Young investors: cut your taxes, grow your savings


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Paying taxes is one of life’s certainties. But young people just starting to invest for the future can do a lot to limit the impact of taxes and increase the amount they save. The key is to take advantage of tax-deferred savings opportunities — ways to let your money grow without being eaten away by taxes.

After all, life is taxing enough. Consider that it takes the average American 22 working days to pay for their payroll taxes. What’s more, a 2011 report by the Tax Foundation in Washington, DC shows that the average property tax bill (between 2007-2009) ate up 2.85% of household income. And the younger you are, the more years you have to pay taxes. So taking measures to shelter your savings from taxes could go a long way toward building a rewarding and comfortable future.

If you’ve already started, great
An important part of gaining a solid financial footing — especially when you’re just starting out — is to consider your whole financial picture, from budgeting to saving and investing. If you’ve already started saving by contributing to your workplace retirement savings plan or through an IRA, that’s great. Just make sure you’re contributing the maximum to take advantage of tax savings and any company match. But if you can manage to invest a bit more, investing in an annuity — either within your workplace retirement plan or separate from it — can have huge benefits when you start at a young age. An annuity is a simple way to add valuable diversity to your investment portfolio. And most important, a tax-deferred annuity can offer steady growth during your savings years and a steady stream of income for life once you retire.

How does an annuity work?
A tax-deferred annuity is a contract where you invest your money with an insurance company, and that money grows tax deferred until you withdraw it. When it’s time to take your money out, the insurance company can turn it into a lifetime income stream that can help support you — or you and a loved one — in retirement. There are two types of tax-deferred annuities, each with different ways of investing your money. Choose one of the following based on your risk tolerance and how the annuity fits into your overall financial picture.

  • Fixed annuity. This guarantees a specific interest rate for a number of years. It might be best if you want to protect your savings from the ups and downs of the market. The interest rate is higher than a money market or CD, and your earnings compound tax-deferred until you withdraw your money. Note that all guarantees are based on the issuer’s claims paying ability. And remember, since guaranteed annuities offer a fixed return that is often less than the long-term return potential of other securities such as stocks and bonds, their payments may not keep pace with inflation. To offset the effects of inflation, you may want to add a variable annuity.
  • Variable annuity. This lets you choose where to invest your money from among different fund options. It offers the potential for higher returns — which may appeal to younger investors with more time to ride out swings in the market. Naturally, that means you also run the risk of lower returns depending on how the underlying investments perform.

But wait, there’s more
Unlike a workplace retirement plan and IRAs, a tax-deferred annuity has no contribution limits, so you can save a lot more for your future. That’s important, given that you can only save up to $17,000 in a 401(k) or 403(b) plan in 2012, and up to $5,000 in an IRA. That may seem like a lot now. But remember, since you’re still early in your career, your salary will likely grow over the years — and you’ll want to find more ways to save more money when you’ve maxed out your employer and IRA contributions. And you’ll probably want to do that, since inflation will make the cost of living even more costly in the years to come.

With a tax-deferred annuity, you can also wait longer until you have to start taking the money out. While the IRS requires that you start withdrawing money from employer-sponsored retirement plans and IRAs when you turn 70½, annuities don’t require distributions until age 90.

So be aware that your current workplace retirement savings plan and IRAs alone may not allow you to save as much as you’ll need to see you through retirement. And remember that annuities are uniquely designed to provide guaranteed lifetime income — that’s unlike any other type of financial product available.

Remember, too, that not all annuities charge the same fees or expenses. So it can pay to shop around for the lower-cost annuities available in the market. Look closely at the sales loads, mortality fees, surrender charges and other fees that a given annuity charges. And take the time to learn about an annuity’s investment options, performance track record and the stability of the company offering it. As with most financial decisions, a little homework now might make a big difference later.

Right now, time is on your side
Besides the income potential, perhaps the biggest advantage to investing in an annuity is the tax-deferred growth. And as a younger investor you’re in the best possible position to take advantage of it. Since your money grows for years — even decades — without current income taxes taken out, it builds up more and grows faster than through a comparable taxable investment. True, you have to pay ordinary income taxes on your investment earnings when you start withdrawing the money in retirement. But at that point you may be earning less money and fit into a lower tax bracket, which means you might pay lower taxes on your investment earnings.

Is an annuity right for you?
That depends on your savings and income goals — not your age. Annuities have evolved quite a bit over the past decade to the point where they have meaningful advantages even for younger investors wanting to maximize their retirement savings opportunities. Consider rounding out your retirement savings plan with a tax deferred annuity if:

  • You are making the maximum contributions to your employer-sponsored plan and IRAs (or aren’t eligible for an IRA).
  • You have an adequate emergency cash fund to cover at least three months of daily living expenses
  • Won’t need your money until you’ve turned at least 59½. Annuities are designed for retirement and other long-term goals. If you withdraw money before you turn 59½, you may be subject to an additional 10% early withdrawal penalty.

As a younger investor, you have many expenses competing for your hard earned dollars — and taxes are certainly among them. With so many years to go before retirement, tax-deferred growth alternatives such an annuity can help you make that time pay off.

For more personalized advice, contact your TIAA-CREF financial advisor.

Please note that annuities do not provide any tax-deferral advantage over other types of investments within a qualified plan.

Withdrawals of earnings from qualified plans and annuities are subject to ordinary income tax and a Federal 10% penalty may apply prior to age 59½.

Please note that equity and bond investing involves risk.

You should consider the investment objectives, risks, charges and expenses carefully before investing. Please call 877-518-9161, or go to www.tiaa-cref.org for a current prospectus that contains this and other information. Please read the prospectus carefully before investing.

TIAA-CREF Individual & Institutional Services, LLC and Teachers Personal Investors Services, Inc., members FINRA, distribute securities products.

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