For many of us, a trip to the grocery store is a constant reminder of how much inflation keeps creeping into our pocketbooks. Add taxes, market volatility, and the rising costs of healthcare and it’s no wonder nearly 75% of us are feeling anxious or even overwhelmed when we think about our retirement savings.* Fortunately, when it comes to taxes, you don’t have to feel powerless. By planning now, you can design a tax efficient plan and feel more confident about reaching your goals.
There are basically three types of accounts in which you can grow your savings. Two types are specifically earmarked for retirement:
Pre-tax retirement accounts: You contribute before taxes, then pay ordinary income taxes on withdrawals after retirement. These are typically business plans such as traditional 401(k)s, 403(b)s, and SIMPLE and SEP IRAs. If you’re in a high tax bracket and/or still working, you’ll generally want to save the most in these types of accounts. Read how to ask your employer for halal 401(K) investment options.
Traditional IRAs can be established outside of work. However, depending on various circumstances, your contributions and withdrawals may not be before taxes.
After-tax retirement accounts: You contribute after taxes, but withdrawals are tax-free, with some caveats. These are business plans like Roth 401(K) or Roth IRAs. Consider taking advantage of your lower income years by contributing to a Roth or even doing a Roth conversion. High-income professionals who earn too much to be able to contribute directly into a Roth IRA may be able to do so through a backdoor Roth IRA. A backdoor Roth could land you with a tax bill so consult with your Azzad advisor before taking advantage of this strategy.
Since taxes are likely to have a bigger impact on your future savings than even market swings, you’ll want at least one-third of your retirement savings in this bucket.
In both these types of accounts, your money grows tax-free while it remains in the account. This helps it accumulate more quickly than if it were subject to ongoing taxes. Each account type has varying rules about when, how, and how much money you can contribute and withdraw without incurring penalties or unexpected taxes owed.
Taxable accounts: You contribute after taxes, and any dividends or capital gains you earn are taxed annually (when they occur). These are mutual funds, stocks, real estate, and investment accounts that are nonqualified. This bucket is essential for emergency funds and growing your required minimum distributions when applicable, and it’s generally more flexible than retirement accounts.
Having a balanced tax triangle empowers you with the flexibility to strategically manage your savings in the most tax-efficient way. It gives you options when you’re ready to dip into them. Your future retired self will thank you.
