We all know that saving for retirement is a good thing. The knowledge that a penny saved is a penny earned has been around since at least the time of Benjamin Franklin. Albert Einstein even got into the game by his pronouncement that compound interest is the most powerful force in the universe. What Einstein himself may have failed to realize is that some forms of compound interest are more powerful than others.

For those of us with 401(k)’s, or some other version of tax-advantaged retirement accounts, it’s important to understand that which investments we keep in these accounts, and which investments we hold outside of them can make up to a 15% difference in the size of our nest egg when we retire.

The basic concept lies in two realities of investing. First, returns from investments can be taxed at different levels, and second, some investments produce more frequently taxed returns than others.

Take stocks for example. Within this general category there are stocks that reward their investors primarily with dividends, and those that rely on rising share prices to attract investment. Both forms of investment perform better in taxed accounts, as dividends and gains on stocks held longer than a year, are both taxed at the lower capital gains rate, i.e. 15%.

The interest payments on Bonds on the other hand, are taxed at the higher ordinary income rate, which depending on you tax bracket, could be as steep as 35%. Since all 401(k) withdrawals are also taxed as income, it makes more sense to put off paying the taxes on this particular type of investment for as long as possible.

As far as stock funds are concerned, those funds which trade frequently should be in a tax-deferred account, while index funds, tax-managed funds, and tax-efficient funds, should be left out of your 401(k) as much as possible.

That’s not to say that it’s wrong to have individual stocks in a 401(k). Most people invest for retirement primarily, if not exclusively, through their employer’s 401(k) plan, and in such cases it is crucial that stocks make up a significant portion of that plan. Just keep in mind when investing outside your employer’s plan, that, thanks to Uncle Sam and his whacky tax code, not all pennies saved are created equal.

Related posts:

1. Succeeding As A Penny Stock Trader Requires Knowing Risks And Steering Clear Of Them
2. Five Great Tax Tips Every Investor Should Know
3. How To Trade Penny Stock? Very Carefully
4. How to Stretch the Almighty Dollar when you Retire
5. Commodities: Funds

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