Taxed Now or Taxed Later?
Building your wealth not only requires you to save for your retirement, but also gives you the opportunity to create a long-term tax strategy. As you are putting money away for retirement, you can decide if you want to be taxed now or taxed later. Here are the differences between pre-tax accounts versus after-tax accounts.
What is a pre-tax account?
Traditional IRAs and 401(k)s are examples of pre-tax accounts that are designed to help you save for retirement. You won’t pay any taxes on the contributions you make to these accounts until you start to take distributions. Pre-tax accounts are also called tax-deferred accounts, as the money you accumulate in these accounts can benefit from tax-deferred growth.
Keep in mind that once you reach age 73, you must begin taking the required minimum distributions (RMDs) from a Traditional IRA, 401(k), and other defined contribution plans in most circumstances. Withdrawals are taxed as ordinary income. If withdrawals are taken before the eligible retirement age, they may be subject to a 10% federal income tax penalty.
What is an after-tax account?
A Roth IRA is the most well-known after-tax account. There are also Roth 401(k)s and Roth 457 plans. When you put money into an after-tax account, the contribution is made with after-tax dollars. The benefit of this is tax-free withdrawals can be taken in your retirement years. After-tax accounts also bypass the rule of taking RMDs at age 73. In addition, beneficiaries of after-tax accounts are also not subject to income taxes. To qualify for tax-free and penalty-free withdrawals in after-tax accounts, distributions must meet a five-year holding requirement and occur after the eligible retirement age.
Another tax consideration
If you’re contributing to a workplace plan and want to add to a Traditional IRA or Roth IRA, check with your tax preparer as there may be income limits that hinder your tax benefit.
Whether you are taxed now or taxed later, making a few financial adjustments may help you maximize your wealth in retirement.
Information in this material is for general information only and not intended as investment, tax or legal advice. Please consult the appropriate professionals for specific information regarding your individual situation prior to making any financial decision.
Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC
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