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Mutual Funds The Culture of Savings
The trick is finding dollars that are painless and largely unseen. The best, first place to look is your tax bill, or more to the point, your tax refund. Often met with disparaging looks, grunts, groans and sighs, the topic is worth discussion. That sacred tax refund has been earmarked by millions of taxpayers as a "suddenly found cache" of money to pay off bills from an over spent Christmas budget or as a way to finance a vacation or a big ticket item that regular earnings could not otherwise afford. That money however can be used to turn a poor savings habit into a profitable and possibly more comfortable future.
The federal government has held onto that money for an entire year and has done so without even the courtesy of a paying you for the privilege. Your tax refund represents no interest gained. Even banks offer a pittance in return for the deposit.
Then, to further add financial insult to injury, these same individuals will pay for tax preparation, when it is often a simple process for the average tax payer. Then, in another moment of genius, many of these same people will actually pay extra to have the money delivered as soon as possible. Not only does this represent a loss of potential return (the interest Uncle Sam failed to pay), but by subtracting the cost of an expeditious refund, they have actually lost money in the transaction - twice.
I consulted with a CPA Ed O'Hanlon, a partner in Portland, OR based Bottaini, Galucci, and O'Hanlon and asked him to run some simple figures for me. Suppose, I asked, using the average tax refund (according to the IRS) of $850, could he calculate what would happen if instead of it being refunded, the money was earmarked for a traditional IRA. Using the average wage for the state he does his primary business in ($42,000), I asked him what the actual tax savings would be.
He called me back with the following numbers: Using that $850 refund as a contribution to an IRA , a taxpayer filing a simple return for a single filer, would save an additional $284 because of a lowered tax bill. That alone is an initial return of 33%. Add that money to the IRA as well and the real savings begins.
That money, allowed to compound, will create wealth. In our example, this money, left alone for thirty years with a modest 6% return, well below the historic averages used by many equity cheerleaders, would amass over $5380 in retirement dollars. Do this every year, even beginning at a late age, and the average person can create real wealth that is relatively painless. Well, almost.
It is important to note that a full contribution to an IRA of $3,000 in 2004, $4,000 in 2005, something few Americans are doing on a regular basis would also save the same taxpayer $1100 or 33% of their base tax bill. That is a real return that is done only when you embrace a culture of savings.
Your 401(k) can also be an excellent source of painless savings. By making regular, pre-tax contributions to these employer sponsored plans, savings can be created without changing your quality of life. As a side note, it is important to tell you that encouraging savings is a truly Sisphysian endeavor. The first thing folks point out is life style changes. They are loathe to give up the conveniences they feel they justly deserve. And I agree. Why should growing wealth change your day-to-day existence?
A 401(k) is a self-directed retirement plan that, without any real direction languishes in the concept of savings without really doing much of anything. It is surprisingly easy to amass a nice nest egg using these pre-tax plans.
Figring a way to use these plans is incredibly easy. A good deal of people have become comfortable with a certain take home pay. A simple increase in your 401(k) deduction, something that is done before taxes are removed, of 3-5% may not have any affect on your take home pay. The reason: In many cases, it could lower your taxable income making the savings not only tax efficient but tax deferred. 401(k) plans, like 403(b) plans, both named after sections of the tax code require that taxes be paid at the time of withdrawal. By deferring taxes to a time when you might possibly be making less, aka retirement, the tax bill will be less making the money and the subsequent growth of those investments worth much more.
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