What is Tax Efficiency? – Millennial Edition

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Prepared by Jonathan Kim, CPA– Staff Accountant

Tax efficiency is an attempt to minimize tax liability when faced with various financial decisions. By learning the different ways to be tax efficient, you can take advantage of legal ways to minimize the cash impact of current tax liabilities; you can preserve your capital and reach financial goals. There are a variety of tools you can utilize to be tax efficient.

One such tool is a retirement plan.

We’ve compiled a list of questions and answers to help you understand the various types and benefits of retirement plans.

  1. What’s the difference between Traditional and Roth accounts?

A traditional retirement account is funded by money that has not been taxed.  In the future, you will be responsible for paying taxes when you withdraw funds. A Roth account, on the other hand, is funded with money that has already been taxed. Although you do not get a current tax deduction for this, the great benefit is that all funds withdrawn later from a Roth account are tax-free.

  1. What’s the difference between a 401(K) and an IRA?

The big difference is that a 401(K) is employer sponsored and an IRA is individually setup. The main benefit of a 401(K) plan is that you can potentially benefit from employer matching. On the other hand, an IRA typically has more investing options.

  1. What is “matching” in an employer-sponsored retirement plan?

When you land your first job, look carefully into how you are compensated — not only via your regular salary or wages, but also the types of benefits your company offers such as retirement plans. If your company offers a plan, such as a 401(K) plan, find out if they provide matching. Matching means the employer puts money into your retirement plan at an agreed upon rate based on how much you put into your plan. Treating the maximum match as your minimum contribution would be a great way to start saving for retirement.

  1. When should I start contributing to a retirement plan?

As soon as you can! Understandably, when you are young, there are many financial priorities that seem to be more urgent than saving for retirement. But the earlier you start, the easier it will be in the long run as you will have time on your side.

  1. Is my retirement savings locked away until I retire?

Nope! Although there are many rules to encourage you to use your retirement funds when you retire, there are situations when you can use the funds ahead of time. Just beware of early withdrawal penalties and income taxes that could apply. One provision that can be a great resource for first time home buyers is the provision that allows up to $10,000 of an IRA to be used towards their home purchase without being subject to early withdrawal penalties.

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