Fear Of Taxes Can Harm Seniors
When it comes to investing, avoiding taxes should not be your primary concern. Regardless of how much that financial salesperson talks about the importance of deferring taxes, you need to stop and consider these important facts before you make a decision. Otherwise, you can actually lose money instead of saving it.
(PRWEB) April 16, 2005 -- “Guarding Your Wealth” is a nationally syndicated
weekly personal finance column written by Jeffrey D. Voudrie, CFP. Mr. Voudrie
is the President of Legacy Planning Group, a private wealth management firm that
employs sophisticated proprietary strategies designed to protect and grow its
clients' investments. Please visit our website, www.guardingyourwealth.com to read past articles in our
archive.
When it comes to investing, avoiding taxes should not be your
primary concern. Regardless of how much that financial salesperson talks about
the importance of deferring taxes, you need to stop and consider these important
facts before you make a decision. Otherwise, you can actually lose money instead
of saving it.
As I talk with seniors from across the nation, it’s
obvious they loathe paying taxes. Financial salespeople often play on this
dislike of paying taxes to motivate seniors into buying a high-commission
investment even though it will earn the senior less in the long run. The only
one earning more in this situation is the salesperson!
There are two
basic kinds of tax-advantaged investments—tax-free and tax-deferred. The two are
often confused even though they are very different. For instance, municipal
bonds are tax-free. You don’t have to pay any Federal income tax on the interest
that you earn on a municipal bond—ever. This allows municipalities to borrow
money for public works projects at lower interest rates, saving the public
money.
The simple way to calculate whether you are better buying a
tax-free municipal bond versus a taxable bond is to divide the tax-free yield by
1 minus your tax rate. For instance, if you are in the 28% tax bracket and a
10-year municipal bond is yielding 3.78% then you divide 3.78 by .72, which
equals 5.25%. That means that you would have to earn over 5.25% on a taxable
bond to give you more after tax income then the municipal
bond.
Tax-deferred investments work quite differently. Annuities are the
most often used tax-deferred investment. You don’t avoid paying income tax in a
tax-deferred investment. You only delay paying taxes, which are due when money
is taken out of the tax-deferred vehicle. If you don’t plan on using the money
yourself, the taxes will still have to be paid at your death.
Not only
will you have to pay taxes on tax-deferred investments in the future, it is
likely that you will have to pay more in taxes then compared to paying the tax
now for two reasons.
First, any earnings on a tax-deferred vehicle will
be taxed at ordinary income rates—for instance the 28% we assumed earlier. If
you invested that money in an investment that paid dividends and/or capital
gains and paid the taxes now, you would only have to pay taxes at the 10% or 15%
level.
That’s a huge difference. In our example, earnings taken out of an
annuity will be taxed at 28%. Dividends and capital gains off of a mutual fund
will be taxed at 15%. That’s a 13% difference!
Financial salespeople will
use the fear of paying taxes in an attempt to convince a 70 or 80 year old that
they should buy an annuity. That is completely bogus! Studies have shown that
your money must be left in an annuity for 20-30 years before you begin to see
the benefits of tax-deferral. Again, the only one benefiting from the
transaction is the salesperson. Don’t fall for this trap.
Another trick
that financial salespeople will use to sell an annuity is to say that it will
keep your Social Security from being taxed. That’s true, but if you use an
annuity you’ll push all those taxes down the road. Later on, that could force
you (or your heirs if you’re deceased) into a higher tax bracket and you’d end
up paying more.
Here’s the bottom line. If you’re in a tax bracket of
27% or higher then use tax-free municipal bonds for the income portion of your
portfolio. For the equity portion of your portfolio, use tax-efficient vehicles
like Exchange-Traded Funds where you can control the timing of the tax event
while having the dividends and capital gains taxed at much lower
rates.
As you can see, there isn’t a single case in my opinion where an
older investor will benefit from a tax-deferred annuity. With current tax rates
it just doesn’t make dollars and sense. Be smart, do the simple math, and you’ll
come out ahead.
Got questions? Go to www.guardingyourwealth.com and click on ‘Ask Jeff’. I’ll be
glad to personally give you an unbiased opinion. Visit our web site to read
previously submitted questions and answers.
In addition to being a
nationally syndicated columnist and Certified Financial Planning Practitioner,
Mr. Voudrie serves clients nationwide using a proprietary money management
system he's personally developed.
Looking for an energetic expert who is
passionate about financial and wealth management? Mr. Voudrie is an excellent
speaker who will excite and inspire your audience. Mr. Voudrie is available for
a limited number of speaking engagements, television appearances and radio talk
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Source : http://www.prweb.com/releases/2005/4/prweb229309.htm