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Taxes in Retirement

The Difference Between Tax-Deferred and Tax-Exempt Retirement Accounts

Hudson, NH Resident Seeks Guidance

A tax-deferred account offers immediate tax deductions for the full amount of the contribution.  Future withdrawals from a tax-deferred account are taxed at your ordinary income rate.  Tax-exempt accounts do not offer any tax benefits at the time of contribution.  However, any future withdrawals are tax-free including returns on the investment.

A resident in Hudson was looking for the best way to begin saving for retirement.  Confused about the difference between tax-deferred and tax-exempt accounts, he sought the advice of Merrimack Tax Associates.

Benefits of Tax-Deferred Accounts

There are immediate advantages to investing money into a tax-deferred account, saving on taxes at the time of contribution.  One of the benefits of this type of savings for retirement is that the tax rate when retired is generally lower than when the money is saved.  The taxes paid when the money is withdrawn during retirement will be taxed at a lower rate than when the contributions were made.  This can give substantial tax benefits by paying the lower rate.

Some of the most common tax-deferred accounts for retirement include traditional IRAs and 401(k) plans.  For the calendar year 2021, contributions of up to $19,500 can be made into these accounts.

Benefits of Tax-Exempt Accounts

While there are no immediate tax benefits for tax-exempt accounts, the money is able to grow with interest tax-free.  Over the years this can end up being a significant amount in gains.  The original money has already been taxed at the time of investment, so withdrawals at the time or retirement are not taxed.  The interest that has accumulated is also tax-exempt in this type of account.

Popular tax-exempt retirement accounts include the Roth IRA and Roth 401(k).  Contribution limits for these accounts are the same as those for traditional IRAs and 401(k)s.

The Hudson resident now has a better understanding of the options for saving for retirement and their tax implications.  With this information, he now has a plan to begin saving that will be best for him and his family.

Retirement Accounts, Tax Deferred, Tax Exempt