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What is a tax-deferred retirement plan and how do I know if mine is?

In an effort to encourage Americans to save for old age the federal government gives a break on taxes for certain types retirement plans. Here’s a look…

Saving on your tax bill while building a retirement fund

The are a number of investment vehicles that Americans can use to save for retirement, however, not enough are doing so. In an effort to encourage Americans to save for old age the federal government lets you defer taxes by putting money into certain retirement plans

The most commonly known tax-deferred retirement plans are traditional Individual Retirement Accounts (IRAs) and 401(k) investment funds. The money put into them is not taxed right away and also reduces your gross income which could move you into a lower tax bracket shrinking what you owe Uncle Sam. However, you’ll have to pay taxes on the money when you withdraw it, usually once you’ve retired.

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Traditional versus Roth IRAs and 401(k)s

Both investment vehicles have two forms, traditional and Roth. As mentioned before “traditional” IRAs and 401(k)s tax deductible but there are limits on the amount you can put in each year. The money and any gains are taxed as income once you start withdrawing, usually after retirement.

If you need to withdraw money from your 401(k) plan before you turn 59½ you could incur a hefty penalty. There are some cases where you can draw down on your 401(k)-retirement nest egg after you’ve turned 55 without being punished such as an additional 10 percent penalty on top of taxes that would be levied.

Withdraws from Roth IRAs and 401(k)s on the other hand don’t come with a tax deduction but the money put in is not taxed when you withdraw it from the account. However, any earnings on the money put into the account will be taxed as income if withdrawn before you turn 59½ and before the account is five years old.

Other tax-deductible retirement plans

Similar to 401(k) plans, public service employees such as doctors and nurses, librarians and teachers have access to 403(b) tax-deferred retirement savings plans. Employees of state and local governments as well as workers tax-exempt non-profit may have a 427 tax-deferred retirement plan.

Those looking to save for retirement can also look into purchasing US savings bonds. There are two types that are tax deferred issued by the government, the Series EE Bond and the Series I Bond. Series I bonds are adjusted for inflation while the Series EE bonds are sold to US citizens at half their face value and mature to full face value in 20 years.

Another investment vehicle to use for tax-deferred retirement savings is a deferred annuity. This is an insurance contract which promises to pay the buyer a lump sum or a regular income starting at a set date in the future. You can chose to have the rate of return computed fixed, indexed or variable with different levels of risk.