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401(k) relief for upcoming tax law changes


Current tax laws are set to expire at the end of 2010 which can mean a substantial tax hit starting in 2011. The expectation is that tax regulations will be adjusted to minimize the effect on the low and middle classes, but those currently in the 33 and 35 percent tax brackets are likely to experience tax rates of 36 and 39.6 percent respectively. Long-term capital gain tax rates for high earners are also scheduled to shift from 15 to 20 percent with dividends to be taxed as ordinary income at each individual’s highest marginal tax rate (versus current 15 percent).

In addition, the recent healthcare bill has provisions that allow for the first time a new Medicare tax of 3.8% on investment income starting in 2013. This will include interest, dividend, capital gains, and other investment income. And there could be more as the bill enables the potential for further tax increases in 2018.

One way to help keep the taxman at bay, and help protect more of your personal money from taxes, is to make use of the high contribution limits of a 401(k) on a pre-tax and/or even on a post-tax basis (Roth 401(k) option has no income limits). As a pre-tax advantage, a 401(k) can lower taxable income for the current year. If you give post-tax into your 401(k) account, it can help manage future tax concerns as earnings and all are never taxed again assuming you use after reaching retirement age. In either scenario, the interest, dividends and capital gains are not taxed in your 401(k) account. Call it a tax diversification strategy or a great tax hedge. Either way it’s a good way to keep more of your money both today and tomorrow.

Sharebuilder Advisors, LLC does not advise on tax requirements or issues. This post is for general information only and should not be construed as investment or tax advice as each person’s situation may be different. It’s always recommended to consult with a tax advisor to discuss the specific details around your individual situation and appropriate tax strategies.

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