Four Kinds of Money- Part 2

Four kinds of money part 2

What Kind of Money are You Using in Your Savings Plan?
by Minya K. Irby | Living Well | Wednesday, September 18, 2013 

In the previous article, I explained the differences and benefits of having the first two kinds of money in your savings plan, which is “free money” and “tax-deferred money.” In this article, I’ll discuss the differences and benefits of having the final two types of money: tax-free money and taxable money. 

Tax-Free Money

The third kind of money is tax-free money. The usage of tax-free money when saving or planning for retirement is individualized. It’s individualized because there are two ways to use tax-free money: through a Roth IRA or life insurance policy, and which of these vehicles you decide to drive toward financial freedom will depend on your individual needs. To use a Roth IRA there are certain rules that apply, such as saving less than $4,000 per year. A Roth IRA may also be your best choice if you’re close to retirement and don’t have the time needed to properly fund your life insurance for growth.  

On the other hand, life insurance, when funded correctly, will not only provide you tax-free growth on your money, but it will also provide your loved ones with a death benefit to take care of your final expenses. Tax-free money is a very powerful weapon to use in your savings or retirement portfolio because you pay the taxes upfront. Money used to pay life insurance premiums and fund a Roth IRA are paid on an after-tax basis, after you get your check and the taxes have come out. You can also rollover your 401(K), 403(b), or Traditional IRA to a Roth IRA, paying the taxes immediately out of the funds you are rolling over. The offset happens at tax time when you begin to factor in deductions you may have over the years lessening the sting of your tax bill. The huge upside to tax-free money is that regardless of the vehicle you choose to utilize this planning strategy, all the growth that your money will experience is free from taxes, simply because you paid them upfront.  

When used strategically, tax-deferred money, free money and tax-free money will help you maximize your savings or retirement dollars while minimizing your tax liability along with when and how you draw out the money when it’s needed. 

Taxable Money

The fourth kind of money, taxable money, is everything else. Just about all money is taxable. Taxable money is simply money that has no favorable tax treatment. Taxable money can potentially make your retirement dreams disappear quickly while making Uncle Sam very happy. 

In order to know what type of savings strategy to use, as well as how to implement that strategy requires counseling from your team. At the same time, understanding the four kinds of money you’re working with will help you control the amount of money you pay in taxes annually while also providing you with a comfortable retirement.  

Photo credit: mustafabilgesatkin/iStock Images

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