement account today.
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig
If you've ever dreamed about where you want to retire, you need to plan ahead – or else unexpected costs could get in the way. Get the details from Doc right here: Will You Ruin Your Retirement Paradise?
You must invest if you're going to compound your wealth steadily over time. And as Doc explains, an important secret can help you make smart investing choices over the long term – even through the market's ups and downs... Read more here.
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