MOR Investing - Spring 2008

The Benefits of Tax-Advantaged Savings Vehicles

Taxes can take a big bite out of your total investment returns, so it's helpful to look for tax-advantaged strategies when building a portfolio. But keep in mind that investment decisions shouldn't be driven solely by tax considerations; other factors to consider include the potential risk, the expected rate of return, and the quality of the investment.

Tax-deferred and tax-free investments
Tax deferral is the process of delaying (but not necessarily eliminating) until a future year the payment of income taxes on income you earn in the current year. For example, the money you put into your 401(k) retirement account isn't taxed until you withdraw it, which might be 30 or 40 years down he road!

Tax deferral can be beneficial because:

• The money you would have spent on taxes remains invested
• You may be in a lower tax bracket when you make withdrawals from your accounts (for example, when you're retired), and
• You can accumulate more dollars in your accounts due to compounding

Taxes make a big difference
Let's assume two people have $5,000 to invest every year for a period of 30 years. One person invests in a tax-free account like a Roth 401(k) that earns 6% per year, and the other person invests in a taxable account that also earns 6% each year. Assuming a combined federal and state income tax rate of 30%, in 30 years the tax-free account will be worth $395,291, while the taxable account will be worth $289,980. That's a difference of $105,311.

Tax-advantaged vehicles for retirement
One of the best ways to accumulate funds for retirement or any other investment objective is to use tax-advantaged (i.e., tax-deferred or tax-free) savings vehicles when appropriate. There are several to choose from when planning for retirement:

• Traditional IRAs— Anyone under age 70½ who earns income or is married to someone with earned income can contribute to an IRA. Depending upon your income and whether you're covered by an employer-sponsored retirement plan, you may or may not be able to deduct your contributions to a traditional IRA, but your contributions always grow tax-deferred. However, you'll owe income taxes when you make a withdrawal (and a 10% additional penalty tax if you're under age 59½, unless an exception applies). In 2008, you can contribute up to $5,000 to an IRA, and individuals age 50 and older can contribute an additional $1,000.
• Roth IRAs — Roth IRAs are open only to individuals with incomes below certain limits. Your contributions are made with after-tax dollars, but they will grow tax-deferred and qualified distributions will be tax-free when you withdraw them. The amount you can contribute is the same as for traditional IRAs. Total combined contributions to Roth and traditional IRAs can't exceed $5,000 each year for individuals under age 50.
• SIMPLE IRAs and SIMPLE 401(k)s — If you're self-employed or the owner of a small business, you may be able to take advantage of these retirement plans. As with traditional IRAs, your contributions grow tax-deferred, but you'll owe income taxes when you make a withdrawal. For 2008, you can contribute up to $10,500 to one of these plans; individuals age 50 and older can contribute an additional $2,500.
• Employer-sponsored plans (401(k)s, 403(b)s, 457 plans) — Contributions to these types of plans grow tax deferred, but you'll owe income taxes when you make a withdrawal. For 2008, you can contribute up to $15,500 to one of these plans; individuals age 50 and older can contribute an additional $5,000.

• Annuities — An annuity can supplement the other vehicles listed here. Under an annuity contract, in exchange for your lump sum or periodic contributions, the annuity issuer (typically an insurance company) agrees to pay you or your named beneficiary an income stream for life (subject to the claims-paying ability of the issuer). There's no limit to how much you can invest, and your contributions grow tax-deferred. However, you'll owe income taxes on the earnings when you start receiving distributions.

An All-purpose tax-advantaged investment
Tax-free municipal bonds--Interest earned on tax-free municipal bonds is generally exempt from state tax if the bond was issued in the state in which you reside, as well as from federal income tax (though earnings on certain private activity bonds may be subject to the alternative minimum tax). But if purchased as part of a tax-exempt municipal money market or bond mutual fund, any capital gains earned by the fund are subject to tax.

Bottom line
Though tax considerations shouldn't be your only concern when investing and building a portfolio, by putting your money in tax-advantaged savings vehicles and investments when appropriate, you'll keep more money in your own pocket and put less in Uncle Sam's.Your Morgan Keegan financial advisor can help you identify the tax-advantaged investments that may work best for your portfolio.

