By Dan Caplinger
Making sure you have enough money to retire comfortably is the biggest long-term financial challenge you're likely to face. Some of the most useful tools to help you save for retirement, however, also have other features that could have an even bigger impact on your finances long before the day you quit your job.
Making the most of a good thing
Tax-favored retirement accounts like IRAs and 401(k) plans come with a host of benefits. The most immediate comes from traditional IRAs and 401(k)s, which give you an immediate tax deduction for the amount of money you contribute. Depending on your tax bracket, a $5,000 contribution to an IRA could be worth as much as $1,750 in tax savings this year.
More important from a long-term perspective, however, are the long-term advantages to having money inside a retirement account. As long as your money is safely sheltered within that account, you don't have to worry about paying any income tax on the capital gains you realize or the investment income you receive. Moreover, if you have a Roth IRA, you'll never have to worry about paying taxes -- even when you take your money out, all the income is tax-free as long as you meet the Roth requirements.
Higher taxes = more savings
Unfortunately, there's every indication that taxes are headed higher for many taxpayers. Although that's bad news for the investments you hold in regular taxable accounts, it makes the value of your tax-advantaged retirement accounts even greater.
As an example, take one of the more draconian tax hikes that could come as early as next year: an end to preferential dividend tax rates. Right now, qualified dividends enjoy a maximum tax rate of 15%. Next year, though, those special provisions are slated to go away, which could result in taxes on dividends rising as high as 39.6%.
That's a big hike -- but it's one you can avoid if you own your dividend-paying stocks inside a retirement account.
Keeping your money
In addition, having money in retirement accounts gives you something you might not have realized: protection from creditors. In particular:
* The laws that govern employer plans have long held that retirement assets within such plan accounts were exempt from bankruptcy laws. That means that even if you file for bankruptcy, you're entitled to keep the money within your 401(k).
* Until a few years ago, the protection for IRAs wasn't as generous. But a 2005 law paved the way for IRA protection. For IRAs that you open yourself by making direct contributions, you're entitled to protection of up to $1 million. That means that even if you file for bankruptcy, you can keep $1 million worth of IRA money for yourself.
* Rollover IRAs -- ones you create by moving money out of an ex-employer's 401(k) or other plan -- aren't even subject to the $1 million limit. You can protect all such assets from creditors.
With many people considering drastic measures like walking away from their mortgages, creditor protection and bankruptcy planning have taken on added importance. The benefits of retirement accounts in this area could be even more valuable to you.
Do it today
For all these reasons, opening an IRA or contributing to your employer retirement plan at work is essential to your financial success. Not only will it improve your chances of financial success in the long run, but it could make a huge difference in your quality of life today and in the years to come, even before you retire.