If tax rates increase in the future, does saving for your future in a tax deferred IRA or 401(k) account make sense? You postpone paying the tax to the future, possibly at a higher tax rate. Wouldn’t saving in an account where you generate tax free income be better?
Tax Free Income Alternatives
There are 4 places you can create tax free income for your future, legally.
Municipal Bonds
Long considered a safe haven to place money to generate tax free income, municipal bonds today have issues to consider.
As the economic crisis unfolds, cities and counties aren’t receiving the revenues they did a few years ago. Now they’re cutting services and laying off people and the default rate on Muni bonds across the country has risen from 16% to 19% in the last 2 years. Nearly 1 in 5 go sour. So, you need to be a smart shopper and light on your feet to exit when necessary.
Second, if you own a Muni bond paying 4% today and new issues come out next year paying 5%, what happens to the value of your bond if you want to sell to get the higher rate? You’ll have to sell at a discount, so you’ll lose money in the transaction.
Third, Muni bonds pay between 2% to 4% today. If you already have a lot of money and simply want tax free income, fine – if you’re a smart, light on your feet shopper. But if you’re trying to accumulate wealth, Muni bonds won’t help you much.
Roth IRA & Roth 401(k)
Roth IRA’s have been the rage since 1997 to save money that can grow tax deferred and from which you can access your funds in retirement tax free.
You can save up to $5000 per year if you’re under 50 years old and $6000 per year if you’re 50 years of age and over. If you’re single and make more than $120,000, you can’t contribute to a Roth IRA. If you’re married and file taxes jointly and make more than $177,000 per year, you can’t contribute to a Roth IRA.
Because most people invest in stocks or mutual funds in a Roth IRA, their money is subjected to market risk. Losses in account values due to market risk have caused many people to postpone retirement plans indefinitely.
The Roth 401(k) is gradually being offered by companies to their employees, and represents an alternative for potential tax free income in retirement. You can contribute $16,500 if you’re under 50 years of age and $22,500 if you’re 50 years of age and older.
Life Insurance
Permanent life insurance that allows for the accumulation of cash values has been used for decades in this country to generate tax free cash flow to supplement lifestyle, even before retirement years. Of the cash value insurance options available, the Equity Index Universal Life contract offers the potential for double digit rates of return on your money and no loss of principal due to market risks.
There are no age, income or contribution restrictions: It doesn’t matter how old you are or how much you make, you can contribute as much as you want.
The Equity Index Universal Life contract offers exceptional liquidity: You may access your money without taxes or penalty, without the restrictions of qualified plans like 401(k)’s or IRA’s. Savvy policy holders use the cash values as their ‘Personal Bank’ for financing investments, business start-ups, car purchases, college funding and even long term care expenses.
Distributions from these contracts is not included in income calculations for Social Security taxation, which can reduce the taxes you pay on your Social Security benefits. It may also allow you to reduce the taxes you pay on your qualified plan withdrawals. This allows you to keep more of the money you’re saved for your future.
The Equity Index Universal Life contract offers the ability to shelter money from taxes and market risk, realize a strong rate of return on your money, create a tax free income stream you won’t outlive, reduce taxes due on other Social Security and qualified plan income and pass a tax free benefit to your heirs.
To learn how this tool works and whether it would be an appropriate addition to your financial profile, call 425-829-4110 or email scott@scottscholz.com
