Most of us are familiar with pre-tax retirement savings programs like 401ks and IRAs. These accounts are perfect for saving for retirement because they give you a tax break today, since any amount that you contribute is done on a before tax basis, reducing your taxable income for the year. In addition, interest accumulated on these accounts are not subject to taxation until you withdraw the funds for income during your retirement.
After tax savings accounts for retirement work in the opposite way. Often called Roth IRAs, these after tax accounts are funded using money that you are paying income tax on in the years that you contribute the money. So, contributing to a Roth IRA, or after tax savings account does not help you reduce your taxable income during the years that you’re working and contributing to them the way that traditional IRAs and 401k accounts do.
Instead, after tax savings accounts provide you with significant tax breaks during your retirement. You see, because you paid income taxes on the money you contributed to your after tax savings account during the year you contributed it, the money is not taxable when you withdraw it during your retirement. Not only is the money you contributed not taxed when you withdraw it, but the interest it has accrued during the years it has been invested is not taxable either.
So, contributing to an after tax savings account today helps reduce the amount of taxes you’ll pay during your retirement. This is beneficial because most of us try to live on a smaller income during our retirement years, and reducing the taxes we pay during our retirement can be a big help.
For a small monthly after tax contribution each month during your working years, you can be accumulating a very large tax free account to use during your retirement years. In the end, you’ll pay taxes on just a fraction of the amount in your account. This is in contrast to traditional IRAs and 401ks, where you’re really just delaying the payment of taxes since you eventually will pay taxes on every bit of money in these accounts, even the interest that has accrued.
Most financial experts recommend that you plan for your retirement using a combination of before tax accounts like 401ks and traditional IRAs along with after tax savings accounts or Roth IRAs. Using this combination helps you to save for your retirement in a way that helps you avoid some taxes both today and during your retirement years. This combination is the best way to save money now and be ready for a financially comfortable retirement, too.
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