Understanding Tax Favored Retirement Plans

Almost every retiree, and particularly those who are getting near retirement, say that they wished they had saved more money. Unfortunately, most people don’t realize that they should have had more money until the money runs out. While some of us, particularly those who are still relatively young, believe the answer is to just keep working, the reality is that this is not always possible. Hence, if that is the point where you are now, you need to start learning how to get as much out of your paycheck as you possibly can.

Saving for Retirement

Luckily, you are not on your own with this. The government is committed to helping people save up as much as they can, even if they are almost ready to retire. They have created a number of plans that are tax favored, designed to help people getting close to retirement. All contributions are tax deferred and there are even some plans where the contributions are completely tax free!

Unfortunately, a lot of people continue to fail to see the point in funding these types of plans, particularly if they are close to retirement. In reality, however, the final years of working are usually the highest earning ones, which means the tax benefits are phenomenal. Furthermore, since what is put into those accounts will be withdrawn in bits, it means that you have a little nest egg to rely on when you do stop working. And any nest egg is better than none.

Two Kinds of Tax Favored Retirement Plans

There are basically two kinds of tax favored retirement plans. The first is the traditional, and the second is the Roth. The vast majority of people have traditional plans, like the 401(k) and the IRA. These are limited in terms of how many tax deferred contributions you can make to them (in 2016, that is $18,000, although those over the age of 50 can increase this to $24,000). Any growth on these plans is also deferred. Once you start to use the money, at which point you must be between 59 and a half and 70 and a half (unless you are still employed), it will be taxed as regular income. This means you don’t pay tax now, but you do pay them later, at which point you are likely to be on a lower tax bracket.

The Roth is different because you fund it with money you have paid taxes on. However, the growth is tax free and it remains tax free when you take it out as well. Plus, you only have to take it out if you need it, which means you can let it grow for as long as you want. If you never use it, you can even pass it on to your heirs when you die, still tax-free. Of course, you can also withdraw it and use it for yourself.

The Issue with the Traditional and Roth IRAs

The only issue with both traditional and Roth IRAs is that they have quite low contributions. In 2016, it is $5,500, or $6,500 for those over the age of 50. Additionally, there are income limits, although they are quite generous. Your income in 2016 cannot be above $117,000, or $184,000 for married couples with a joint filing.

Understanding Tax Favored Retirement Plans
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