Retirement Account Contributions Analysis

Our financial planning team uses sophisticated analytical techniques to develop a cash flow and investment strategy that is designed to increase the chances that the client will have sufficient retirement income.

We can help you make sense of all the retirement account options you have to choose from (403b, 457(b), Roth options, IRA, Roth IRA, SEP, Solo 401(k), Taxable) and determine the optimal contribution amount and asset allocation for each respective account.

It is important to match different types of accounts (i.e. taxable, retirement, etc.) with particular investment strategies.  Not regularly contributing to tax efficient accounts is a common mistake in retirement planning. Making increased contributions to retirement accounts including 401(k), 403(b), IRA, SEP IRA, Roth IRA, Spousal IRA (spouse not in workforce), and “backdoor” Roth IRAs can help put you on track to be prepared for retirement. These plans are important because they combine the power of compounding with the benefit of tax deferred (and in some cases, tax free) growth. For most people, it makes sense to maximize contributions to these plans, whether it’s on a pre-tax or after-tax (Roth) basis.

Just as we focus on allocating our investments between stocks, bonds, etc., to reduce volatility, it’s also important to think about the tax consequences of where we locate our funds. Asset location means that you want to hold your assets in different types of accounts from a tax perspective. Asset location can make a meaningful difference in the taxes you pay over your investing lifetime and it is important to match different types of accounts (i.e. taxable, retirement, etc.) with particular investment strategies.

You can hold investments in tax-deferred accounts (e.g., Individual Retirement Accounts or IRAs), taxable accounts, or tax-exempt accounts (e.g., Roth IRAs). Paying attention to asset location can improve your portfolio’s after-tax returns and allow you to keep more of what your investments earn.

You should consider the following factors when deciding where to locate an investment.

  • Taxation of Interest. While there are some exceptions (e.g., municipal bond income), most interest is taxable as ordinary income.
  • Taxation of Capital Gains. You realize a capital gain when you sell or exchange an investment for more than the purchase price. Short-term capital gains get taxed as ordinary income. They arise when you sell investments held for a year or less. Long-term capital gains result from the sale of an asset held for more than one year. The tax rate for long-term capital gains is lower than the investor’s ordinary income tax rate.
  • Taxation of Capital Losses. You realize a capital loss when you sell or exchange an investment for less than its cost basis. In taxable accounts, capital losses offset any capital gains first. Short-term gains and losses get combined, leaving you with a net gain or loss. Then you follow the same process for long-term gains and losses.  If capital losses exceed gains, you can deduct up to $3,000 of such losses annually. You can carry unused capital losses until used. Generating a capital loss in a tax-deferred account provides no tax benefits.
  • Taxation of Dividends. Qualified dividends are paid out of corporate earnings and receive the same preferential tax rate as long-term capital gains. But not all dividends are qualified. For a dividend to be qualified, it must have been paid by a U.S. corporation or a qualified foreign corporation. You must also own the stock for more than 60 days during the 121-day period that begins 60 days before the stock’s ex-dividend date. Dividends from tax-exempt corporations or organizations that generally are not subject to income tax are non-qualified. They generally get taxed at the same rate as ordinary income. 
  • State and Local Taxes. Some securities are exempt from federal and/or state taxes (Interest Income from Treasury Bills, U.S. Savings Bonds and Municipal bonds).
  • Foreign Taxes Paid. If you own non-U.S.-based securities, you may pay withholding tax on any dividends you receive. If you hold the shares in a taxable account, you can claim either a credit (dollar-for-dollar reduction in taxes) or a deduction for the withholding tax when you file your tax return. Please note that only income taxes, which include withholding taxes, qualify for credit on your U.S. tax return.

Considering which account should hold which investments is an important strategy, but one that is often overlooked. It can help investors with both taxable and tax-advantaged accounts reduce their taxes.