Are you tax savvy?
If you're like most Americans, taxes take a pretty big bite out of your take-home pay. And for many, the costs keep rising on multiple fronts:
- The highest marginal income tax rate now stands at 37% for individual single taxpayers.
- The dividends and capital gains tax rate has increased to 20% for investors in the highest tax bracket.
In a rising tax environment, it may make sense to take a fresh look at your retirement savings and investment strategies to help make sure you're being tax savvy.
Three tax-smart strategies for retirement
#1: Consider increasing your pre-tax contributions
One tax-smart strategy for reducing your current taxes - and building your retirement savings - is to increase your pre-tax contributions to your employer - sponsored retirement plan or account. By increasing your contributions, you can help reduce your current taxable income and lower your current tax bill. You should also be aware that with many retirement plans or accounts, if you are age 50 or older, you can make annual catch-up contributions that allow you to put away even more for retirement.
#2: Take advantage of the power of tax deferral
If you make contributions to your employer-sponsored retirement plan or invest in other tax-deferred savings and investment products, you don't pay any taxes on your interest or earnings until withdrawn, which is typically at retirement when you may be in a lower tax bracket. That means you pay:
- No current tax on interest
- No current tax on dividends
- No current tax on capital gains.
If you're not already enrolled in your employer's plan, it’s important to remember how beneficial tax deferral can be over time. With tax deferral, money that might otherwise go to pay current taxes remains invested for greater long-term growth potential.
Hypothetically, to save $100,000, earning a 7% interest rate in a fully taxable investment account, one could save as much as $267,359 over 20 years. However, with tax-deferral, that same $100,000 could become $386,968 over the same 20-year timeframe. That’s a $119,609 difference!1
#3: Avoid potential tax-time surprises
It's important to be aware that taxable investments (unlike tax-deferred investments, such as an employer-sponsored retirement plan) can generate taxable distributions, even if you don't take money out. That means you'll need to look out for:
- Possible capital gains at tax time
- Annual 1099 forms to collect
- Transfers between investment portfolios and money managers, or rebalancing which could both trigger current tax consequences.
If you're enrolled in an employer-sponsored retirement plan or account - or other tax-deferred savings and investment strategy - you won't have to deal with these concerns since all interest, dividends and capital gains accumulate free of current taxes and are taxed as ordinary income when withdrawn. Keep in mind, capital gains and dividends within a taxable investment may be taxed at a rate that is lower than tax rates on ordinary income.
Tax-savvy next steps
- If you're not already enrolled in your employer-sponsored retirement plan, please review your options and consider enrolling.
- Consider increasing your contributions if you're already enrolled in your employer - sponsored retirement plan.
- Review your completed 1040 tax form - look for ways to reduce taxes with the help of your financial and tax advisors.
- Consider repositioning a portion of your investment portfolio to tax-deferred savings or investment strategies - to help reduce current taxes and avoid tax-time surprises. Explore annuities2 as another way to save for retirement on a tax-deferred basis.
If you're not already taking advantage of these tax savvy strategies, don't delay -start building your financial independence plan today!
1 The tax deferral illustration is hypothetical and is intended solely to demonstrate the comparative effect of compounding on tax-deferred vs. taxable investments. It does not reflect the actual return of any product or its investment options, nor does it reflect any withdrawal charges, insurance charges, contract administration charges or portfolio operating expenses associated with a tax-deferred or taxable investment. Such expenses would lower returns. Lower maximum capital gains rates may apply to certain investments in a taxable account (subject to IRS limitations, capital losses may also be deducted against capital gains), which would reduce the difference between the performance in the accounts. You should consider your personal investment horizon and current and anticipated income tax brackets when making investment decisions as they may further impact the results of the comparison.
2 Annuities are long-term products designed for retirement. Early withdrawals may be subject to withdrawal charges. Withdrawals of taxable amounts are subject to ordinary income tax and, if taken prior to age 59 ½, an additional 10% federal tax may apply. An investment in a variable annuity involves investment risk, including possible loss of principal. The contract, when redeemed, may be worth more or less than the total amount invested. Retirement plans and accounts, such as an IRA, 401(k) or 403(b), etc. can be tax-deferred regardless of whether or not they are funded with an annuity. The purchase of an annuity within a retirement plan or account does not provide additional tax-deferred treatment of earnings. However, annuities do provide other features and benefits that may be important to you, including options for guaranteed lifetime income and a guaranteed death benefit for your beneficiary.
Annuities are issued by The Variable Annuity Life Insurance Company, Houston, TX. Variable annuities are distributed by Corebridge Capital Services, Inc., member FINRA.
Securities and investment advisory services offered through VALIC Financial Advisors, Inc., member FINRA, SIPC and an SEC-registered investment advisor.
All companies above are wholly owned subsidiaries of Corebridge Financial, Inc. Corebidge Retirement Services, Corebridge Financial and Corebridge are marketing names used by these companies.
Copyright © The Variable Annuity Life Insurance Company.
All rights reserved.
RO 2868257 (5/2023)