Another common mistake is when investors focus on the immediate tax savings of contributing to a Traditional IRA, SEP-IRA, or similar vehicle. I’ve heard many hardworking, honest people say to me, “Oh, my accountant said that because I’m in the 25% bracket, it would save me only $1,000 and the money would be locked up for decades.” The tragedy is that the real savings include not only that $1,000 which will now compound for you instead of going to the government, but instead the fact that these accounts allow you to plow back your profits into more investments, tax-free, until they are withdrawn. That can mean literally hundreds of thousands or millions of dollars more working for you.
Additionally, investors who are in the top tax brackets will almost always, without exception, buy tax-free municipal bonds. This makes sense as they can actually make more money on a tax-free yield of 4.5% than a taxable yield of 6.5% (to learn how to calculate the taxable equivalent yield yourself, take five seconds and check out Investing in Municipal Bonds.) The flip side of this is that if you own bonds through a tax-advantaged fund, it is foolish to buy these sorts of issues as they usually have lower yields to compensate for their favored status. In a tax-advantaged account, this obviously has no value. You’d be better off going with a fully taxable corporate bond base widely diversified among issuers.
