Deferred Money! Retirement Programs! Taxable Earnings! Non-Taxable Accounts!
I apologize ahead of time if I insult the intelligence of anyone, but there seems to be continuing confusion about the terminology of “retirement” money.
When you work (yes work), the money you earn is taxed by the Federal and State Government. The result is you “take home” a lot less than you earn. You will retire some day. Other than Social Security the only way to provide for your own retirement is to save (s-a-v-e). There is that word again. Save! Everything you save has already been taxed and it is yours to put in the bank or coffee cans.
In the 1980’s, the Federal Government decided to create programs that were an incentive for you to save. The idea was to allow you to take part of your wages and put it into a secure account. The accounts were called an IRA’s, 40k(k), and for public workers, 403’s. The incentive was, you could set your wages aside without paying Federal and State taxes. Now come the new terms. You were setting aside pre-tax money. Taxes are deferred until you withdraw from the unique accounts (IRA, 401(k), 403). Because you are avoiding paying taxes, you have more money to invest and can accumulate a bigger retirement “nest egg”. The most common reference to these accounts avoiding taxes on earnings is “tax-deferred” accounts.
Okay! You can either save for retirement with the money you bring home each payday (you’ve paid the taxes) or save through retirement accounts at work (you’ve deferred the taxes).
You can only defer money into the IRA, 401K, 403 from earnings (W-2).
You will eventually pay taxes on the deferred money. Because the Government allows you to temporarily avoid taxes, there are rules. You can not touch the deferred accounts until you are 59.5 years of age (and then there are conditions). You cannot defer the tax obligation forever. You must start withdrawing prescribed amounts of deferred money when you reach 70.5 years of age. If you try to pass the deferred money onto your children, they will pay the tax obligation. Someone will eventually pay taxes on the deferred money. There is no “free money” anywhere.
It is pretty simple. Pay taxes now on your earnings and save on your own. Defer some of the taxes on earnings through IRA’s, 401(k)s, or 403’s and pay taxes when you withdraw and use the money. It litterally is the government saying “pay me taxes now or pay me later”.
The term “retirement money” can be already taxed earnings or tax deferred money. Be clear when you use the term “retirement money”!
Love,
Dad