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Saving more can help, but there are other factors too. In this article, we’ll share suggestions you can use to build wealth.
Start with your employer’s retirement plan
Given its advantages, it’s surprising that only about 14% of workers save the maximum allowed by law in their plan. Even among those making more than $100,000, only about one-third contribute the maximum allowed.*
If you want to achieve the freedom to retire at the age you choose, travel the world, or send your children to college, save like a champion. Start by contributing all you can to your retirement plan.
Open the back door to a Roth IRA
After maxing out their retirement plan, many wealth builders contribute every dollar allowed to a Roth IRA. But as you may know from experience, income limits can prevent high earners from contributing to a Roth IRA.
There’s another way in!
If you can’t contribute directly to a Roth IRA, consider going through the back door. Here’s how it’s done:
- Open a traditional IRA account and make a nondeductible contribution. Come tax time, you’ll need to report your nondeductible traditional IRA contribution by completing IRS Form 8606, Nondeductible IRAs.
- Quickly convert that traditional IRA to a Roth IRA. Speed counts, because any earnings that you convert to the Roth IRA would be reported as taxable income in the year of the conversion. (You won’t owe taxes on the contributions you convert because they were made with after-tax money.)
Learn how Roth contributions can get you tax-free retirement income.
Special tax considerations
Share your employer’s success
As a reward for your hard work, some employers allow you to invest in the stock of your company.
It can be through a stock purchase plan, through stock options, or through your retirement plan.
Investing in your company’s stock can allow you to share in your company's success. Just remember that a single stock is much more volatile than an investment in a diversified mutual fund. That’s why Vanguard suggests that you invest no more than 10% of your overall retirement savings in company stock.
Tax-saving tip: Consider taking advantage of potentially lower capital gains taxes versus ordinary income taxes. When you roll over your stock to an IRA or sell it and withdraw the money, the entire amount will be taxed as ordinary income when the stock is sold.
Instead, consider transferring the stock from your plan in kind (that means without selling it) to a taxable brokerage account. You would owe ordinary income tax on the cost of the shares, but any unrealized gains on the shares could be taxed at a lower long-term capital gains rate.
Consult a tax advisor before rolling over shares of company stock.
Whenever you invest, there's a chance you could lose the money. Diversifying means having different types of investments. It doesn't guarantee you'll make a profit or that you won't lose money.
Whether you keep your money where it is, move it to an IRA, or move it to another employer's plan depends on your situation and preferences. Some things to consider are available investments and services, fees and expenses, and protection from creditors. Also consider withdrawal penalties, required distributions, and the tax effects of moving company stock to an IRA. There are other factors too. Weigh the pros and cons before you make your decision.
Benefit from compounding
Compounding generally refers to the process of earning interest on interest (known as compound interest). So not only can the passage of time help lower your investment risk, it can potentially increase the rewards of investing.
For example, if you earn 6% on a $10,000 investment, you’ll make $600 in the first year. But then you start the second year with $10,600—during which your 6% returns net you $636. In the 20th year of this hypothetical example, you’ll earn more than $1,800—and your balance will have increased more than 200%.
Start saving for college early—really early
You probably already know that college costs a lot of money.1 Even if you can’t save a lot, the sooner you start saving for college, the more time your money will have to grow. That way, when the time to start college arrives you won’t have to jeopardize your retirement by dipping into your own savings.
There are lots of ways to save for your child’s college education, and it can be fairly easy to find the best one to suit your family’s needs. Here are a few that have federal and state tax benefits:
- 529 plans.
- Roth IRA.
- The Uniform Gift to Minors Act (UGMA).
- Uniform Transfers to Minors Act (UTMA).
Get the details about how to save for college.
Keep more of what you make
Wouldn’t it be nice to make more money … by paying less in taxes?
Less well known is asset location—positioning those assets between taxable and tax-advantaged accounts to try to increase effective returns after taxes have been paid.
The key to asset location
One rule of thumb is that investments that are designed to generate significant income—for example, taxable bond funds or real estate investment trusts (REITs)—might be better located in a tax-deferred account, like a 401(k), where you don’t have to pay taxes on the income these investments earn until you withdraw the money.2
Alternatively, with an investment that isn’t designed to generate much income, like a stock or stock index fund, it might be better held in a taxable account. Although there are no guarantees, the lion’s share of any price appreciation might be taxed at a lower long-term capital gains rate when the investment is sold.
How tax rates differ
Tax rules are constantly in flux, so it’s best to consult with your tax advisor before taking action. Because future returns are uncertain, asset location is more of an art than a science. Yet, if used wisely, it could increase effective returns without adding investment risk.
1 The average published tuition and fees, not including room and board, for the 2024-2025 school year was $43,350 at private colleges, $11,610 for in-state residents at public colleges, and $30,780 for out-of-state residents attending public universities. Source: College Board Trends in College Pricing and Student Aid 2024.
2 You may need to pay income tax on the money you take from your retirement account. If you’re under age 59½, you may also have to pay a 10% federal penalty tax.
The performance of a company stock fund depends on the price of a single stock, which can move up or down dramatically. So this type of fund can be riskier than a stock mutual fund, which may own hundreds or thousands of stocks.
Bond funds are made up of IOUs, primarily from companies or governments. These funds risk losing value if the debt isn't repaid on time. Also, bond prices can drop when interest rates rise or the issuer's reputation suffers.
Taxes: When you convert pre-tax money to Roth, you'll owe taxes on the whole amount. When you convert traditional after-tax money, you'll owe taxes on just the earnings. You should talk with a tax advisor before you do this. Later, when you take the Roth money out, you won't owe taxes as long as you meet two conditions. First, you're at least age 59½. Second, you converted the money at least five years earlier. If you take the money out early, you may have to pay income tax and a 10% federal penalty tax. If required by law, Vanguard will withhold some taxes for you.
There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
Vanguard does not provide individual tax advice. You should discuss your situation with your tax advisor.