Invest in your Future: Tax-Deferred Growth Potential
Last time we looked at how you can save taxes currently by contributing to your 401(k) plan. This time let's look how your 401(k) plan can save you taxes along your path to retirement.
Tax deferral is the process of delaying (but not necessarily eliminating) the payment of income taxes on returns you earn. Whereas in taxable investment accounts, you would have to pay taxes on your earnings—even if you reinvest them.
In a tax-deferred account, you can delay paying taxes on your returns until you withdraw money. For example, the money you put into your employer-sponsored retirement account isn't taxed until you withdraw it, which might be 30 or 40 years down the road!
Tax deferral can be beneficial because:
• The money you would have spent on taxes remains invested so it can continue to grow for you,
• You may be in a lower tax bracket when you make withdrawals from your accounts (for example, when you're retired), and
• You can potentially accumulate more dollars in your account due to compounding.
Compounding means that your earnings become part of your investment dollars, and they in turn can potentially earn returns. In the early years of an investment, the benefit of compounding may not be that significant. But as the years go by, the long-term boost to your total return can be dramatic.
Keep in mind that returns cannot be guaranteed. Your investments will fluctuate through the years. Also, withdrawals prior to age 59 ½ will be subject to a 10% penalty tax in addition to regular income taxes unless an exception applies.
Bottom line is that although tax considerations shouldn't be your only concern when investing for retirement, it's a plus to know that participating in your employer-sponsored plan can help you keep more money in your own pocket and put less in Uncle Sam's!
Dennis Horr and Faith Financial Advisors are the advisors on your plan. You may reach them for more information at 513-898-1897 or