A retirement plan is different than a typical investment account (like a taxable brokerage account) because it provides specific tax benefits meant to encourage you to keep up with your retirement savings. What does it mean to have tax benefits? In the case of a retirement plan, like a Traditional IRA or your 401(k), your contributions are tax deductible, which means you can deduct your contribution amount from your income each year and only pay taxes on the remaining amount.
For example, let’s say Susie makes $50,000 and contributes $4,000 to her Traditional IRA. She would only have to pay income taxes on $46,000 ($50,000 – $4,000). You also don’t have to pay taxes on any of your earnings as long they stay in your account. Instead, you only pay taxes on the money that you withdraw in retirement which is referred to as a tax deferral benefit. In plain English, this means that you not only get to contribute to your retirement savings tax free each year, but your savings also grow tax free – a great benefit that should not be overlooked. Because of these generous benefits, retirement plans have a few restrictions like annual contribution limits and specific eligibility requirements.
