We often talk about diversification in your investment portfolios but focusing on different tax treatments in your retirement accounts is equally important. The type of account(s) you can contribute to are based on many factors including income, age, and filing status. Each investment account type (i.e., Roth, Traditional, Brokerage, etc.) offers unique ways to save with your taxes. Some common account types include:
Traditional 401(k), 403(b), or IRA: A tax deduction at the time you contribute but you will pay taxes when you withdraw funds during retirement.
Roth 401(k), 403(b), or IRA: Funds are taxed when contributions are made, gains are not taxed, and qualified withdrawals are tax-free.
Taxable Savings or Brokerage: Taxes are paid on dividends, interest earned, and capital gains.
As you can see, Roth IRA account contributions are made in after-tax dollars, which means you pay for the taxes upfront. When you reach retirement age and withdraw the funds, it is tax-free. Compared to a tax-deferred Traditional IRAs where distributions are taxed at your ordinary income tax rate during retirement.
In addition to choosing the best account types, it is beneficial to create a strategy for how and when you will withdraw your funds. Distributions are almost always considered income and can bump you into a higher tax rate. By staggering distributions, you can maximize savings by keeping taxable income below the next tax-bracket rate increase.
There are several strategies you can implement to reduce lifetime taxes and our list is certainly not comprehensive. Take some time to consult with your tax professional or book your appointment with KJ Dykema, MRFC® today and find new ways to save.
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