Taxes Deferred
Growing up in a family where both parents earned a living, and there was no spare cash for ‘investments’ (other than our home). Taxes were simply the cut the government took out of every paycheck. Sure, there was sales tax, but it was just part of every thing’s purchase price. My first experience with ‘tax avoidance’ was when I arrived in Massachusetts for college and I found out that there was no sales tax on clothing. It was a revelation. I bought for all my family. States had different tax policies? What else was hiding in the tax codes I didn’t know about?
Fast forward to my working years, I was quick to grasp the concept of employer sponsored, tax deferred retirement accounts. By moving money into my 401k, I could defer paying tax on the money and let it grow and compound yearly. I scrimped to put as much money as I was allowed into it. Of course there were other tax deferred accounts I could have contributed to (IRAs), but I was young and didn’t see the need - I just assumed the 401k would take care of everything.
Of course, life happens. I quit work to help raise our family and left the 401k contributions to my husband. I ran my own company and began, haphazardly to contribute to an IRA, but it seemed like too little too late. One thing led to another and suddenly I was in my late 40s. And I was learning to manage our savings.
We had finally had accumulated enough cash to invest. Almost immediately, I was frustrated to realize that our investment returns were going to be taxed, again. We had already paid tax on the money prior to investing it - having to pay again was simply double taxation. All short term trading profits (capital gains), particularly the option trading I taught myself and is taxed as if it is regular income. What is frustrating it that the state of Massachusetts piles on an additional surcharge of 12% on short term capital gains. It makes no sense for traders like me to live in Massachusetts.
What I now appreciate is that trading in my and my spouse’s smaller IRA accounts is done tax free. We will only have to pay tax when I take the money out. Every quarter, when I write checks to the Federal and state government to pay the tax due on my investment accounts I regret not having built up my tax free accounts when I was younger. If I had, I would have lots of capital to trade and could avoid the quarterly depletion the capital every month to pay the tax man.
While the current $6000 dollar annual limit on a self directed IRAs may seem like a lot when you are starting out, the benefit of building your IRA up as quickly as possible is huge. Time is your friend here. Simply putting the money into an index fund, assuming the the stock market averages a minimal annual return of 6%, that will give you about one million dollars in 40 years time - better still it will give you at least $60,000 a year in tax free income. An 8% return could mean that you get to that million dollar mark in about 35 years. The beauty is, you can open a Roth IRA as soon as you start to earn income, even if you are a teenager. Baby sitting or helping someone clean out a garage, that money can go in. Imagine, you would be 50, with a tax free income of $60,000. Putting money into tax free accounts is critical if you plan making your money work for you at any time in your life. Otherwise, you will alway be giving up a large chunk of what you earn to the tax man.
Remember: Taxes eat into your returns on any regular investment account. My advice is to start as young as possible and build your self-directed IRA. Better still, make it a ROTH IRA and you will not have to pay any tax on withdrawals when you are over 59 1/2. This is a huge benefit. Do it for yourself and then help any young people in your life start their accounts as soon as possible. Their future selves will thank you.
Market Today: Some days the market soars and you have to sit it out, or worse, watch in dismay as a single stock pulls you down. Every year, it seems like one stock hurts bad. It happens. Just have to remember the objective is the portfolio’s return and know when cut losses. Not sure if it is that time yet. Today it was mostly calls being closed, particularly ones that softened the blow for a major slump in a favorite. Glad I write covered calls. 41.3