Funding Retirement Accounts

Some people are reluctant to fund Individual Retirement Accounts and 401(k) plans, fearing they are setting themselves up for big tax bills in retirement. After all, retirement-account withdrawals are typically taxed as ordinary income, which can mean paying a federal rate as high as 35%. By contrast, in a taxable account, any qualifying dividends and long-term capital gains are taxed at a maximum federal rate of 15%.

What to do? If you're eligible, you can always fund a Roth IRA or Roth 401(k) instead. Roth accounts don't offer an initial tax deduction, but withdrawals can be federal and state tax-free if you follow the rules.

But even if the Roth isn't an option, a tax-deductible IRA or 401(k) remains a fine choice. That's because the initial tax deduction often pays for the eventual tax bill. To understand why, consider a simple example. Suppose you are in the 25% federal income-tax bracket today--and you're still in the 25% bracket once you retire. If you put $1,000 in a tax-deductible IRA, your out-of-pocket cost would be $750, thanks to the $250 tax savings.

By the time you retire, let's assume your IRA has grown a hypothetical 100% to $2,000 (though there are, of course, no guarantees). At that juncture, you cash out the account, paying 25% to the government. That leaves you with $1,500, or 100% more than your $750 investment. In effect, the IRA gave you tax-free growth on your initial $750 out-of-pocket cost.

To be sure, if you are in a higher tax bracket in retirement, you won't enjoy totally tax-free growth. On the other hand, if your tax bracket falls in retirement--which often happens--you will benefit at Uncle Sam's expense.

INVESTMENT PRODUCTS: NOT FDIC INSURED • NO BANK GUARANTEE • MAY LOSE VALUE

Citigroup Inc. and its affiliates do not provide tax or legal advice. Any such taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.

The example listed above is hypothetical and does not represent the experience of other clients, nor do they indicate future performance. Investment results may vary. The investment strategies presented are not appropriate for every investor.

Investments are subject to market fluctuation, investment risk, and possible loss of principal.

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