Trick or Treat - The Tax Advantages of Retirement Savings

October 23, 2018 No Comment

The “treats” of an IRA are the tax advantages associated with them. The deposits made to an IRA are tax deferred, tax deductible, or tax-free depending on the type of account. The “trick” is determining which is right for you.

In the case of a Traditional IRA, your contributions are tax deferred and may be tax deductible. The theory is that by deferring taxes until your retirement years will put you in a lower tax bracket and thus pay less in taxes.

To better understand the tax benefits of investing in an IRA, think of it this way: if you make $20,000 a year and are taxed 15% of your income, you will be paying $3,000 in taxes. If you invest 10 percent, or $2,000 of your $20,000 into an IRA, you will only be taxed on $18,000 which would make your hypothetical tax payment $2,700.

While the tax benefits and savings are considerable, you will however need to pay taxes on Traditional IRA money once you begin to withdraw it in retirement. You should also keep this in mind: avoid withdrawing money from your Traditional IRA before retirement, as to do so means that you will be facing stiff penalties (often up to 1/3 of your saved funds will be lost to taxes if you withdraw early).

Roth IRAs provide a slightly different tax advantage, in that the money is tax free once you begin to withdraw it in retirement. Any contributions you make along the way before retirement are subject to normal taxes. The “treat” with a Roth IRA is that growth within the account is not subject to taxation.

The bottom line here is that you are going to be paying some sort of tax on whichever option you choose. The trick is choosing the right account for you. Talk to your tax professional and determine which option will minimize the amount of tax you will need to pay.

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