May 06 2008
dividend distribution tax on mutual funds
» Escrito en Business Tips por writer3 a las 13:48
dividend distribution tax on mutual funds
IRAs and 401(k) plans, in addition to a regular income during retirement, provide tax savings that are well worth the effort they require. These savings plans are swiftly overtaking the traditional company pension as the primary source of retirement income for today’s workforce.
Before we look more at the benefits of IRAs and 401(k) plans, let’s examine what defines these plans.
The term IRA stands for Individual Retirement Account. An IRA can be set up by a person as a way to save money that can be used for retirement. This money is placed in various investments like mutual funds. IRAs come in several varieties; two of the more prominent are the Traditional and the Roth IRA. Any contributions and dividends paid to a Traditional IRA are not taxed until the individual begins withdrawing the money in retirement.
The 401(k) plan was created by the federal government in 1978 (Source: http://invest-faq.com/cbc/ret-plan-401k.html). The 401(k) plan is essentially a savings account that is created for you by your employer. The way a 401(k) plan works is you authorize your employer to deposit a percentage of each paycheck to an account. The money in a 401(k) plan is used to purchase shares of various investments like mutual funds, stocks, etc. In many cases, an employer will actually deposit an additional “matching” amount to your 401(k) balance. You will be able to withdraw money from your 401(k) plan to use in retirement once you have reached a specified retirement age (usually at least 59 1/2 years old). The contributions to a 401(k) are usually automatic, which makes it easy for even the most undisciplined saver to get a nice retirement nest egg started. Since its inception, the 401(k) plan is being offered by an increasing number of employers as a benefit.
One very important benefit of both IRAs and 401(k) plans is the tax advantage. Deposits made to both of these plans are tax deductible. In the case of a Traditional IRA, your contributions are tax deductible. The contribution amount made through a 401(k) is deducted from the taxable amount on your pay for the year, so you do not pay taxes on that money or on any dividends paid into the account at that time.
To better understand the tax benefits of investing in an IRA or 401(k), think of it this way: if you make $20,000 a year and are taxed 15% of your income, you will be paying $3,000 in taxes. If you invest 10 percent, or $2,000 of your $20,000 into an IRA or 401(k), you will only be taxed on $18,000 which would make your hypothetical tax payment $2,700.
While the tax benefits and savings are considerable, you will however need to pay taxes on Traditional IRA and 401(k) money once you begin to withdraw it in retirement. You should also keep this in mind: avoid at all costs the temptation to withdraw money from your 401(k) and Traditional IRA before retirement, as to do so means you will be facing stiff penalties (often up to 1/3 of your saved funds will be lost to taxes if you withdraw early).
Roth IRAs provide a slightly different tax advantage, in that the money is only tax free once you begin to withdraw it in retirement. Any contributions you make along the way before retirement are subject to normal taxes. The bottom line here is you are going to be paying some sort of tax on whichever option you choose. The best thing you can do is to look for an option that will minimize the amount of tax you will need to pay.
Preparing for retirement is one of the most important things you will ever do in your life. The important thing is to start some savings plan and keep it going. If your employer offers a 401(k) plan with a match, you are essentially being offered extra money from them if you just sign up for the plan. Even if your employer’s 401(k) plan doesn’t offer matching funds, the savings in your income tax will still amount for a considerable benefit. If your employer doesn’t offer a 401(k) plan of any kind, you still have the option of an IRA, provided you can supply a minimum opening balance which usually isn’t very much (maybe the $2,000 range - shop around).
You owe it to yourself to have a comfortable retirement. Taking action like enrolling in a retirement plan is the first step to get there. Remember that while no one will do your retirement planning for you, you can contact a financial planner for help. Getting started, however, is your move to make.
Educate yourself for retirement investing - you won’t regret it. Find more resources at http://prhsolutions.com/retirement
dividend distribution tax on mutual funds
