IRAs, 401(k)s and More

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reduces your income tax bill for that year. Also, you hope that the account will increase in value over the years through appreciation and any interest or dividend earnings, and that growth would be tax-deferred. Another advantage with IRAs and other self-directed plans is you have a say as to where your funds will be invested.

Tax-deferred retirement accounts may be best suited for people who anticipate their income tax rate will be lower after retirement than before retirement. What's the disadvantage of tax-deferred retirement plans? Taxes are deferred – the taxes must be paid at some point in the future.

You must pay taxes on the funds you withdraw from the account. Withdrawals after age 59½ are taxed as ordinary income and are not subject to the 10 percent tax penalty imposed on early withdrawals (those taken before age 59½). For many people, withdrawals usually start April 1 of the year following the year in which they turn 70½ years old, which is when a "required minimum distribution" (RMD) must be taken.

After-tax retirement plans, which include Roth IRAs and employer-sponsored Roth 401(k)s, enable a consumer to make contributions using after-tax dollars. This means the consumer has already paid income taxes on the funds that will be used for the deposits or investments.

One advantage is that, if certain conditions are met, you will not have to pay income tax on withdrawals. Your interest or dividend earnings and the appreciation in the account will grow tax-free. And what could trigger income taxes on withdrawals? A common example is the IRA owner taking distributions prior to age 59.

Another advantage of after-tax retirement plans is that there is no requirement that you have to take distributions when you reach 70½. That flexibility Read More>>