Understanding 401(k) tax rules and 401(k) tax benefits puts you in a position to take steps to minimize taxes overall. Here are some things to consider:
Your tax bracket: Contributing to a traditional 401(k) is essentially a bet that you’ll be in a lower tax bracket in retirement — you’re choosing to forgo taxes now and pay taxes later. Contributing to a Roth 401(k) takes the opposite approach: Pay taxes now so you don’t have to pay taxes later. The best approach for you will depend on your income, your tax situation, and your expectations for your tax treatment in the future.
Your account mix: Having savings in different types of accounts— both pre-tax and post-tax— may offer more flexibility in retirement. For instance, if you need to make a large purchase, such as a vacation home or a car, it’s sometimes helpful to be able to pull the income from a source that doesn’t trigger a taxable event. This might mean a retirement strategy that includes a traditional 401(k), a Roth IRA, and a taxable brokerage account.
Your living plans: Seven U.S. states don’t charge individual income taxes at all: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. And Tennessee and New Hampshire only tax interest and dividend income. This can affect your tax planning if you live in a tax-free state now or if you intend to live in a tax-free state in retirement.
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