Editor's note: If you're like most Americans, there's a good chance you're paying the tax man far too much money.
In today's edition of our weekend Masters Series, Doc Eifrig shows how to greatly boost the gains in your retirement accounts with a simple strategy that takes about an hour per year... and will get you on the road to worry-free wealth...
How to Double Your Returns in Just One Hour a Year
By Dr. David Eifrig, editor, Retirement Millionaire
Each year, Wall Street firms pay out billions of dollars in pursuit of 1% or 2%.
Wall Street employs some of the world's smartest people... with the best degrees. It pays for the most detailed research and the fastest data.
Wall Street goes to all that effort and spends all that money in the pursuit of an extra 1% or 2% per year above its "benchmarks," or the common yardsticks used to measure stock and bond performance.
If a fund manager guides his fund to 10% a year when the stock market in general is up 8%, he's considered a big success. He'll get a huge bonus. And it's all because of that extra 2% per year. An extra 2% is a big, big deal for many fund managers.
Wall Street is right to make a big deal over 2% per year. Over the course of decades, making an extra 2% per year has large effects on a person's wealth.
But did you know that you don't have to spend a penny – or do hardly any work – to make an extra 15% on your own?
Just don't pay taxes.
It's difficult enough for most people to set their income aside and build wealth. The median household wealth in the U.S. is just $10,890 (excluding the value of homes). The personal savings rate is just 4%.
One reason is taxes. The median federal tax burden is 11%. If every American could keep that 11% and combine it with a personal savings rate of 4%... they'd be saving 15% a year. That's close to a perfect savings rate.
Of course, the true tax burden for those with above-average income can get much higher than 11%. A married couple earning $100,000 a year would pay 16% of that in federal income taxes in 2013. That's before state and local income taxes, property taxes, sales tax, and levies added to the cost of things like gasoline and alcohol.
But even after you pay your income taxes and add to your savings, your investments get taxed, in some cases, over and over again. Capital gains, interest, and dividends all create taxable events. Most Americans pay a 15% tax rate on long-term capital gains. That's a major drag on your wealth-building.
Most people view taxes as unavoidable... They're inevitable, like death, right? That thinking leads many people to ignore the huge benefits gained from investing through tax-sheltered accounts.
All you have to do to get that extra 15% on your investments is take full advantage of government laws that allow you to set aside pre-tax income in vehicles like IRAs and 401(k)s.
How Retirement Accounts Boost Returns 33% on Day One
In an effort to protect us from its own taxes, the government graciously allows individuals to invest through several tax-deferred accounts.
The main examples are an individual retirement account ("IRA") and a 401(k).
An IRA lets you park your cash and compound your wealth tax-free. You don't have to pay taxes on capital gains, dividends, or interest income for any stocks, bonds, or funds you hold within an IRA. (If nothing else, this makes for simple accounting come tax time.)
Even better, you make contributions to a traditional IRA with pre-tax dollars. For instance, say you make $100,000. With a marginal tax rate of 25%, you would owe roughly $16,857 a year in taxes (depending on a lot of other assumptions). So you'll take home $83,143. If both you and your spouse make the maximum annual IRA contributions of $5,500, you'll adjust your taxable income to $89,000. Your tax bill will drop to $14,107. You end up taking home $74,892... but you also set aside $11,000.
Another way to look at it: You get $11,000, but it only costs you $8,250. That's an immediate 33% return on your investment, which you then compound for decades.
The only downside is that you can't withdraw your money until you reach 59 and a half years of age. If you do withdraw before then, you have to pay the taxes due on it plus a 10% penalty.
After 59 and a half, your withdrawals are taxed as ordinary income. If you withdraw $50,000 a year, that will count toward your annual income. You'll be taxed accordingly. And when you reach 70 and a half, you must start making the minimum required withdrawals.
If you don't have an IRA now... open one immediately!
Save Taxes and Get a Pay Raise
The other main type of account is the 401(k). It is similar to an IRA. You make contributions before taxes, and the gains add up tax-free.
The key difference with 401(k)s: Your employer sponsors and manages them. And the employer often matches contributions up to a certain limit.
If there's one financial decision that absolutely every single person needs to make, it's this... Always contribute to your 401(k) to earn the maximum employer contribution.
Skipping out on that free money is the most senseless mistake in personal finance. I cannot stress this enough: Employer 401(k) contributions are free money... Make sure you invest enough to claim the full benefit.
Take an employer that will match half of an employee's contributions up to 6%. That means if the employee sets aside 6%, the employer adds 3% for a total of 9%. That's an instant 50% return on your money... even more when you consider the tax effect.
The most you can put into your 401(k) in 2014 is $17,500. If you're older than 50, you can contribute $23,000.
The potential downside of 401(k)s is that they sometimes come with limited investment options. Your employer chooses a plan manager and works out the investment options that will be included. Most plans have a decent range of funds to choose from, but it can be hard to find good, low-cost funds for every one of your asset classes.
Talk to your benefits administrator and see if your company offers a self-directed 401(k). This type of account has all of the benefits of a 401(k) with none of the restrictions. It works just like a regular brokerage account and allows you to buy single stocks, options, exchange-traded funds (ETFs), or mutual funds.
For those who know nothing about investing – and who don't want to learn – the restricted 401(k) probably works just fine. But if you want to take more control of your financial future, convert to a self-directed 401(k).
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig
Editor's note: We recently reached out to one of the most powerful businessmen in the world – Tony Robbins.
Captains of industry and finance – from President Bill Clinton to billionaire trader Paul Tudor Jones – have paid Robbins up to seven figures for his wisdom. And today, he's sounding the alarm on a new crisis set to hit retirees across America… and sharing powerful solutions, which he has spent years investigating.
We just put together a brief summary of Tony Robbins' groundbreaking new work, which you can view free of charge. If you are retired or thinking about retirement… or simply looking for a way to safely generate more income, I urge you to click here.