As tax season rolls back around, it has become a prescient time for us to talk about taxes in relation to retirement accounts. Perhaps you are trying to decide which type of retirement account(s) you should have to minimize your tax burden, or perhaps you are filling out your taxes now and need guidance on related actions.
What Types of Retirement Accounts Exist?
There are basically two types of retirement accounts: Traditional IRAs and Roth IRAs. IRA stands for individual retirement account, and it is an investment vehicle that is funded and managed by an individual (or, in some cases, an individual’s investment manager like a financial advisor).
A Traditional IRA is funded with pre-tax dollars, meaning that the funds that go into a traditional IRA are deposited straight from your paycheck and are never taxed. This is advantageous because it allows your investments to grow tax-free until you withdraw at retirement. Then, when you retire the funds that you withdraw are taxed based on your current tax bracket, which will often be lower than while you are working.
A Roth IRA is funded with post-tax dollars, which means that the funds you pull at retirement will be tax-free at that time, but your investments probably won’t grow as quickly as in a traditional IRA.
Deductions for 2016 Taxes
With that said, if you made any sort of Roth IRA contribution during 2016, that contribution is NOT tax-deductible for this tax season as many will often misquote. This is because Roth IRA deposits are already being made with post-tax dollars, so you aren’t eligible to “double dip” by getting a deduction as well.
However, most Traditional IRA contributions are considered fully tax deductible. This changes a little bit based on a variety of factors, such as whether or not you and/or your spouse have work-sponsored retirement plans that you participate in and how much your annual income is.
Required Minimum Distributions Explained
If you are nearing retirement age, you may have heard about required minimum distributions (RMDs). The government requires that all retirement account owners begin withdrawing at least a little bit from their accounts by the April 1st that follows you turning age 70.5 or from the time that you retire.
The only exception to this is Roth IRAs, which do not require withdrawals to begin until after the death of the owner. If you are still unsure about required minimum distributions and would like to learn more, we encourage you to read this great article from Fidelity that explains them more thoroughly.
Also, if you would like to calculate what your RMDs should be, there are calculator worksheets available on this IRS page.
Thank you Accuplan Benefits Services for this guest submission.