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The Importance of Tax Diversification for Millennial Households

Mike Metzger, Founder | CERTIFIED FINANCIAL PLANNER™

Salt Lake City, Utah

In today’s fast-paced and ever-changing financial landscape, it is important to understand the significance of tax diversification for millennial households and why they should consider allocating as much of their wealth as possible into tax-free assets, retirement plans, and other investment vehicles. This strategic approach not only provides a hedge against potential future tax rate increases but also offers several advantages in terms of health longevity, overall flexibility, and financial security. In this blog, we will delve into the benefits of tax-free assets and explore some pertinent strategies that can help millennials build a robust and tax-efficient financial portfolio.

1. Tax Diversification and Risk Management: One of the key reasons why millennials should prioritize tax diversification is to mitigate the risk posed by future changes in tax legislation. By spreading their investments across taxable, tax-deferred, and tax-free accounts, individuals can effectively manage their tax liabilities and optimize their after-tax returns. Tax diversification also provides a buffer against market volatility and economic uncertainties, ensuring that millennials can weather financial storms without facing excessive tax burdens.

2. Advantages of Tax-Free Assets: Tax-free assets, such as Roth IRAs, Roth 401(k)s, and Health Savings Accounts (HSAs), offer several compelling advantages for millennial investors. Firstly, these accounts allow individuals to contribute after-tax dollars and enjoy tax-free growth on their investments, providing a valuable source of tax-free income in retirement. Moreover, withdrawals from Roth accounts are generally tax-free, offering flexibility and peace of mind during retirement years. In addition, HSAs provide a unique opportunity to save for healthcare expenses in a tax-efficient manner, making them an attractive option for millennials concerned about rising healthcare costs.

3. Hedge Against Future Tax Rates: With the national debt at an all-time high and ongoing discussions about potential tax reforms, millennials face the prospect of higher tax rates in the future. By investing in tax-free assets, individuals can shield a portion of their wealth from these potential increases, ensuring that they can enjoy a tax-advantaged income stream even in a high-tax environment. This proactive approach to tax planning can help millennials preserve their wealth and achieve their long-term financial goals with greater confidence.

4. Health Longevity and Financial Security: As millennials plan for retirement and beyond, health longevity is a critical factor to consider. Tax-free assets can play a key role in supporting long-term financial security by providing a reliable source of tax-free income throughout retirement. With medical technology advancing, it is very possible that the average life expectancy will continue to be longer. This makes it all the more important to have assets that can avoid erosion to taxes, and instead, create a pool of money that can be easily accessible.

Setting Up and Contributing to Roth Accounts:

In 2024, the Roth IRA and 401(k) contribution limits are expected to follow the annual adjustments set by the IRS based on inflation. For individuals looking to maximize their retirement savings and take advantage of tax-free growth opportunities, understanding these contribution limits is crucial. As a millennial business owner, setting up a Roth IRA and 401(k) can offer significant benefits in terms of retirement planning, tax diversification, and long-term wealth accumulation. Here’s a discussion on the 2024 Roth IRA and 401(k) contribution limits and how millennial business owners can capitalize on them:

1. 2024 Roth IRA Contribution Limits: For 2023, the Roth IRA contribution limit is $6,000, with an additional catch-up contribution of $1,000 for individuals aged 50 and over. It is important to note that these limits are subject to change based on IRS regulations and inflation adjustments. In 2024, millennial business owners can contribute $7,000 to their Roth IRA up to the designated limit with $1000 additional for individuals 50 and over, allowing them to benefit from tax-free growth on their investments and tax-free withdrawals in retirement.

2. Setting Up a Roth IRA: To set up a Roth IRA, millennial business owners can choose from a wide range of financial institutions, including banks, brokerage firms, and online investment platforms. They can open a Roth IRA account and start making contributions to it, either on a one-time basis or through regular automated contributions. It is essential to select investments that align with their financial goals and risk tolerance, ensuring a diversified and well-balanced portfolio for long-term growth.

3. Taking Advantage of Roth 401(k) Contribution Limits: In addition to a Roth IRA, millennial business owners can also benefit from a Roth 401(k) through their business. The 2024 contribution limits for a Roth 401(k) are expected to be higher than those for a Roth IRA, allowing individuals to save up to $23,000 for retirement, with an additional $7,500 for those 50 and over while enjoying tax-free growth on their investments. By offering a Roth 401(k) to employees, business owners can also enhance their company’s employee benefits package and attract top talent.

4. Setting Up a Roth 401(k): To establish a Roth 401(k) for their business, millennial business owners can work with a retirement plan provider or CERTIFIED FINANCIAL PLANNER™, such as Lifepoint Financial Design, to design a customized plan that meets their company’s needs and complies with IRS regulations. By setting up a Roth 401(k), business owners can contribute a portion of their salary on a pre-tax or after-tax basis, depending on their preference, and enjoy tax-free growth on their retirement savings. Offering a Roth 401(k) can also provide valuable tax advantages for the business and its employees, while helping millennial business owners secure their financial future.

Additional Strategies for Tax Efficiency: In addition to investing in tax-free assets, millennials can employ several other strategies to enhance their tax efficiency and maximize their after-tax returns. These include optimizing contributions to employer-sponsored retirement plans, leveraging tax-loss harvesting to offset capital gains, and strategically planning charitable donations to maximize tax deductions. By working with financial advisors and tax professionals, millennials can develop a personalized tax strategy that aligns with their goals and priorities, ensuring that they make the most of their financial resources while minimizing their tax burden.

Tax diversification is a crucial element of financial planning for millennial households, offering a range of benefits in terms of risk management, tax efficiency, and long-term financial security. By prioritizing tax-free assets, retirement plans, and other tax-efficient investment vehicles, millennials can build a resilient and flexible financial portfolio that withstands the test of time. Through proactive tax planning, strategic asset allocation, and ongoing financial education, millennials can position themselves for success and achieve their financial goals with confidence and clarity.

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Disclosures:

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal.  Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.

Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

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