Replies to post #30 on Tax Questions

[Fisher]

It's important to carefully explain the differences. There are qualified and non-qualified plans, and Roth IRA's. Most people have 401(K) programs that they can contribute to in which they recieve an employer match. The first thing anyone should do is max out whatever percentage their employer is offering because that is really free money. After maxing out your employer match you should max out your Roth IRA (currently $4k/yr set to move to $5k/yr in 2008). Unlike qualified plans (401(K), SEP IRA's, Simple IRA's, etc) contributions to a Roth IRA do not reduce your AGI when filing income tax. Thus, the money you contribute to a Roth IRA goes into the account post-income tax. The advantage to this is that you don't pay any taxes on your distributions (consider if you put $50k into the account over a number of years and it grew to $300k through compounding and interest). You will save a huge amount of money by paying income tax on the small portion you contribute than the large portion you withdraw. You can withdraw from a Roth IRA without consequence to purchase your first home as well as some other reasons, otherwise not before age 59 1/2 or you will have tax penalties. For couples filing jointly your AGI cannot exceed $150,000/yr or you cannot contribute to a Roth IRA, or if you do and your income exceeds $150k your contributions for that year will be taxed 50%. Individuals also have a cap on their AGI with the same rules & consequences.

After maxing out your Roth IRA you should start putting money back into your other qualified plans such as your 401(K) or if you are self-employed your Simple or SEP IRA's. Non-qualified accounts are taxable for yearly capital gains and dividends, and should only be used for trading accounts, or short-term liquidity accounts such as your 6 month emergency fund (probably in a money market account), or any other short-term savings that you want to invest.

A combination of qualified, non-qualified, and Roth IRA's (or if you have access to it the new for 2006 Roth 401(k)) should be utilized to diversify your tax exposure during retirement.

Cash value life insurance is a way of saving money in a tax-advantaged vehicle where the interest and dividends grow tax-deferred like qualified plans and usually have virtually unlimited contribution limits (used primarily by highly compensated executives and business owners). Cash value life insurance is also good because if you have the need to put more money away in a tax-deferred account because you are maxing out your other plans your estate will probably need some liquidity for estate taxes upon you or your spouses death. Cash value life insurance held in an irrevocable trust with an eyelit with the right kind of trust planning can allow indirect access to the cash value for the spouse and children and also protect from an estate tax perspective.

Whew, that ended up being a long post. That's the kind of stuff I advise my clients on based upon their specific needs and goals.

[Fisher]

In addition to having diversification of your taxable, deferred-tax, and non-taxable accounts you should implement some tax strategies.

One strategy that is commonly used by financial advisors for their clients, or more sophisticated individuals is called "Tax Loss Harvesting". While rebalancing your portfolio between different asset classes you can harvest the tax loss of the portion of your portfolio that is performing poorly. An example is that you hold a diversified U.S. small-cap mutual fund XYZ that after six months is down 15%. You sell your XYZ fund to lock in the deductable tax loss and then purchase a relatively similar U.S. small-cap mutual fund from perhaps a different mutual fund family, but one that meets the asset class of the mutual fund that you sold to lock in the tax loss.

While rebalancing you can use this method and reduce your transaction costs by rebalancing while purchasing the new, but very similar mutual fund of that asset class.