The Elements of Investing: Easy Lessons for Every Investor, Updated Edition

APPENDIX: SAVE ON TAXES LEGALLY

Because the U.S. government wants to encourage us to save more, a variety of retirement plans are available that allow individual taxpayers to deduct from their federal taxes every dollar they save. Moreover, these plans allow the earnings and gains from these savings plans to compound over time tax free. Here we describe the details of these tax-advantaged plans. This section is, by necessity, more detailed and dryer than most readers would like. You can skip it if you wish. Just make sure you are taking full advantage of at least one of these plans. They not only permit you to save more but also let the earnings from your savings compound at a faster rate.

INDIVIDUAL RETIREMENT ACCOUNTS (IRAs)

The simplest form of savings and retirement plan available to everyone is the individual retirement account. All people with earnings from employment can take $5,500 a year ($6,500 if you are over 50 years of age) and invest it in a mutual fund or other investment vehicle.^* If your income is moderate, you can deduct the entire $5,500 from your taxable income. Thus, if you are in the 28 percent tax bracket, the $5,500 contribution really costs you only $3,960 because your tax bill will go down by $1,540. Moreover, all the earnings from that $5,500 investment will accrue tax free. Wealthier individuals cannot get the same initial tax deduction, but they do enjoy the benefits of the tax deferral from the investment earnings on their IRA investment account. The ...