When you put $5,000 into a traditional IRA, you get a tax deduction of the same amount which can save you a good amount of money. Open a second IRA account for your spouse and you double your savings.
If you’re a small business owner, physician with a private practice, a sub-contractor or other kind of self-employed individual, you might qualify for a SEP IRA plan. This type of account would allow you to invest up to $49,000 per year which offers you a much larger tax deduction.
Remember that there are deadlines to open IRA accounts. Make sure you start the process early so that you can immediately take advantage of the benefits that tax-deferred accounts offer.
Doesn’t deferred taxes mean I pay taxes later?
While it’s true that you still have to pay taxes later on most retirement accounts, the big advantage is that you can compound the growth of your portfolio using the cash that you would have otherwise paid to the IRS. The value of compounding returns is much bigger than you might think. If you were to invest $100,000 now with no other deposits and considering a tax rate of 28% and an annual return of 8% per year, you would have $333,588 in ten years. If you put the same amount in a tax-deferred account, you would have $466,095.
Another consideration is that when you retire, your tax rate may be much lower than it is during your peak earning years. Therefore, deferring taxes to a later stage in life really can save you more money than you might think.
Strategic buying and selling
When you invest in individual stocks or ETF’s (exchange traded funds), you get more control over your profits and losses. For example, if you sell stock ABC in your portfolio that has a gain of $1,000, you can also sell stock XYZ that has a loss of $600. This reduces your total taxable gain to $400.
Contact your investment advisor towards the end of the year for assistance with strategic buying and selling to reduce your tax exposure.