The Bogleheads' Guide to Investing, 2nd Edition

Chapter Eleven Taxes: Part Two: Managing Your Portfolio for Maximum Tax Efficiency

Of all the expenses investors pay, taxes have the potential for taking the biggest bite out of total returns.

—The Vanguard Group

USE TAX-SHELTERED ACCOUNTS

We think the best way for most investors to minimize taxes is to take advantage of IRS tax-favored retirement plans specifically designed to encourage people to save for their retirement (401(k), 403(b), IRA, etc.). We know that if we don’t save for ourselves, our government or our families will be forced to undertake the burden. There are now dozens of tax-reducing retirement plans available to workers and their spouses. Unfortunately, these plans are constantly changing and all are ridiculously complex. For example, the Internal Revenue Service Publication 590 contains the IRA instructions for use in preparing tax returns. It’s impossible to give complete details of the many retirement plans available. However, we will take a general look at the various provisions of the most popular plans, so that we can select the best plan(s) for our particular situation.

401(k) Plans

A section 401(k) plan is a type of deferred compensation plan in which an employee can elect to contribute a portion of his or her wages to the plan on a pretax (qualified) basis. The contribution limit is 17,500. Employees age 50 and over are allowed an additional “catch-up” contribution of $5,500, meaning their contribution limit is $23,000. Generally, all deferred ...