- Roth Accounts- you contribute to these with post-tax money, but the earnings are not only tax-deferred, they are TAX-EXEMPT. This is a very powerful feature meaning if you put $4000 into an IRA in 2011 and in 2025 you retire, the account is now worth $25,000 and you will owe NO TAXES on $21,000 you earned.
- Examples: Roth IRA, Roth 401K, Roth 457(b), and Roth 403(b)
- Traditional Accounts- you contribute to these with pretax money, and the earnings are tax-deferred. These plans offer a way to reduce your current taxable income. For example if I make $60,000 and contribute $15,000 to a 401K my taxable income is now $45,000. Which if I am single, my income between $45,000 and $60,000 were being taxed at 25% versus 15% for income between $8,351and $33,950. The bottom-line is this reduces my current tax liability and if I making more money now than in retirement, this is advantageous.
- Examples: Regular IRA, 401K, 457(b), and 403(b)
Commonly use terminology defined:
- Contributions are the money that you put into the account initially
- Once in the account the contributions are referred to as the basis
- Post-tax means you pay taxes on the money before it goes into the account.
- Tax deductible/pretax means you do not pay taxes on the money on the way into the account
- Tax-deferred means you do not pay tax on earnings as they accrue.
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