RETIRMENT  -  GLOSSARY
 

Tax-advantaged Investment Glossary
 

Deductible Tax-deferred Investments

401(k) Plan. 401(k)s are among the most attractive tax-advantaged retirement investment accounts your money can buy.  When you participate in a 401(k) plan, your employer diverts a fixed portion of your pre-tax salary into a company-sponsored investment plan. There are two advantages to this: your overall taxable income amount is reduced, which is the equivalent of a tax-deductible contribution. Second, as with all tax-deferred investments, your money grows tax-deferred until you begin withdrawing it when you're retired. Many employers match part of each employee's contribution to 401(k)s, which is icing on the cake.

403(b) plan. If you work for an educational institution, government, or other nonprofit organization you may be eligible to participate in a 403(b) plan. 403(b)s - also known as tax-sheltered annuities - are a special type of salary-reduction retirement savings plans that are similar to 401(k)s. And they have the same advantages of 401(k)s insofar as the money that you contribute to the plan is not subject to federal income taxes and your contributions grow tax-deferred until they are withdrawn.

SARSEP plan. SARSEP stands for Salary Reduction Simplified Employee Pension Plan. Certain small businesses can set up SARSEPs for their employees. As with the 401(k) or 403(b) plan, employees elect to have contributions deducted from their pay.

SEP plan. A SEP is a Simplified Employee Pension Plan that is simple to set up, simple to maintain, and a simply wonderful way for self-employed people to save for retirement. Instead of maintaining a separate pension plan (required with a Keogh, which is described below), SEP contributions are deposited directly into your (and if applicable, to your employees') IRA account(s). Your contributions to a SEP are tax-deductible.

Keogh plan. A Keogh plan is a formal arrangement in which a self-employed person (but not a corporation) establishes a retirement plan for the owner(s) and their eligible employees, if any. As with SEP plans, Keoghs permit self-employed people to set aside a considerable amount of money each year. All contributions to the account are tax-deductible, and all investment earnings in the account accumulate tax-free until withdrawn.

Tax-deductible IRA. There are two types of IRA contributions - tax-deductible (discussed now) and nondeductible (discussed below). If neither you nor your spouse is an active participant in a qualified retirement plan, you may make tax-deductible IRA contributions regardless of your income. Fully or partially tax-deductible IRAs are also available if you participate in company retirement plans but your adjusted gross income is below $35,000 for a single taxpayer or $50,000 for married taxpayers. Deductible IRAs are simply too attractive to pass up. Think of it this way: if you are in the 28 percent Federal tax bracket you can either contribute $2,000 into a tax-deferred retirement account or you can pay an extra $560 in income taxes ($2,000 in extra taxable income X 28%).
 
 

Non-deductible Tax-deferred Investments

Nondeductible IRA. If you are not eligible for a deductible IRA, you should still consider the advantages of a non-deductible IRA as a place to put money that you can afford to part with until retirement. Nondeductible IRAs still provide the benefits of tax-deferral on all income earned in the IRA account.

Holding individual stock and/or real estate. While many people don't think of it in these terms, buying and holding individual stocks (not stock funds) and real estate are in and of themselves tax-deferred investments. Why? Because so long as you hold onto the stock or the property, you pay no taxes on its appreciation in value until you sell it. Many of the families who have accumulated a lot of wealth in this country have done so by buying and holding stock and/or real estate. These rich folks enjoy a rising source of dividend and rental income (which is taxable), but they never pay a dime of tax on the appreciation in value of their stock and real estate investments until they sell them.

Deferred annuity. A deferred annuity is an investment account which is used to accumulate retirement savings. While the money you put into a deferred annuity is not tax-deductible, your investment capital grows tax-deferred. Many investors are attracted to the tax-deferral benefits of deferred annuities which, unlike other tax-advantaged retirement accounts, have no limit in the amount you can contribute. But wise savers will not contribute to a deferred annuity until they have taken advantage of all other retirement savings accounts which are at least somewhat more attractive than are deferred annuities, largely because these other accounts are less expensive to maintain.
 
 
 

Tax-free Investments

Municipal bonds and municipal bond mutual funds. You don't have to be rich to benefit from tax-free investing. Interest earned on most municipal bonds and municipal bond mutual funds is not subject to federal income taxes. If you own a bond issued by a municipality or state agency in your home state or if you purchase a single-state municipal bond mutual fund that restricts its investments to municipal bond issuers in your state, you enjoy interest income that is free from both state and federal income taxes. While municipal bonds usually don't pay as much interest as Treasury or corporate bonds, after taxes have been taken into consideration, municipals have pretty consistently provided a higher after-tax return than have taxable bonds. Remember, it's what's left over after the tax people have been paid that's most important.