Retirement Planning – Concept vs. Action
Most are familiar with the concept of retirement planning, including some common terms like IRA and 401k. To be sure, that’s an important first step, learning the language of retirement planning can make the process easier. Yet, it’s just as important to know the long term tax implications of the different types of traditional qualified retirement plans and the options available.
Two Ways Retirement Planning Can Minimize Tax Bills
Let’s talk about two common types of retirement accounts that allow people to minimize their tax bills. These are tax-deferred and tax-exempt
accounts. Both types of retirement account minimize the amount of lifetime tax expenses a retiree will incur. This provides an incentive to start saving for retirement now, at an early age. For the best results you need to understand the difference between the two types of accounts, including knowing just when the tax advantages kick in so you can create a plan that works best for you.
Tax-Deferred Accounts
Tax deferred accounts allow you to realize immediate tax deductions up to the full amount of your contribution. The money in your plan account grows at full value because no taxes were deducted. This is where the term deferred becomes the important consideration. When you take withdrawals from your account in the future, those withdrawals, or payments to yourself, will be taxed at your ordinary income rate at the time of the withdrawal. For most people the tax bracket you pay increases as they get older, for example because their income goes up, or because they have additional investment income, or both. There are other reasons as well, but these are the most common.
Tax-Exempt Accounts
Tax exempt accounts provide future tax benefits rather than tax breaks on contributions today. This means withdrawals at retirement are not subject to taxes, since contributions to the account are made with after-tax dollars. You contribute to your plan with money which you’ve already paid taxes on, so there’s no immediate tax advantage today. The primary advantage of the tax-exempt plan structure is that your investment returns keep growing until you draw them out, and can be withdrawn entirely tax free.
Get an Early Start
This is why your retirement planning from the start is so important to your future. Building your plan with the advice and guidance of a professional is an important step toward long term success. Talking with a professional financial advisor doesn’t have to be intimidating or scary either. It is probably easier than you think it will be.
Finding the Right Advisor
Remember financial advisors started off knowing just as much, maybe even less than you do now. An honest and frank discussion about your goals now and for the future are the smart way to start. A great advisor will listen first, ask questions second and then explain options that they believe will work for you. Make sure you feel comfortable and confident with the recommendations the advisor you’re speaking with offers. Since there’s no one size fits all investment plan, don’t feel squeezed into anything. Just remember that retirement planning is all about you, your plans and your future.