What are the Tax Benefits of Retirement Plans?

Do you wonder what tax benefits various retirement plans have and how those work? You might be asking yourself which plans would benefit you the most. Here is a brief overview of the tax benefits some of the different retirement plans offer.

Employer Provided Retirement Plans

Many employers offer retirement plans as one of the benefits for their employees.

401(k) – This is the retirement plan most people are familiar with. This plan lets an employee contribute a fair amount before taxes are deducted from their pay. As of 2014, an employee could contribute up to $17,500 annually to their 401(k). An immediate tax benefit is realized as it lowers the income from which taxes are deducted. When the employee retires and begins withdrawing funds from the account, income taxes must be paid on the money withdrawn.

403(b) – Though this plan is much like the 401(k) with the same benefits and limits, it is usually only available to non-profit and state employees. It has the same rules as does the 401(k) for the most part.

IRA Retirement Accounts

Though some employers do offer IRA retirement accounts as an optional retirement benefit, IRA accounts are mostly as their name implies – Individual Retirement Accounts. Anyone with an earned income can open an IRA. This option came about as a way for people whose employer don’t offer retirement benefits to set up their own retirement plan. You have two IRA options.

Traditional IRA – This IRA option is the original version of the Individual Retirement Account. Contributions to IRAs are made from income after taxes have been deducted but contributions are tax deductible. As with 401(k)s, taxes must then be paid when you withdraw funds, including any interest the account has accrued. The contribution limit for this type of retirement account is much lower than a 401(k). Currently, it is $5,500. One of the benefits an IRA has is that you can consolidate 401(k)s from former employment into your IRA in what is called a rollover. Doing such a rollover doesn’t count toward your annual contribution limit.

Roth IRA – This type of IRA is more income based as your income determines how much you are able to contribute each year. A full annual contribution is $5,500 and available to those whose income is not over a certain amount based on tax filing status. Above that limit, only partial contributions are available. Roth IRAs have the benefit of tax free interest growth and no taxes on withdrawals if the account has aged at least five years.

Both types of IRA accounts do require a 10% penalty or an added 10% tax if funds are withdrawn before the account owner is fifty-nine and a half years old.

If you have the option of a 401(k) or 403(b) through your employment, you might wonder if those are better options than an IRA account. If it is financially possible, you don’t have to choose. You can have several retirement plans and that may be your best option.