Need A Retirement Plan? Is Tax Deferred For You?

Now is a good time to consider whether a tax-deferred retirement plan is appropriate for your circumstances. Your retirement may be a while off for you, but it will come faster than you think.

What Are Retirement Tax Deferred Plans?

Retirement tax-deferred plans are plans that allow contributions to be made and accumulated tax-free until paid out as benefits. These plans cover financial accounts such as Traditional 401ks and Traditional IRAs.

Tax-deferred plans are often contrasted with non-tax-deferred plans, which relate to financial accounts such as Roth 401ks and Roth IRAs.  Under these types of accounts, contributions are taxed in the year in which they are deposited into the retirement account.   

401k Retirement Tax Deferred Plan

There are several types of retirement plans that are tax deferred. The most common is the 401k employer-sponsored retirement plans. With a 401k, you have the ability to make higher contributions than some other plans, and the opportunity to earn interest on your investments. Under the rules regarding a Traditional 401k, your earnings are only taxed when they are paid out to you from your 401k. 

This contrasts with a Roth 401k in which contributions are initially taxed as income while money paid out of the account is acquired tax-free.

IRA Retirement Tax Deferred Plan

Individual Retirement Account, or IRA, is another popular retirement plan that can offer tax-free interest accumulation.

The tax treatment of IRAs is similar to the treatment of 401ks. Under the rules of a Traditional IRA, your initial contributions are not treated as taxable income. However, any withdrawal from the account is treated as taxable income.

With a Roth IRA, your initial contributions are treated as taxable income, but when you reach 59 and 1/2, any money taken out of the account is tax-free.

The Costs and Benefits of Retirement Tax-Deferred Plans

The key characteristic of a tax-deferred retirement plan is that your money is allowed to appreciate tax-free until you withdraw it. This can be good or bad depending on your tax situation. If you wish to put off tax liability until your retirement, a Traditional 401K or Traditional IRA may be right for you. However, you wish to decrease the amount of money you will have to pay during retirement, a tax-deferred plan is probably not right for you and you should investigate a Roth 401k or a Roth IRA. 

More generally, tax-deferred retirement plans can be a better way to accumulate money for retirement than relying on your own self-discipline to put money away.

However, while there are many benefits to participating in retirement plan, you should always keep in mind that you can lose money with these plans if the investments in your portfolio perform badly.

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