Understanding the Tax Implications of Your IRA or 401(k)
16 Oct 2015
When it comes to retirement plans, remember that the government giveth and the government taketh away. When you open your IRA or 401(k) statement, you may be proud of the number—but are you aware that not all that money is yours? The government has a lien on it, and it’s called taxation. The portion of that account that’s not yours depends on your tax bracket. Depending on your circumstances, you might choose between a traditional IRA and a Roth IRA. The difference is how that money is going to be treated.
Let’s just say you start investing in an IRA account at the age of 22 and do that for 45 years until retiring at age 67. At $5,500 a year, in 45 years you will have put away just under $250,000.
- In a traditional, tax-deferred account, you would subtract that $5,500 from your annual income to reduce the amount subject to taxation. You pay no tax until you withdraw the money in retirement.
- In a Roth account, you get no tax break up front for that $5,500 deposit, but you are not taxed upon withdrawal.
In essence, there is a tax lien on your traditional IRA and 401(k) assets—and that lien has an adjustable rate. You don’t know what the tax rate will be upon withdrawal, but you might presume at least 43 percent. I call those “tax-infested” accounts. If you have a tax-infested retirement account, you are going to need a strategy to maximize the amount of money you get out and minimize the amount of taxation. That’s why you need a tax strategy that works for you. You want to be invested for your future, not infested.