How to Survive a Recession

LESSON 25: Maximize Your Retirement Account Investments

Many countries allow employers and individuals to make tax-advantaged investments in their own retirement accounts. In the U.S., the most popular programs are 401(k), IRA, 403(b), and Flexible Savings Account (FSA) plans, all of which offer the opportunity to save and invest pre-tax dollars in a variety of assets. Most of the capital held in these accounts is placed in mutual funds, and most providers offer many investment options to choose from.

The short- and long-term benefits of investing pre-tax dollars in your retirement are substantial. Pre-tax investing adds an instant return on investment equal to the expected taxes you would have paid on the income if you had received the income and invested post-tax. For example, an average American making $65,000 per year may pay a total of 32% to 44% in federal, state, and local taxes on every dollar of income earned. By investing in a pre-tax retirement account such as a 401(k), the dollars invested are not taxed at all, which can be viewed as an instant 32% to 44% return on investment! If those dollars are invested intelligently, they will grow over time, compounding the your returns until you need the money for retirement. Your money can still be withdrawn, less income taxes, if necessary in an emergency. You can borrow your own money back from several types of retirement accounts to invest in a home or pay medical bills, and pay the interest back to yourself as additional non-taxable income!

Access to these programs is available to just about anybody. You need to be employed to contribute to a 401(k) or 403(b), but that does not mean you have to work for somebody else. Small businesses and sole practitioners can set up their own retirement accounts, so nearly every business owner (no matter how small) can have access to this tremendous tax-free accumulation program.

Individual Retirement Accounts (IRAs and Roth IRAs) can be opened by any American, and require no employer involvement. The tax benefit in a traditional IRA is actually a deduction from your earned income, which has the effect of making your contributions tax-free until withdrawal. With a Roth IRAs, you pay income taxes on your contributions, but none on your future withdrawals.

If you have adequate income to be able to save regularly, a recession is the ideal time to invest in your retirement accounts. Retirement account stock investments made during recessions have extremely low risk and high potential return. Stock markets drop significantly during recessions, which means you buy shares at very low prices compared to the long-term holding period. Assuming you begin investing in a retirement account sometime in your 20’s, you have 40 years or more until retirement at age 65 for the market to rise. The probability of the stock market rising is almost 100% guaranteed over the very long term.