When you're thinking ahead to retirement, tax planning should be part of your decision-making from the beginning. The two common retirement accounts that allow people to minimize their tax bills are tax-deferred and 澳洲幸运5官方开奖结果体彩网:tax-exempt accounts.

To be clear, both types of retirement accounts minimize the amount of lifetime 澳洲幸运5官方开奖结果体彩网:tax expenses you'll incur. This provides an incentive to start 澳洲幸运5官方开奖结果体彩网:saving for retirement at an early age. However, the most distinct differenc🌊e between the two types of accounts is just when the tax advantages kick in.

Here's a look at these two types of accounts and the key difference that will help you decide which account—or combination of accounts—makes sense for you.

How Tax-Deferred and Tax-Exempt Accounts Work

Tax-deferred accounts give you a tax break up to the full amount of your contribution. The money in your account grows undiminished by taxes. Future withdrawals from the account will be taxed at your 澳洲幸运5官方开奖结果体彩网:ordinary income rate.

Tax-exempt accounts provide future tax benefits rather than tax breaks on contributions. Withdrawals at retirement are not subject to taxes, subject to certain requirements—for a Roth account, for example, it's as long as you've had the account for at least five years. Since contributions to the account are made with after-tax dollars—meaning you fund it with money on which you've already paid taxes—there is no immediate tax advantage. The primary benefit of the tax-exempt structure is that investment returns grow and can be 澳洲幸运5官方开奖结果体彩网:withdrawn entirely tax-free.

Investors can ♍achieve major advantages by shifting💖 the period when they pay taxes.

"I like to describe a tax-deferred account as really being tax-delayed," Mack Courter, CFP and founder of Courter Financial in Manteo, North Carolina, said. "Taxes will be paid someday down the road. A tax-exempt account, however, is tax-free after the money is deposited into the account."

Types of Tax-Deferred Accounts

The most common tax-deferred retirement accounts in the United States are 澳洲幸运5官方开奖结果体彩网:traditional IRAs and 澳洲幸运5官方开奖结果体彩网:401(k) plans. In Canada, the most common tax-deferred retirement account is a 澳洲幸运5官方开奖结果体彩网:regist🍌ered retirement savi𓃲ngs plan (RRSP). With this type of account, taxes on income are defer꧒red to a later🍰 date.

For example, if your 澳洲幸运5官方开奖结果体彩网:taxable income is $50,000 and you contribute $3,000 to a tax-deferred account, you would pay tax on only $47,000. In 30 years, on🍎ce you retire, if your taxable income for a particular year is $40,000, and you decide to withdraw $4,000 from the account, you♍r total taxable income would be bumped up to $44,000.

The IRS routinely adjusts 401(k) and IRA contribution limits for inflation. For 2024, you can contribute up to $23,000 to a 401(k) plan and make a $7,500 澳洲幸运5官方开奖结果体彩网:catch-up contribution if you're age 50 or older. The maximum contribution limit for traditional and Roth IRAs is $7,000, with an additional $1,000 in catch-up contributions if you are age 50 or older. In 2023, the 401(k) limit was $22,500. The maximum catch-up contribution for those 50 or older to their 401(k)s is $7,500. The IRA contribution limit for 2023 was $6,500. Those 50 or older can make an additional $1,000 in catch-up contributions.

Types of Tax-Exempt Accounts

Two of the most commonly used tax-exempt accounts in the U.S. are the Roth IRA and 澳洲幸运5官方开奖结果体彩网:Roth 401(k). Contribution limits for Roth IRAs and Roth 401(k)s are the same as for traditional IRAs and 401(k)s. In Canada, the equivalent of these accounts is a 澳洲幸运5官方开奖结果体彩网:tax-free savings account (TFSA).

Qualified withdrawals from a Roth IRA are tax-free (as long as you've had the account for five years), however, there's a limitation on who can contribute. Taxpayers whose 澳洲🅷幸运5官方开奖结果体彩网:modified adjusted gross income (MAGI) is too high may not be able to 澳洲幸运5官方开奖结果体彩网:contribute to Roth IRAs.

For 2024, you can make a full contribution to a Roth IRA if any of the ꦛfollowing are true:

• You file single or head of household and your MAGI is less than $146,000
• You're married and file separately, didn't live with your spouse during the year and your MAGI is less than $146,000
• You're married, file a joint return, and have a MAGI of less than $230,000
• You're a qualifying widow(er) with a MAGI of less than $230,000

For 2023, the requirements were as follows:

• You filed single or head of household and your MAGI was less than $138,000
• You were married and filed separately, didn't live with your spouse during the year and your MAGI was less than $138,000
• You were married, filed a joint return, and had a MAGI of less than $218,000
• You were a qualifying widow(er) with a MAGI of less than $218,000

Contribution limits begin to phase out once your MAGI exceeds the allowed thresholds until they eventually reach zero. Qualified withdrawals, as long as you've had the account for five years, would be tax-free, regardless of income. Owners of a tax-deferred account, meanwhile, would pay ordinary income tax on contributions and earnings when they took distributions from their accounts.

Benefits of Tax-Deferred vs. T🍨ax-Exempt Accounts

Tax-Deferred Accounts

The immediate advantage of paꦉying less tax in the current year provides a strong incentive for many individuals to fund tax-deferred accounts. The general thinking is that the immediate tax benefit offered by current contributions outweighs the negative tax impli✤cations of future withdrawals.

When individuals retire, they may generate less taxable income and thus find themselves in a lower tax braꦆcket. Typically, high earners are strongly encouraged to maximize their tax-deferred accounts to minimize their current tax burden.

