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Protect Your Retirement From Uncle Sam

This just in from the Department of the Blatantly Obvious: The more money you keep, the more you'll have. That's true on all kinds of levels, from spending less on things you don't need to paying less for things you do. One of those things you need to pay for is civilization, which, as Oliver Wendell Holmes Jr. told us, is bought with taxes. Here are seven ways to keep Uncle Sam's hands off your retirement.

1. Choose tax-fighting accounts.
With a traditional IRA or an employer-sponsored account such as a 401(k), you'll get a tax deduction for putting money in, and the investments grow tax-deferred until you take the money out. Then there's the Roth option, which forgoes today's tax break in exchange for tax-free growth forever (assuming you follow the rules and you define forever as "while my spouse or I am alive").

2. Choose capital gains over ordinary income.
Taxes that are deferred must eventually be paid. In the case of a traditional IRA or 401(k), the withdrawals are taxed as ordinary income -- the highest rate possible. Investors closer to retirement should consider keeping some of their money out of tax-deferred accounts and choosing tax-efficient mutual funds or low- or no-dividend stocks such as Google (Nasdaq: GOOG  ) or Dell (Nasdaq: DELL  ) . Once you sell those investments, you'll pay long-term capital gains, which nowadays are taxed at rates of 5% or 15%, compared to the maximum 35% income tax rate.

3. Choose dividends over ordinary income.
If you are retired, do the opposite of what I just said -- at least in terms of dividend-paying stocks. In your situation, you want your higher-yielding stocks -- such as Citigroup (NYSE: C  ) , Altria (NYSE: MO  ) , or even Johnson & Johnson (NYSE: JNJ  ) -- outside of your retirement accounts. Why? Because you'll be living off those dividends, which are also taxed at rates of 5% or 15%. If those stocks are held in a traditional IRA, however, the dividends will be taxed as ordinary income when they come out.

4. Keep taxable bonds in retirement accounts.
The interest from corporate bonds and certificates of deposit are taxed as ordinary income, making them very tax-inefficient. Give yourself some shelter by keeping them in retirement accounts.

5. Consider tax-advantaged bonds.
Bonds issued by the government are either free of state taxes (in the case of Treasuries) or all taxes (municipal bonds, for some investors). But these bonds have lower returns, right? As we discuss in the recent issue of Rule Your Retirement, investors in federal government bond funds haven't earned all that much less than comparable corporate bond funds, and the tax break is the cherry on top.

6. Protect Your Social Security.
Social Security is completely or partially free of taxes; if you earn too much, however, that "partially" will become "mostly." If your benefits are in danger of being taxed, keep your taxable income down by, for example, withdrawing from your Roth IRA instead of your traditional IRA.

7. Don't forget about after-tax contributions.
If you've contributed after-tax money (i.e., you didn't receive a deduction) to an annuity or a non-deductible traditional IRA, the withdrawal of your original investment is free of taxation. But you have to submit the proper paperwork to stay on top of this.

For more on keeping Uncle Sam out of your nest egg, click here for a free 30-day trial to Rule Your Retirement.

Robert Brokamp, who doesn't own any of the stocks mentioned in this article, thinks that if Uncle Sam lost the hat and donned black glasses he'd look like Colonel Sanders. Since the original Uncle Sam (Samuel Wilson, 1766-1854) was a meat-packer during the War of 1812, perhaps this is not a coincidence. Johnson & Johnson is a Motley Fool Income Investor recommendation. Dell is a Stock Advisor and Inside Value pick. The Fool has a disclosure policy.

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