The 401k accounts are generally referred to as a tax free saving. That is because we do not pay any tax on the contributions made to the 401k account during the financial year. However, any withdrawal made from the 401k account for expenses, after retirement, is liable to tax deductions. Thus, a 401k account is in fact a tax-deferred savings account, and not a tax-free account.

The 401k account can be used as a foundation for retirement planning. One has to realize that every withdrawal from the 401k account will be taxed, this goes for interest earning as well. The withdrawal from this account is treated as income received by you and taxed accordingly. This you are deferring the payment of tax on the money until you use it, hence the term tax deferred savings. A small advantage is that you may pay tax at a lower rate as compared to what you would have paid during your working years. This is because the income level is lower after retirement and you may pay taxes in the lower tax bracket. This will entail a slight reduction in the overall tax you will pay.

However, a little planning will go a long way in helping you maintain some tax-free savings, instead having all your funds in tax-deferred savings. You can opt for a Roth IRA account. Under this scheme, you can invest money in the account after deduction of tax. Since the investment in the Roth IRA account is on an after tax basis, withdrawal of funds from the account are not taxed. Interest earnings on contributions to Roth IRA accounts are tax free, provided you withdraw the money after attaining the age of 59

Abhishek Agarwal
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