There is a concept in retirement planning called tax diversification. The idea is that by contributing to several tax lien accounts, you can have better control over your taxes today and in retirement.
There are many different retirement accounts you may be able to use, and each has its own unique tax treatments and withdrawal rules. Using just three retirement savings accounts—a traditional 401(k), a Roth IRA, and a health savings account—can provide a very flexible set of assets when you retire.
1. Traditional 401(k) and/or IRA
Many people have access to a 401(k) at work. The big draw in a 401(k) is the employer match. This is money your employer will add to your account just to save in a 401(k) plan. There is no better return on investment than that!
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Contributions to a traditional 401(k) are tax deferred. This means that you don’t pay income taxes on this money today, but you will pay income taxes on your withdrawals. You will also not pay any taxes on dividends or capital gains.
The 401(k) contribution limits are huge. Employees can defer up to $20,500 from their salaries in 2022. The employer’s contribution goes along with that. Some plans then allow employees to increase the maximum 401(k) with non-Roth contributions after taxes, with a total contribution limit of $58,000. If you are 50 or older, you can contribute an additional $6,500.
I’ve rounded up the traditional IRA here, because most people will eventually benefit from converting a 401(k) into an IRA. IRAs offer more investment options than most 401(k) plans, and most providers don’t charge any fees.
2. Ruth Era
A Roth account works the opposite way to a traditional retirement account. Instead of deferring taxes until retirement, you pay taxes in the year you make a contribution. In return, you won’t have to pay any taxes on your distributions in retirement.
A Roth IRA is especially useful as a supplement to your 401(k) if you exceed the income limits for contributing to a traditional IRA. That would be $78,000 in adjusted income for an individual or $129,000 for a couple.
It’s also useful if you’re able to make after-tax contributions to a 401(k) and make an in-service withdrawal to a Roth IRA. This is called Huge tailgate dung.
The maximum direct contribution to a Roth IRA is $6,000 per year. There is an additional contribution limit of $1,000 for those 50 and over.
3. Health savings account
Health Savings Accounts (HSAs) are designed to help people with health plans with high deductibles pay for Medicare. Hayel Saeed Anam contributions are tax deductible in the year in which they are made. If you make the contribution directly through your payroll, you can avoid the FICA tax as well (although it does reduce Social Security wages). When the money is used to pay for eligible medical expenses, withdrawals don’t incur any taxes either.
But there is no rule that money must be withdrawn at the time of medical expenses. You can keep your receipts for years, allowing your money to grow in HSA, before you decide to make a withdrawal. Then you can withdraw the money tax-free in retirement.
If you do not have any qualifying medical expenses, you can begin withdrawing money at age 65 without penalty, but you will have to pay income tax on the distribution.
put everything together
The beauty of keeping all of these accounts is that you can exercise more control over your taxes when you retire.
For example, if you build a giant nest egg in a 401(k), you can make a systematic Roth IRA Transfers early in retirement. The benefit is to lower your traditional 401(k) or IRA balance, which reduces your balance Minimum Distributions Required Later in retirement. And when you start collecting Social Security, you’ll be able to draw more from your Roth account, which won’t affect the taxability of your benefits.
Ideally, you’ll eventually have enough money in your Roth and HSA accounts at retirement so that you can exercise complete control over how much you’ll pay. Taxes during retirement. And while you may not be able to pay $0 in taxes on your retirement accounts, you can significantly reduce your tax burden by taking advantage of the different accounts.
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