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Getting Started with Financial Planning, Part Deux

Before we move along to picking investments, I wanted to make a brief follow-up to my previous post.  While picking your brokerage company is very important, equally important is understanding the types of accounts that are available to you, from a tax perspective.  What we will be discussing in this series is a traditional brokerage account.  However, there are other tax-deferred and tax-preferred accounts that may be more appropriate for you, or that you may want to use in conjunction with a basic brokerage account.

This is not a comprehensive essay on tax implications and strategies, but is merely a starting point for your consideration in choosing the right account for you.  Of course, you should consult your tax professional before making any drastic changes to your finances.

Traditional Brokerage

  • No tax deduction for investments
  • You pay capital gains tax when you sell your investment (assuming you made money on it)
  • You pay income tax on dividends (annual payments made to stockholders by the company you own)

Tax Defferred

  • These come in several forms:
    • IRA’s – Limited to $3,000 per year investment for most investors
    • 401(k) – only available through your employer
    • College Saving’s Plans – self-explanatory (this may qualify for tax-free dispersal…talk to an advisor about these before you sign up)
    • A hodge-podge of options for Small Businesses, public employees, and Self-Employed people that we won’t discuss here
  • Invested money is tax-deductible (reduces your taxable income)
  • Penalty-Free withdrawals start at age 59 1/2.
  • You may incur penalties with early withdrawal
  • All withdrawals are taxable at your current income tax rate (in the year it’s withdrawn)
  • Basic premise is that you reduce you save on taxes now, and pay income tax on the money as you take it out during retirement, which will theoretically be when you are in a lower tax bracket, thereby saving on your tax burden

Tax Preferred

  • A rather generic term for vehicles like:
    • Roth IRA’s – similar investment limits as IRA’s
    • Roth 401(k) – Pretty rare, although they’re becoming more popular
  • You get no tax deduction for investing, but your income comes out tax-free
  • No tax on growth or dividends
  • Must be 59 1/2 to withdraw penalty-free
  • Premise is that you may make more money later in life, resulting in a higher tax bracket, or taxes may go up (hey, it’s a liberal administration…it’s bound to happen) and that  you’re better off shouldering a tax burden now, while you have plenty of other deductions, like business expense, mortgage interest, college loans, etc, than later in life when you will likely not have those deductions

A truly comprehensive financial plan for life goals and retirement might include money going into each of these.  If you’re just getting started, pick the one you find most accessible, and that meets your goals.  Keep in mind that most 401(k) accounts do not allow you to invest in the market as you choose, but limit you to a selection of funds approved by your company and their brokerage provider.  We’re also not going to touch on employer-directed accounts, like pensions, here . . . since who gets those anymore to begin with?  And they basically don’t matter . . . since if you’re lucky enough to have one, you can’t do much with it anyway.  Stick around for the next post in this series, discussing basic types of investments.

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