Is that true when you withdraw your money at retirement that you pay less tax for a traditional IRA than a 401(k)?
The tax rates are the same, but the amount of money that is taxed may be different depending on whether your made pre-tax or after-tax contributions.
The great thing about traditional IRAs and 401(k)s is that the earnings are tax-deferred. You don't have to pay taxes on dividends, capital-gains distributions or profits when you sell the investments as long as you don't withdraw the money from the account. When you finally do take the money in retirement, it is taxed at your income-tax rate, which can be from 10% to 35% depending on your income. After you retire, your income-tax rate is likely to be lower than it was when you were working.
But the portion of your withdrawals that is taxed may be different for your 401(k) than it is for your traditional IRA. If you've only made pre-tax contributions to the account -- which is the case for many 401(k) participants -- then the entire amount you withdraw will be taxed. But if you've made any non-deductible contributions -- common for IRA participants with income above the cut-off for deductibility -- then you'll owe taxes only on the earnings from those contributions, but not the contributions themselves.
If you withdraw money from several traditional IRAs to which you made both tax-deductible and non-deductible contributions, then the portion that escapes taxes is based on the ratio of non-deductible contributions to the total balance in all of your IRAs. See The Taxing Side of IRA Conversions for more information.
And if you have any Roth IRAs, the tax calculation becomes much easier. Your Roth withdrawals are 100% tax-free as long as you're at least age 59½ and have had a Roth for at least five years.
As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.
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