A tax Shelter is one investment strategy that investors should consider. By pursuing tax-deferred investments, you can allow the investment to accumulate unimpeded by taxation until it is time to withdraw it. Two advantages exist for this kind of strategy. The capital gains, interest, and dividends the investment accumulates occur when the investor is making more money and thus is taxed at a higher rate. The accumulated investment is withdrawn when the investor is making little or no money, upon retirement for example.
A number of investments are available that defer taxation.
An annuity is a product that allows someone to accumulate savings over a fixed period. This is the accumulation phase. The investment then pays out a fixed amount of money to the investor. This is the annuitization phase. The number of time payouts occur can be a fixed period, 20 years, for example, or as long as the investor and his or her spouse (when a survivorship benefit is included) are alive. The advantage of an annuity is that it removes the possibility of someone outliving their retirement investment.
A deferred annuity, as the term suggests, delays payments until the investor elects to receive them. The tax benefit is that the earnings are only taxed after the withdrawal period begins. This kind of annuity also has a death benefit in which the beneficiary of the investor receives both the principal and earnings.
Roth IRAs vs. regular IRAs
An IRA or individual retirement account is an investment that accumulates retirement savings. An individual investor can invest money in a regular IRA or a Roth IRA.
Contributions of a regular IRA are deductible from your income, therefore deriving a tax benefit. However, distributions from the account subject to ordinary income tax. The advantage is that the distribution is likely to have a lower tax rate after the investor retires.
Contributions to a Roth IRA are not deductible from your income. However, distributions occur tax-free. Furthermore, transactions such as capital gains, interests, and dividends occur without a tax penalty.
If you withdraw money from an IRA before you reach retirement, you will likely incur a penalty. Exemptions to the penalty include becoming disabled or being a first-time home buyer.
401k, 457, and 403b plans
Your employer will often offer tax-deferred investments called 401ks, 457s, or 403bs. Your employer will often chip in a fixed amount depending on how much you contribute as part of your benefits package. When you change employers, you can either roll over your investment into an IRA or into your new employer’s plan without incurring a tax penalty. Like a regular IRA, there is a penalty for withdrawing sums before you reach retirement age. Withdrawals after retirement are subject to income tax.
Cash value life insurance
Investing in a cash value life insurance policy has two purposes.
When you’re young and starting a family, the life insurance policy provides a payout to your children in the event of your premature death.
However, as you near retirement and your children have grown, the insurance policy becomes a source of retirement income. The cash value of the insurance policy has increased over time as the issuer of the policy credits interest to the account. You can, therefore, start to withdraw from the cash value periodically tax-free to supplement your retirement income. Alternately, you can continue to maintain the cash value of the insurance policy and use it for a death benefit for your spouse.
Tax Shelter Conclusion
With the number of tax-deferred investments available, it behooves you to consult an investment advisor to craft a strategy that includes such tax shelter investments.
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