Must you Pay Taxes On Your Retirement Account?

In order to answer this question, we have to understand the different types of retirement accounts available to you.

An Individual Retirement Account is an account into which you deposit money prior to paying taxes.  This means that you reach your taxable income after you have deducted the money you deposit into an IRA.  The money is not taxable until you withdraw it, theoretically, upon your retirement.  You will also face penalties if you withdraw funds from an IRA prior to age 59 ½.

You must begin withdrawing money from your IRA by age 70 ½.

A 401k plan is named after a Tax Code from 1978.  It allows your employer to deduct money from your paycheck prior to taxes and place that money in a retirement savings account.  You pay taxes when you withdraw money from the 401K.  The idea behind all of these tax-free retirement accounts is that you will be in a lower tax bracket upon retiring.  Therefore the money you withdraw from these accounts upon retirement will have a lower tax liability than it would now.

There are customized retirement plans available for the self-employed.  If you are a sole proprietor or a member of a partnership, a you can open such an account which might be your best bet for retirement savings.  As a self-employed individual, you can set up any type of qualified retirement plan for yourself.  You are not stuck with these plans, but it does have some benefits that a standard IRA and 401K do not.

For instance, in such plan your contributions are deducted from your gross income, and the contributions can be higher.  Just like the other retirement accounts, you do not pay taxes until the money is withdrawn.  Lump sum withdrawals may be eligible to ten year averaging, which is another benefit above IRAs and 401Ks.

A Roth IRA works oppositely of the other retirement accounts we have discussed.  With a Roth IRA, you pay your income taxes before you deposit the money and you do not pay any taxes upon withdrawal.  This means that your account grows tax-free.  Many people feel that such tax-free growth is the way to earn as much as possible toward retirement.  Also, you do not have to begin taking money out of a Roth IRA at any certain age.  You can leave your money in there and watch it grow, tax-free, for as long as you like.

Chintamani Abhyankar, is a well known expert in the field of finance and taxation for last 25 years. He has written many books explaining inside secrets of the magic world of personal finance. His famous eBook Stop donating your money to IRS which is now running in its second edition, provides intricate knowledge and valuable tips on personal finance and income tax.

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