How To Protect Your Income From The I.R.S.

Taxes can chomp away a third or more of your income. Here are some investments that can help eases your tax bite.

reduction or forgo a salary increase and instead have the money placed in the 401(k) plan. You can contribute up to 25% of your earned income or the maximum dollar amount allowed per year ($9,500 in 1996). All earnings in the plan are tax-deferred.

“Maxing out,” that is making the maximum contribution allowed, should be your investment mantra, says Carol Ward, a budget analyst at Brandeis University in Waltham, Massachusetts. With no dependents or property to claim as deductions, Ward, 32, found herself under a huge tax burden. But she now defers 15% of her pre-tax income by maxing out on her 401 (k) and contributing to an IRA.

If you-aren’t able to make the maximum contribution allowed, then start out small but incrementally increase your allocation at least 1%-2% every year, suggests Anita Robertson D’Aguilar, a financial consultant with Merrill Lynch in Century City, California.

Ward started with a 5% contribution last year, and recently boosted her allocation by 10%, thanks to a recent promotion and salary increase. Her money is invested in four different growth and balanced mutual funds. To make the most of your 401(k), you need to understand the investment menus offered by your company. Know the objectives and performance of the funds and review your options yearly advises D’ Aguilar.
You’ll be offered several investment options, including a least four mutual fund categories. Some funds will be better suited for producing income, others for maximizing capital growth. If you want to grow your assets, don’t pick conservative or fixed-income investments. If your 401(k) plan has a company match, there’s greater potential for compounding your investment.

You should take a look at specific options within your retirement plan, and if they’re not adequate or if you don’t have access to a company plan, then consider an IRA, suggests Bird Patrick, president of Security General, a financial planning firm in Boston.

IRAs were enacted by Congress as a way to encourage people to save and invest for retirement. Anyone who contributes to one receives a tax deferral, and most people get a tax deduction as well. With an IRA, your taxable income is reduced. If you’re in, say, the 28% tax bracket, a $2,000 IRA contribution reduces your taxes by $560.

IRAs are inexpensive and widely available from banks and mutual fund companies. Plus, with IRAs you can create your own basket of investments.
If you have 20 years till retirement, Patrick recommends a mix that’s 55% growth stocks or mutual funds, 45% balanced investments and 5% fixed income.

There are some limitations to IRAs. You can contribute annually up to $2,000 (or $4,000 for you and your spouse). Your IRA contributions are partially deductible if you’re single and earn up to $35,000 annually, or if you’re married and your combined income is $50,000 or less.

Kim Dulaney, a certified financial planner at Rinehart & Associates in Charlotte, North Carolina, also points to Simplified Employee Plans (SEPs) and Keoghs for the self-employed. You can put up to 20% of your income, or $30,000 a year, in

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