Taxes. You’re not getting around them, even when it comes to your retirement. Any comprehensive retirement planning strategy has to include a good, long look at taxes. Any good, long look at taxes has to include your tax bracket. Your tax bracket will have a significant impact on your financial health as you invest and save toward your retirement, as well as when you’re doing and enjoying the fruits of your discipline.
Traditional IRAs and Roth IRAs
Ground zero when evaluating your tax bracket as relates to investment is weighing the relative merits of a traditional IRA and a Roth IRA.
Traditional IRA: Qualified contributions are tax deductible. Most contributions will be tax deductible and your limits are not dependent upon your tax bracket. What’s more, when you start collecting traditional IRA payments, you will pay taxes on them based on your tax bracket.
Roth IRA: Qualified contributions are not tax deductible. The up side of this is that when you retire and begin drawing payments, you will not have to pay taxes on your withdrawals, assuming that they are standard, qualified withdrawals.
Both IRAs: Offer tax-free growth as long as the money is in your account.
Do you save money now with tax-free deposits? Or do you save money later by paying taxes up front? This is a question that has plagued people just like you planning for retirement for ages.
Basically, if your tax rate is going to be the same or higher during retirement, the Roth IRA is most likely for you. If your tax rate is going to be lower during retirement, a Traditional IRA may be a better fit. Many people choose to split contributions.
Taxation and Municipal Bonds
Another major investment strategy for retirement are municipal bonds. But how does your tax bracket affect your municipal bond investments?
- Interest: Interest payments paid on municipal bonds are not taxable and do not affect your tax bracket.
- Capital Gains: Capital gains are not going to affect your tax bracket. With that said, you’re going to pay taxes on any capital gains incurred from the sale of a municipal bond in either the short term or the long term
Short-term capital gains are taxed at a maximum of 35 percent, while long-term capital gains are only taxed at a maximum of 15 percent. So holding on to your muni bonds for more than a year can have significant tax advantages.
Other Types of Investments and Your Tax Bracket
As stated above, capital gains do not affect your tax bracket. However, many types of dividends and interest qualify as taxable income. In fact, municipal bonds are one of the few types of bonds whose interest is not taxable, which is one reason why they are so attractive to people saving for retirement.
The views expressed represent the opinion of the author and are not intended to reflect those of FutureAdvisor or serve as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell securities.