To Maximize Income Later, Now Is the Time to Plan Tax Strategy

By Albert B. Crenshaw
Special to The Washington Post
Wednesday, October 15, 2008

With the decline of traditional pensions, tax-deferred saving through 401(k) plans, IRAs and the like has become a key element of most Americans' funding.

But tax-deferred isn't the same as tax-free. And when retirement -- or at least relatively old age -- rolls around, people who have built up substantial tax-deferred nest eggs will find that they are required to start pulling that money out and paying taxes on it, whether they want to or not.

And these withdrawals, or "distributions," as they are called in tax jargon, get no special benefits, such as the lower rates for long-term capital gains. It's all "ordinary income," taxable at the same rates as wages and interest.

Thus, when the baby boomers, and the generations behind them, reach retirement, they will find that any tax planning they did while working and/or steps they took at and in retirement will make a major difference in the amount of spendable income they have late in life.

"People should think about tax planning in terms of maximizing their lifetime net worth," said Elissa Buie of Yeske Buie, financial advisers with offices in Vienna and San Francisco. For example, opting for tax-deferred saving over taxable investments that qualify for capital-gains rates "may or may not be the smartest thing for them to do," Buie said.

Knowing the right moves to make, however, isn't simple. Not only are the tax laws complicated, but individuals' circumstances vary, so that what works best for one person might be a bad idea for another.

But whether you are just setting out on a career or are on the cusp of old age, it's not too soon, or too late, to try to minimize your taxes. Remember, said Buie, when you have to pay taxes, "that's money that's just gone."

Here are some areas to look at as you try to work out the most advantageous strategy:

While You're Working

ยท Get the match. Of course, for taxes to matter in retirement, you've got to have some income in retirement. So as soon as you begin work, be sure and sign up for your employer's 401(k) or other retirement plan if there is one.

Check also to see if your employer will match some of the money you put into the plan. If there is a match, find out what the maximum is and try to contribute enough to get all of it. The match is free money, tax-deferred, and if you don't sign up or if you contribute too little, you'll be leaving some or all of it on the table.

And remember, both contributions and any match are "pre-tax," meaning that they are not counted when you figure your taxable income next April 15, typically reducing the tax you pay. Taxes on the contributions and on any income earned in the account are deferred until you begin withdrawal, presumably after you have retired.

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