Retirement Savings Accounts
In order to encourage people to take responsibility for their own retirement savings, the U.S. government has created several types of retirement accounts which provide significant tax benefits if you abide by the strict rules they have imposed on these accounts. These rules limit the amount you can put into these accounts each year, when you can take money out, and for what purposes the money can be withdrawn, until you reach retirement age.
For most types of retirement accounts you receive a tax deduction each year for the amount you deposit into the account. This means your taxable income for that year is reduced by the amount you contribute. You don’t have to pay taxes on any growth in the account until you take money out.
Any withdrawals from retirement accounts after your age 59-1/2 will be taxed as ordinary income, except Roths, which allow tax-free withdrawals. If you take any withdrawals before age 59-1/2, you will also be subject to an extra 10% penalty, with some limited exceptions, such as death, disability, qualified higher education expenses, and qualified first-time home purchase (click here for details). After age 70-1/2, you are required to withdraw a certain percentage each year, even if you don’t need the money, so the IRS can start receiving tax revenue from your retirement accounts. Roth accounts are not subject to these Required Minimum Distributions (RMDs) because all withdrawals after age 59-1/2 are tax-free.
Some people ask questions like, “Do 401(k)s get a good rate of return?” A 401(k), IRA, or any other type of retirement account is not an investment in and of itself. They are simply types of accounts in which you can deposit a variety of investments. For example, in an IRA you can deposit stocks, bonds, mutual funds, savings accounts, and several other types of assets. The performance of the IRA depends on the performance of the investments you place inside the IRA.
The remaining pages in this section describe the most common tax-favored retirement accounts in use today. The rules listed for each type are general descriptions and do not fully explain all exceptions and nuances of the laws that govern these plans. Choosing the right type of retirement savings plan and determining the best options for each type can be overwhelming. It is very important to work with a qualified financial coach and tax professional to be sure your choices best suit your needs.
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