Whether you’re five years away from retirement or twenty five years away, you should have some sort of retirement account set up for tax free savings. Tax free savings accounts, like 401k and IRA accounts are typically the backbone of any person’s retirement plan. They work like this:
Each year, you can set aside a certain amount of money to save for your retirement tax free. This means that you’re reducing the amount of money you must pay taxes on each year right now, and you’re saving for your retirement. You’ll pay income taxes on your tax free savings during your retirement years, as you withdraw from the account.
The best type of tax free savings account is a 401k account sponsored by your employer. The reason this sort of account is so beneficial is because your employer typically contributes to the account on your behalf in addition to the contribution you make to the account. In most cases employers will match your contributions either .50 on the dollar or dollar for dollar up to a certain percentage of your salary (typically 5%). You can contribute more than this percentage of your salary if you wish, but your employer’s contributions will max out at the designated salary percentage. Because of the employer contributions, these accounts can grow quite rapidly if you take advantage of them.
If your employer doesn’t offer a 401k savings program, or if you want to have an additional tax free savings program, you can open a traditional IRA with your bank or other financial institution. There are many ways you can invest your tax free savings, including stocks, bonds and mutual funds as well as more traditional savings instruments like certificate of deposit and money market accounts. If you have a 401k at work, you may not be able to set up an additional IRA as a tax free account, as the IRS imposes limits on how much an individual can set aside as tax free savings in a year.
It’s important to note that your retirement accounts must be set up as retirement accounts in order to receive the tax free benefits. It’s also important to note that withdrawals from a retirement account are subject to penalties. If you choose to withdraw money from your IRA or 401k before you reach the age of 59 ½, your withdrawals will be subject to the taxes you would have normally paid on this money as well as a penalty for withdrawing the money before retirement age.
Tax free savings are an important part of any retirement plan. They can help you avoid taxes today as well as make it easier to have the money you need for a comfortable retirement in the years to come.