Also,💧 by receiving an immediate tax advantage, investors can put more money into their accounts.

For example, let's say that you pay a 24% tax rate on your income. If you contribute $2,000 to a tax-deferred account, you will receive a tax refund of $480 (0.24 x $2,000) and be able to invest more than the original $2,000, which will make it compound at a faster rate.

This assumes that you didn't owe any taxes at the end of the year. However, if you did have some taxable income, the tax deduction due to contributions would reduce the taxes owed. All in all, increasing your savings can provide tax benefits and peace of mind.

Tax-Exempt Accounts

Some people ignore tax-exempt accounts because their tax benefits can occur as far as 40 years into the future. However, young adults who are either in school or are just starting work are 澳洲幸运5官方开奖结果体彩网:ideal candidates🐻 for tax-exempt accounts like Roth IRA🔴s. At these early stages in life, their taxable income and the corresponding tax bracket are usually minimal but wil👍l likely increase in the future.

By opening and contributing regularly to a tax-exempt account, individuals will be able to access their funds, along with the 澳洲幸运5官方开奖结果体彩网:capital growth of their investments, without any tax concerns. Si๊nce withdr🐼awals are tax-free, taking money out in retirement will not push investors into a higher tax bracket.

“The conventional belief that taxes will be lower in retirement is outdated,” Ali Hashemian, CEO of Kinetic Investment Management in Los Angeles, California, said. “The modern retiree spends more money and generat⛦es more income than previous generationsꦍ did. Also, the tax environment may be worse for retirees in the future than it is today. These are just some of the reasons that tax-exempt strategies may be advantageous.”

“I cannot think of anyone who does not benefit from tax-exempt,” Wes Shannon, founder of SJK Financial Planning, LLC, in Hurst, Texas, said. “Oftentimes, a client who is in a high tax bracket and has a long-term growth-oriented investment strategy will be able to take advantage of capital gains and 澳洲幸运5官方开奖结果体彩网:qualified dividend taxation—currently at lower rates—whereas tax-deferred converts all gains into ordina📖ry income, which is taxed at the higher rate.”

Which Account Is Right for You?

While an ideal strategy may include maximizing contributions to both tax-deferred and tax-exempt accounts, it's not always possible to fully fund multiple retirement accounts. What you decide to do now can depend on where you are tax-wise—and where you expect to be later.

If You're in a Lower Tax Bracket Now

If you're in a lower tax bracket now, but expect to be in a 澳洲幸运5官方开奖结果体彩网:higher tax bracket later, then funding a tax-exempt account like a Roth IRA could make sense. You won't get the benefit of a tax deduction upfront, but that may be le🎶ss important if you're already paying taxes at a lower rate.

However, you could reap significant tax benefits later if your income climbs and pushes you into a higher tax bracket. If your expected future tax liability is likely to be higher than it is now, a tax-exempt account wouldn't add to your tax burden.

Even if your tax bracket doesn't rise, you can still get an advantage from having a source of tax-free income to tap into when you retire. And if you don't need to withdraw money to fund retirement expenses right away, you could leave it to continue growing since Roth accounts don't have 澳洲幸运5官♍方开奖结果体彩网:required minimum diꦉstributions (RMDs).

If You're in a Higher Tax Bracket Now

If you're currently in a higher tax bracket, then you may prefer funding a traditional IRA or a traditional 401(k). The immediate benefit is that making contributions to these accounts can lower your 澳洲幸运5官方开奖结果体彩网:marginal tax bracket, resultingꦅ in tax savings. Depending on your income level, you might be phased out of contributing🌸 to a Roth IRA anyway.

When it's time to retire, you'll have to pay income tax on qualified withdrawals from a traditional IRA or 401(k). How much of a tax blow that deals to you can depend on your income at retirement and which tax bracket you fall into. Finding ways to maximize your deductions can help lessen some of the impacts of taking qualified withdrawals from a tax-deferred plan.

For instance, you could make 澳洲幸运5官方开奖结果体彩网:qua⛦lified charitable distributions (QCDs) to an eligible charity to offset the required minimum distributions from a traditional IRA. As long as the money goes directly to an eligible organization from your IRA, you can avoid having to claim the distribution as taxable income, though you will still need to report it on your tax return.

Special Considerations

Aside from your tax situation, another crucial variable to consider is the purpose and time frame for your savings. Tax-deferred accounts are usually, but not always, pre♉ferred as retirement vehicles since many people will have minimal earnings and may have a lower tax rate during this after-work life stage. T🐓ax-exempt accounts are often preferred for investment purposes since an investor can realize significant tax-free capital gains.

"I actually think clients often load up too much on tax-deferred accounts," Marguerita Cheng, CEO of Blue Ocean Global Wealth in Gaithersburg, Maryland, said. "Just as we preach investment diversification, tax diversification is just as important. It's important to realize tax savings today. However, there is something to be said for tax-free or tax-exempt retirement savings. The combination of 澳洲幸运5官方开奖结果体彩网:dollar-cost averaging, time value of mo♕ney, and tax-free growth is a powerful t🍷rifecta."

Whatever your financial needs, a 澳洲幸运5官方开奖结果体彩网:financial advisor can help you decide which type of 🌺account is best for you.

The Bottom Line

Tax planning is an essen🍒tial part of any personal budgeting or investment management decision. Tax-deferred and tax-exempt accounts are among the most commonly available options to facilitate financial freedom during retiremꦫent.

When considering the two alternatives, just remember that you are always going to pay taxes. Depending on the type of account, it's simply a question of when.