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Pre-tax Savings
457... 403(b) ... 401(k) ...What do these numbers really mean? More than just sections of the dreaded tax code, they're actually numbers that can boost your bottom line.
Your employer may let you participate in a 457 plan (deferred compensation plan) or a 403(b) plan (tax-deferred annuity or account), and you may also have heard of 401(k) plans. They're all special kinds of retirement savings plans that allow you to make automatic investments from your paycheck or from a bank account. But besides making regular saving easy, these plans give you something extra - a vacation from taxes!
Wait a While, Uncle Sam!
Pre-tax payroll deductions allow you to put money into your retirement savings before the government collects taxes on your salary. This means that you delay paying taxes on the money deducted from your paycheck. You'll have to pay taxes on the money eventually when you withdraw it during retirement. In the meantime, though, your savings can grow without being reduced by taxes.
What's the better answer?
Meet Michelle. She's 32 years old and has to pay 25 cents of every $1 of her paycheck in taxes to Uncle Sam. Her boss just gave her a raise, so she's decided to save $75 per month out of her take-home pay.
- (After-tax saving) If she puts $75 in a regular taxable account paying 8% interest per year, she would pay taxes on her interest earnings each year. After 30 years, Michelle would have $75,339 as a nest egg.
- (Pre-tax saving) If Michelle can afford to save $75 out of her already-taxed take-home pay, she can afford to have $100 taken out of her monthly paycheck before tax and put directly into her 457 account, which is tax deferred. The $25 difference is the tax she would have paid on the $100 if it hadn't been taken out of her paycheck before taxes. She would not pay taxes until she withdrew the money from the 457 program. If she contributed $100 a month, after retiring in 30 years, Michelle could withdraw her money and have $111,777 as a nest egg, even after paying taxes.
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