Senate Finance Committee Chairman Max Baucus (D-Mont.)
and Ranking Member Orrin Hatch (R-Utah) have launched a process to reform
America’s tax code. They claim that
everything is on the table including education credits, child credits, mortgage
interest, and charitable donations.
However, one tax benefit that appears to be safe from Congress is deferred
retirement breaks like the 401K, 403B and the government’s version of the 401K
known as the Thrift Savings Plan or TSP.
As an Enrolled Agent who has prepared thousands of tax returns in my
lifetime, I can personally attest that retirement accounts are the greatest
investment that a taxpayer can make for several reasons:
1. They have tremendous tax breaks. A taxpayer can contribute $17,500 or $23,000
if 50 years old or over to a 401K plan and be taxed at a lower income. For
example, if your salary is $90,000 per year and you’re 50 years old, you can
contribute $23,000 to your retirement account and your taxable income would
only be $67,000 ($90,000 - $23,000) not counting other deductions or exemptions. Since the person in this example is in the
$25% tax bracket, the taxpayer would save $5,750 in federal taxes and another
$1,955 in Maryland taxes for a total savings of $7,705. That is a return on investment of 33.5% not
counting the earnings that his money will be making in the retirement
account. How much is the bank paying you
for your savings accounting or money market fund? How much are you earning with your mutual
fund? Is it 33.5%?
2. Fees are relatively small with a retirement
fund that you contribute at work. For
example, the administrative fee for the government’s TSP fund is only .027% or
27 cents per $1,000 invested. In
comparison, mutual fund fees average about 1% or $10 per $1,000 invested.
3. Many companies match employees’ retirement
contributions. The government’s TSP
program matches up to 5% of an employee’s salary. According to a 2010 report from the Office of
Personnel Management, 73% of employees who participated in TSP contributed enough
money to quality for the maximum matching rate of 5% from the government. Are you one of them?
4. Most retirement funds have options
for employees to choose how to allocate their funds. TSP has several options ranging from Government
securities to International funds. We
all need to monitor the performance of these funds at least quarterly so that we
take advantage of performance trends.
For example, the Bond market, known as the F Fund in TSP, lost money last
year due to climbing interest rates, so we need to review and adjust our allocations periodically.
Here are the rates of return for TSP in the past year:
Last L
Income L
2020 L 2030
L 2040 L
2050 G Fund
F Fund C Fund S Fund
12 months 5.09%
11.66% 14.42%
16.49% 18.51% 1.44%
-.48% 20.58% 25.66%
As they say in the financial industry, past
performance does not guarantee future returns.
If you are not sure which fund to invest, my advice is to select the Lifecycle
or L fund for the decade that you plan to retire. Investment experts have selected a blend of
funds in the Lifecycle fund that should meet your retirement needs for the
future.
Please let me know if you have any questions.
