Retirement Accounts and Taxes in the USA
As we step into your 40s, a common question that arises is whether we are on track for retirement. While many of us estimate how much we’ll need and work toward that goal, one crucial aspect we often overlook is taxes. In this article, we'll explore different types of retirement accounts and how they are taxed during retirement.
There are mainly two category of retirement accounts. One set of accounts funded with pre-tax money and another with post-tax money. For the accounts funded with pre-tax money, we are not paying taxes now but will pay when we are withdrawing money during retirement. Uncle Sam guarantees one-time taxes :-). For the accounts funded with post-tax money, we have paid taxes now and will not pay taxes during withdrawal.
Let's review different types of accounts.
- Tax deferred
- Employer 401k/403b/Annuities
- Traditional IRA
- Health Savings(HSA) account (really!)
- After Tax
- Roth IRA
Tax Deferred
Employer 401k/403b/Annuities
Though it's not mandatory, 401k plans are a common retirement benefit offered by many employers in the USA. It's like provident fund in India. The contributions to 401k are tax-deductible. These contributions reduce your taxable income and reduces your tax liability. As of 2025, for individual under 50 years, the contribution limit is $23,500. The tax is paid when you withdraw the money from the account during retirement.
In addition to the contribution from the employee, it's common for employers to contribute towards employee 401k. Though different matching arrangements are possible, below are two common employer matching arrangements.
- Matches 50% of employee contributions.
- Matches 50% up to 6% of employee contributions.
Recommendations
You should contribute enough to 401k to get maximum employer contribution. Imagine your employer contribution as immediate returns on your investment. In the above example you should max out your 401k for the first case. For the second case you should contribute a minimum of 6%.
Traditional IRA
Contributions to Traditional IRA are tax deductible based on the income. If you are married filing jointly, then the income limit for year 2025 is $146k. If the employer is not providing 401k, then the limit is $246k
If the income exceeds the above limits, the contributions to traditional IRA are not tax deductible. You can still contribute but will not get tax benefit. If the tax is paid now on the contributions, then, during retirement you pay the taxes only on the earning portion.
Recommendations
If your employer is not providing 401k, then traditional IRA is alternate option. Also, the traditional IRA account will have more investing options than the employer 401k. So, if you have strong preference on the investing options or want to diversity in certain way, traditional IRA might be good choice.
Health Savings(HSA) account
The HSA account is eligible with high deductible health insurance plans. If the health insurance is from your employer, then, employer also might contribute some amount to the HSA account. HSA contribution limit for family is $8550 for year 2025. You can withdraw money from HSA account tax free for qualified medical expenses. Some HSA providers do offer the option to invest your HSA funds in a range of investment options, such as mutual funds, stocks, bonds, and exchange-traded funds (ETFs). Let's see the recommendations below which gives an idea on how this account can be used as another retirement savings vehicle.
Recommendations
Contribute to your HSA and if the account has investing option, then, invest that money. If you can afford to pay the medical expenses now without touching the HSA account, then, do so. The advantage is, your HSA money is getting invested and generating more money. During your retirement, you can withdraw money from HSA tax free not only against that year medical expenses but also against any qualified medical expense occurred after opening HSA account. You just need to do extra work saving all the bills you are paying now without touching HSA account money.
After Tax
Roth IRA
Things get more interesting here. The contribution to Roth IRA is done with post-tax money. So, you pay taxes now. But the earnings are tax free. You will not pay taxes while withdrawing money from these accounts during retirement.
As of 2025, the limit to Roth IRA contributions is $7500 for individuals less than 50 years old. Also, there is an income limit that determines whether you can contribute to Roth IRA. As of 2025, if you are married filing jointly, $246k is the income limit. Note one difference between traditional IRA and Roth IRA. You can contribute to traditional IRA, even you exceed the income limit. It's just that you won't get the tax benefit. But for Roth IRA, you can't even contribute if you exceed the income limit.
Recommendations
Roth IRA is my favorite. We fund it with post tax money, but we will never pay taxes on the earnings. Everyone should leverage this vehicle. There are ways to work around the income limits. I will cover those in another short article.
That's a wrap for this week. Happy learning!
