Less than half of Americans are investing for retirement. That may shock some of our readers. But it really shouldn’t.
For one thing, a sizeable portion of our population has no idea how to invest. We have shamefully low standards for financial literacy in this country. And to the uninformed, it may seem as though capital gains tax makes investing pointless.
[ad#Google Adsense 336×280-IA]Short-term rates can get near 40%.
But what most Americans fail to understand is that these taxes are, in a sense, optional.
There are a variety of tax-advantaged accounts available to you.
These vehicles allow you to save and invest your money tax-free until you’re ready to retire.
And there’s one to fit every financial situation.
Let’s go over how to invest without capital gains tax.
IRA vs. 401(k)
The first question when choosing a tax-advantaged account is a simple one. Are you employed?
If the answer is yes, you should ask if your employer offers a 401(k). It offers some of the best options for retirement investing of any tax-advantaged account.
By definition, a 401(k) is an employer-sponsored retirement account. You contribute part of your paycheck to the account, and your employer (in many cases) matches some portion of that contribution. 401(k)s also offer other advantages, like the ability to borrow money from them. However, they also have some downsides. Your employer’s 401(k) may offer a limited menu of mutual funds for you to invest in.
If you’re unemployed, self-employed or you want total control over what stocks and bonds you buy, then you may prefer an individual retirement account. IRAs offer you more investment choices; they don’t force you to pick from a set list of funds available through your employer.
But IRAs also miss out on some of the benefits of a 401(k). You can’t withdraw money from them before retirement – not as a loan or for any other reason. And obviously, no employer means no employer matching.
Roth vs. Traditional
The second question is a bit more complex – and no one really knows the answer. Do you think taxes when you retire will be higher or lower than they are during your career?
Folks disagree about this one. Some economists argue that tax rates have decreased historically. But the accuracy of that statement depends on how much you make. As a whole, the trend of tax rates over time is… hard to quantify.
Because of this debate, IRAs and 401(k)s come in two different flavors: Roth and traditional.
In Roth accounts, you pay taxes on the money you contribute to the account. But when you hit retirement and start withdrawing that money, it’s totally tax free. Thus, Roth investors are betting that taxes will go up between their prime working years and their golden years.
In traditional accounts, your contributions are tax-deductible. That means it’s effectively tax-free going in. But once you start withdrawing from the account at retirement age, your withdrawals are taxed as income. If taxes go down between your working years and your retirement, then you’re getting a bargain with a traditional account.
But in all of these cases – Roth or traditional, 401(k) or IRA – what happens inside the account is totally safe from the taxman. You can buy or sell stocks, bonds and funds all you want, with zero capital gains tax. And any earnings or dividend payments are yours to keep.
It’s really that simple. As long as you invest in a retirement account, rather than a regular taxable brokerage account, you don’t pay capital gains tax. Hopefully, more and more Americans will learn how to invest this way. If we can restore confidence in our financial system and get more people investing, then we’ll all benefit.
— Samuel Taube
Source: Investment U