Taxes and retirement accounts
Saving for your retirement is a great goal, however, unless you consider the tax ramifications of your various savings vessels, you may not be as well off in retirement as you suspect. For example, a person who has a million dollars in their 401k probably feels pretty good about their retirement savings. However, if when they retire they are in a tax bracket where they owe 47% taxes, they effectively only have a little over half a million to retire on. Considering taxes with retirement is essential. When saving for retirement a good mix of taxable, tax free, and tax deferred accounts is wise.
The following is a better look:
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If you earn too much to qualify for a Roth, then a deductible IRA is a good choice if you aren't covered by a retirement plan at work. But if you don't qualify for either option, then you'll usually do better with a taxable account than a different option.
A taxable account has advantages because it doesn't have some of the strings attached to other types of retirement accounts. For example, you won't have to take required minimum distributions and your heirs won't owe income taxes on your earnings when you die. However, with these types of accounts, you do want to be careful of how much tax you pay each year, as you are taxed on sales, dividends and capital-gains distributions every year, so while it is great during retirement, it may be difficult to handle the taxes now.
Employer-sponsored and other plans that allow contributions and earnings to be made and accumulate tax-free until they are paid out as benefits. This means that if you contribute to a 401k you are lessening your taxable income for this year, and you get to earn interest etc. on the money, invest it, etc. and then pay taxes on it when you start taking money out of your 401k.
A traditional IRA: Has contribution limits, but allows you to qualify for a tax deduction. It is taxed as ordinary income when you start taking distributions. You can't take money out until you are 59.5, and have to after age 70.5.
Roth IRA: Has contribution limits. Has no tax deduction. You can take what you put in out without penalty. There are qualified events that you can take money out for. Money is not taxes when you take it out at retirement. You do not have to take distributions at 70.5, there is an income limit to who can contribute to Roth IRAs.
401k: Contributions are made before taxes. Can put in only a certain amount per year. Allows you to retire as early as 55. You have to take distributions at 70.5. It is federally protected from creditors. You may or may not be able to access the money early. Matching may be vested.
There are many other kinds of retirement accounts, so talk to your financial person and have them help you determine which options are best for you.
