Understanding taxes and your retirement savings

Tax-related decisions to consider when you’re saving for retirement

You have plenty of options for saving money—such as in a 401(k), IRA, or savings account. But each of those accounts taxes your money differently.

Is it better for you to save before or after paying taxes? The answer depends on many factors, including when you expect to be in a higher tax bracket—now or in retirement. And you don’t have to pick just one option. Since no one knows for certain what future tax rates will be, you might consider doing both.

With an employer-sponsored plan, such as a 401(k):

• Your contributions are typically pretax—they’re taken out of your paycheck before you pay taxes. This can actually reduce the taxes you pay today by putting you in a lower tax bracket. 
• Depending on your plan, you may also have the option to save in a Roth 401(k). Taxes on Roth 401(k) contributions are treated differently because they’re deducted from your paycheck after you pay taxes. The benefit is that you pay taxes now and can potentially take tax-free withdrawals at retirement.¹

You can also build your retirement savings with an IRA:

• With a traditional IRA, your contributions may be tax deductible, and you don’t have to pay taxes until you make a withdrawal. 
• With a Roth IRA, contributions are after tax, so you pay taxes now and may be able to take tax-free withdrawals at retirement.

With a regular savings account, you save your money after you’ve paid taxes, and the interest you earn is taxable when you file your annual tax return.

How your savings and investment growth affect your taxes

Your investments in your retirement plan, IRA, and savings accounts may earn interest or dividends. Interest and investment earnings are taxed differently, depending on the type of account. And they may grow tax deferred, meaning you generally won’t pay any federal income taxes until you take money out of your account.²

With your 401(k), Roth 401(k), IRA, and Roth IRA, your interest and earnings may grow over time, and you usually don’t owe any taxes while they’re in the account. With your personal savings accounts, you’ll generally pay taxes on these investments every year if your account earns interest or dividends. 

Tax implications when withdrawing 

When the time comes to retire, you have to decide how and when to withdraw your money. The question becomes which account do you tap first and when? How each account may be taxed can help you put a strategy in place to maximize your income while potentially minimizing your taxes. 

The money in your retirement account is for retirement, so ideally, you don’t want to touch it until then. But some retirement plans allow you to take money out to help you address an immediate financial need. It’s important for you to understand the potential tax and penalty consequences to help you make informed decisions, should the situation ever arise. 

Tax benefits of 401(k) savings

It’s hard work to build your retirement savings. Taking the time to plan your savings and tax strategies today can help you keep taxes from eating up too much of your hard-earned savings. You may also want to consult a financial professional or tax advisor to help you fully understand your options and choose the ones that best align with your financial needs and goals.

1 Distributions from Roth accounts must be “qualified” for both the contributions and earnings to be treated as tax free. Certain conditions would apply. See your plan document for more details. All references to tax-free treatment of qualified distributions are intended to refer to the treatment of such distributions at the federal level only. You may want to consult a professional tax advisor regarding any tax issues discussed. 2 If you wish to take a withdrawal from your account before retirement, the amount available will depend on the terms of your retirement plan and IRS regulations. Withdrawals of taxable amounts will be subject to income tax and, if taken prior to age 59½, a 10% IRS penalty may apply.