Which Retirement Plans Offer Tax Benefits

Which Retirement Plans Offer Tax Benefits

When it comes to saving for retirement, there are many potential options and paths to choose, as there’s no one size fits all approach.

But as you lay the groundwork for financial security in your golden years, it’s important to keep in mind that some retirement savings vehicles provide substantial tax benefits – either now, or in the future.

Roth IRAs, Traditional IRAs, 401(k) accounts, and SEP IRAs all offer certain tax advantages that you may not be aware of. How and when those tax benefits apply varies, and it’s important to note that any benefits could be undermined by a hefty 10 percent penalty if you take distributions before you are 59 and a half. Here’s a closer look.

401(k) Accounts

Let’s start with the 401(k), which can only be made available to you through your employer. According to the Investment Company Institute, at least 55 million Americans are currently saving in employer-sponsored 401(k)s!  

There are a few notable tax benefits associated with this type of account beginning with the fact that contributions are made on a pre-tax basis, meaning they lower your overall taxable income for the calendar year you make the contributions–so you pay less tax! 

That’s not the only benefit associated with this popular retirement account. Earnings in your 401(k) grow tax deferred. In other words, any investment growth, dividends or capital gains you realize during the course of your working years will not be taxed – at least not right away.

The caveat to keep in mind is that once you start drawing on your 401(k), which you can only do penalty free after you reach age 59 and a half, is that the money will be subject to Ordinary Income tax. However, even here, there may be something of a benefit to be had. Those who will be in a lower tax bracket during retirement than during their working years will not pay as much in taxes on the money when it is withdrawn.

Traditional IRA

IRAs are one of the primary retirement vehicles available to self-employed individuals. And during the past 10 years or more, they’ve been one of the most rapidly growing segments of retirement wealth. As of June 2018, there was more than $9.7 trillion in assets in IRAs, according to the Investment Company Institute.

Traditional IRAs in particular are the most common IRA – about 33.2 million American households have one.

As for the tax benefits of a Traditional IRA, the contributions you make to this type of account are tax deductible for the year that you make them. In other words, similar to a 401(k), your contributions will ultimately lower your annual taxable income. And by lowering your gross income, you may find yourself suddenly eligible for other tax benefits.

Also similar to a 401(k), the money contributed to a Traditional IRA will be taxed upon withdrawal. But again, if you’ll be in a lower tax bracket during retirement, you’ll pay a reduced tax rate on the money when it comes to withdraw it.

An important note to keep in mind, IRS guidelines for 2019 and 2020 allow for contributing up to $6,000 to a Traditional IRA and claiming a deduction. Those 50 and older are allowed to contribute an additional $1,000 and claim a deduction.

Roth IRA

The second most popular IRA, about 22.5 million American households had a Roth IRA as of 2018, the Investment Company Institute reported.

Like a Traditional IRA, there are tax advantages associated with this type of account, however the timing of those tax advantages is somewhat different. Furthermore, Roth IRAs are not subject to taxable Required Minimum Distributions like a Traditional IRA and other retirement accounts.

Established in 1997 and named after Sen. William Roth, these IRAs do not provide a tax deduction for the year the contribution is made. Translation – they will not lower your adjusted gross income. However, because you’re paying taxes on the money at the outset, you will not be paying taxes when you withdraw it during retirement.

There are some contribution limits associated with Roth IRAs based on your annual income, so it’s important to familiarize yourself with IRS rules and qualifications surrounding this type of account.


A Simplified Employee Pension, otherwise known as a SEP IRA, is an option available to self-employed individuals and small business owners.

For small business owners, the advantage of a SEP is that you’re able to make tax-free contributions to your employees’ retirement accounts and the contributions are tax deductible. It’s a win-win.

Self-employed individuals meanwhile, are allowed to contribute as much as 25% of net earnings income toward a SEP, and again, contributions are deductible. In this case, the contributions are deducted in the form of an adjustment to your income on your Form 1040 submission, thus decreasing your federal tax bill.

403(b) Accounts

One last notable retirement account that offers tax benefits, a 403(b) is available to those who work in the nonprofit world including at charities, schools and religious institutions. Like 401(k) accounts, participating in a 403(b) plan lowers your federal tax burden.

Contributions are taken from your pre-tax income and deposited into the account, thus reducing your annual taxable income. As the money grows over the years, you won’t be paying taxes on dividends, interest, or other capital gains either.

However, like a 401(k), those pre-tax contributions to a 403(b) plan will ultimately be taxed once you start taking distributions. 


Getting the most tax benefit from your retirement plan takes planning and preparation. If you are not sure whether or not you are taking full advantage of the financial tools you are using to save for retirement, reach out to me at hilaryhendershott.com/hello