Retirement accounts are tax-advantaged investment accounts. Depending on the type of retirement account, you could either get a tax benefit when you deposit money (tax deduction) or when you withdraw in retirement (tax-free withdrawals).
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There are many different types of retirement account. Some are designed for salaried employees, some are designed for business owners and self-employed individuals, and others are available to anybody with earned income. Each retirement account has different tax benefits, contributions limits, investment options and withdrawal rules.
• Tax deductions: Anything you contribute to an account reduces your taxable income for the tax year. • Tax-free compounding: Most retirement accounts allow you to compound tax-free. If you buy and sell assets for a profit, you don’t have to pay taxes until you withdraw. With a regular investment account, you have to pay capital gains tax whenever you sell assets for a profit. For example, if you invested $10,000 into Tesla stock and it grew to $100,000, you would owe capital gains tax on the $90,000 in profit. With a retirement account, profits go straight back into your account and it can all be reinvested, allowing your retirement nest egg to grow significantly faster and larger. • Tax-free withdrawals: Roth retirement account contributions are made with after-tax income, but withdrawals in retirement are tax-free, no matter how large your gains. With Roth accounts, you have tax-free compounding and then tax-free withdrawals in retirement.
While most retirement plans offer tax-free compounding, whether you get a tax deduction or tax-free withdrawals depends on whether you contribute to a traditional (pre-tax) account or a Roth (after-tax account).
If you’re familiar with the traditional and Roth IRAs, a traditional IRA is considered a pre-tax retirement plan and the Roth IRA is considered a Roth retirement account. This works the same way with a 401k and Roth 401k or solo 401k and Roth solo 401k.
Traditional retirement accounts give you tax benefits when you deposit money into your plan and Roth retirement accounts give you tax benefits when you withdraw money from your plan.