Investing Unit 7: Advantages of Retirement Accounts

Personal Finance January 02, 2019 Print Friendly and PDF

 


Advantages of Retirement Accounts

A major advantage of tax-deferred investing is making contributions to a retirement account with pre-tax dollars. In many instances [e.g., 401(k) plans], the government allows taxable income to be reduced by the amount of the contribution to a tax-deferred retirement plan. As a result, you can have the same amount of money in your pocket and invest what you would have paid the government. For instance, if you are in the 22% marginal income tax bracket and you contribute $1,000 to a tax-deferred retirement plan, you would lower your federal income taxes by $220 (0.22 times $1,000). The savings is based on your marginal tax rate, i.e., the rate you pay on the highest dollar of earnings.

There are seven different tax rates in 2019-- 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The higher your marginal tax rate, the more you, as an investor, benefit from pre-tax dollar contributions to retirement savings plans and tax-deferred earnings. Figure 1 shows the 2019 tax rate schedules for your reference in determining marginal tax rates. These figures are adjusted annually for inflation.

Figure 1. 2019 Tax Rate Schedules

Single-Schedule X

Taxable Income Over But Not Over Marginal Tax Rate
$0

   $9,700

 10%
     9,700    39,475  12%
   39,475    84,200  22%
   84,200  160,725  24%
 160,725  204,100  32%
 204,100  510,300  35%
510,300 ---  37%

Head of household-Schedule Z

Taxable Income Over But Not Over Marginal Tax Rate
$0  $13,850  10%
   13,850    52,850  12%
   52,850  84,200  22%
   84,200  160,700  24%
 160,700  204,100  32%
 204,100 510,300  35%
510,300 ---  37%

Married filing jointly or Qualifying widow(er) - Schedule Y-1

Taxable Income Over But Not Over Marginal Tax Rate
$0  $19,400  10%
   19,400    78,950  12%
   78,950  168,400  22%
 168,400  321,450  24%
 321,450  408,200  32%
 408,200 612,350  35%
62,350 ---  37%

Married filing separately - Schedule Y-2

Taxable Income Over But Not Over Marginal Tax Rate
$0    $9,700  10%
   9,700    39,475  15%
  39,475    84,200  22%
  84,200  160,725  24%
 160,725  204,100  32%
 204,100 306,175  35%
306,175 ---  37%

 

A second advantage of tax-deferred investing is that earnings grow faster because they aren't taxed until withdrawn. Instead of paying tax on the interest earned, it continues to compound until the investment is sold. Over time, the gap between the value of a taxable and a tax-deferred account, earning the same rate of interest, increases sharply.

 

Connect with us

  • Twitter
  • Facebook
  • YouTube
  • Pinterest

Welcome

This is where you can find research-based information from America's land-grant universities enabled by eXtension.org

LOCATE

USDA / NIFA

This work is supported by the USDA National Institute of Food and Agriculture, New Technologies for Ag Extension project.