THE NEW RULES OF RETIREMENT SAVING • 47
In long-term savings, there are two ways you can handle taxes, which I’ve outlined below. Defer Your Taxes To defer means to postpone. With this approach, you save for retirement tax-deferred, meaning you do not pay any taxes today on the money you set aside for retirement. As that money grows, you pay no annual taxes on the growth. When you finally use the money in retirement, you pay taxes on all the money you with- draw from the account according to your tax rate at that time. • Vehicles : Many of your traditional retirement vehicles use a tax-deferred approach. 401(k)s, IRAs, 403(b)s and most government savings plans (like TSPs) are tax-deferred re- tirement savings plans. • Pluses : You can deduct contributions in the year you make them, lowering your overall taxable income that year. For some people, their tax rate could be lower in retirement than it is today, making it wise to defer paying those taxes. • Minuses : All the money you grow from the day you start saving until retirement will be taxed. If your $20,000 de- posit grows to $100,000, you will owe taxes on the entire $100,000 when you withdraw it. Pay Your Taxes Upfront With this approach, you pay taxes upfront before you put the money into a savings vehicle. As the money grows and is spent in the future, you do not owe any additional taxes: not on the money you’ve contributed, nor on the growth. Sometimes this approach is called “tax-free accumulation,” because the money accumulating in your account is never taxed. • Vehicles : Several types of vehicles allow for this approach. Roth 401(k)s and Roth IRAs are two of the most common, along with the savings in certain life insurance vehicles.
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