• Taxes affect how much of your hard-earned savings you get to keep.
  • Knowing the tax rules is important for minimizing their impact.
  • Tax-management strategies may help reduce your tax rate.

Taxes are unavoidable, but mismanaging taxes can result in paying more to the government than necessary. By understanding how tax-efficient strategies can affect your retirement, you can keep more of your savings for yourself.

Retirement plans typically include either pre-tax or after-tax investments, or both. Pre-tax contributions help increase savings in your pre-retirement years while after-tax contributions may help reduce your tax burden during retirement. You may also save for retirement outside of a retirement plan, such as in an investment account. Generally, your retirement income should come from both retirement plans and after-tax investment accounts.

Pre-tax contributions

Pre-tax investments, such as 401(k)s and traditional IRAs, are also described as "tax-deferred." They allow you to postpone paying taxes on the amount you contribute and the earnings that are generated as long as they remain in the account. When you withdraw funds at retirement, you'll pay taxes on them.

Potential advantages:

  • The account value may grow faster than a comparable taxable investment since the earnings in the account can grow tax-deferred.
  • When you do pay taxes later, there's a chance you'll be taxed at a lower rate if your taxable income is taxed at lower rates than in your working years.
After-tax contributions

A Roth IRA which takes after-tax contributions, can create a source of tax-free income in the future if certain qualifications are met. Contributions are not tax-deductible in your saving years, but tax-free withdrawals can help reduce your total taxable income when you reach retirement.

An annuity gives you the benefit of being able to grow your after-tax dollars like a pre-tax investment -- you will pay taxes on any earnings only when they are withdrawn. In addition to tax-deferred growth potential, variable annuities provide you with an opportunity to grow your assets with professionally managed investment options that are diversified among various types of stocks and bond funds. (Annuities can also be used in tax-deferred retirement plans, such as IRAs, but will not benefit from any additional tax-deferral.) Keep in mind, diversification does not assure a profit or protect against loss.

Tips for managing taxes more effectively

A key goal of tax planning is to reduce your taxable income — and your effective tax rate. There are a number of strategies to consider:

  • When working, deduct as much pre-tax from your gross pay as possible. Max out your 401(k) contributions and take advantage of company benefits such as payroll deductions for flexible spending accounts, transportation, supplemental insurance, etc.
  • Focus on long-term capital gains (gains on assets held longer than one year), which are taxed at lower rates than short-term capital gains or ordinary income.
  • Consider selling securities in non-qualified accounts that have had a capital loss to offset the losses against realized capital gains and up to $3,000 of an individual's ordinary income each year to lower your current tax bill. Please note that for investors with capital gains in the 10% and 15% tax brackets, the tax rate is 0% on long-term capital gains. In this scenario, recognizing losses simply to offset long-term capital gains may not be advisable since no long-term capital gains tax may be due.
  • Approach charitable giving in the most advantageous way. For example, you might be better off giving appreciated stock that has been held more than one year to a charity, rather than a cash donation. You may get a tax deduction for the full value of the asset, and an eligible charity could sell it without incurring capital gains tax on the appreciation.
  • Think ahead to estate planning to help minimize the impact of estate taxes. Annual gifting is one way to reduce the value of your taxable estate. For 2013 the annual gift tax exclusion allows each donor to give up to $14,000 to an unlimited number of donees without paying federal gift tax. Over time, this is a strategy you might consider to remove assets from your taxable estate.

The tax landscape changes frequently as rates, limits and thresholds adjust, and provisions are introduced or expire. An Ameriprise financial advisor, working with your tax professional, can recommend tax-efficient strategies that are customized to your individual situation, whether your assets are still growing or are already generating retirement income.

Do not use this information as the sole basis for investment decisions; it is not intended as advice designed to meet the particular needs of an individual investor.

Neither Ameriprise Financial nor its affiliates may provide tax or legal advice. Consult with your tax advisor or attorney regarding specific tax issues.

Brokerage, investment and financial advisory services are made available through Ameriprise Financial Services, Inc. Member FINRA and SIPC.