This information is for illustrative and discussion purposes only. Morgan Keegan does not provide legal or tax advice. You need to contact your legal and tax advisors for additional information and advice before making any investment decisions.

© Copyright 2007 Forefield Inc. All rights reserved.

Should You Pay Off Your Mortgage or Invest?

Having a mortgage can be a huge burden on your budget, and paying it off may be the first item on your financial to-do list. But competing with the desire to own your home free and clear is your need to invest for retirement, your child's college education, or some other goal. Putting extra cash toward one of these goals may mean sacrificing another. So how do you choose?

Evaluating the opportunity cost
Let's assume that you have a $300,000 balance and 20 years remaining on your 30-year mortgage, and you're paying 6.25% interest. If you were to put an extra $400 toward your mortgage each month, you would save approximately $62,000 in interest, and pay off your loan almost 6 years early. By making extra payments and saving all of that interest, you'll clearly be gaining a lot of financial ground. But before you opt to prepay your mortgage, you still have to consider what you might be giving up by doing so — the opportunity to potentially profit even more from investing. To determine if you would come out ahead if you invested your extra cash, start by looking at the after-tax rate of return you can expect from prepaying your mortgage. This is generally less than the interest rate you're paying on your mortgage, once you take into account any tax deduction you receive for mortgage interest. Once you've calculated that figure, compare it to the after-tax return you could receive by investing your extra cash.

For example, the after-tax cost of a 6.25% mortgage would be approximately 4.5% if you were in the 28% tax bracket and were able to deduct mortgage interest on your federal income tax return (the after-tax cost might be even lower if you were also able to deduct mortgage interest on your state income tax return). Could you receive a higher after-tax rate of return if you invested your money instead of prepaying your mortgage?

Keep in mind that the rate of return you'll receive is directly related to the investments you choose. Investments with the potential for higher returns may expose you to more risk, so take this into account when making your decision.

Other points to consider
While evaluating the opportunity cost is important, you'll also need to weigh many other factors. The following list of questions may help you decide which option is best for you.

• What's your mortgage interest rate? The lower the rate on your mortgage, the greater the potential to receive a better return through investing.
• Does your mortgage have a prepayment penalty? Most mortgages don't, but check before making extra payments.
• How long do you plan to stay in your home? The main benefit of prepaying your mortgage is the amount of interest you save over the long term.
• Do you have an emergency account to cover unexpected expenses? It doesn't make sense to make extra mortgage payments now if you'll be forced to borrow money at a higher interest rate later.
• Are you saddled with high balances on credit cards or personal loans? If so, it's often better to pay off those debts first. The interest rate on consumer debt isn't tax deductible, and is often far higher than either your mortgage interest rate or the rate of return you're likely to receive on your investments.
• Are you currently paying mortgage insurance? If you are, putting extra toward your mortgage until you've gained at least 20% equity in your home may make sense.
• How will prepaying your mortgage affect your overall tax situation? For example, prepaying your mortgage (thus reducing your mortgage interest) could affect your ability to itemize deductions (this is especially true in the early years of your mortgage, when you're likely to be paying more in interest).
• Have you saved enough for retirement? If you haven't, consider contributing the maximum allowable each year to tax-advantaged retirement accounts before prepaying your mortgage.
• How much time do you have before you reach retirement or until your children go off to college? The longer your timeframe, the more time you have to potentially grow your money by investing.

The middle ground
If you need to invest for an important goal, but you also want the satisfaction of paying down your mortgage, there's no reason you can't do both. It's as simple as allocating part of your available cash toward one goal, and putting the rest toward the other.

And remember, no matter what you decide now, you can always reprioritize your goals later to keep up with changes to your circumstances, market conditions, and interest rates.

Your Morgan Keegan financial advisor can help you determine whether investing or paying down your mortgage is best for your situation.

This information is for illustrative and discussion purposes only. Morgan Keegan does not provide legal or tax advice. You need to contact your legal and tax advisors for additional information and advice before making any investment decisions.

© Copyright 2007 Forefield Inc. All rights reserved.

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