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How do taxes work on Plan 3? Thumbnail

How do taxes work on Plan 3?

How do Taxes work on Plan 3?

In order to understand how taxes work on Plan 3, we must fully understand what plan three is first. Plan 3 is a pre-tax retirement account, meaning that we haven't paid the taxes associated with this money yet. Every dollar we have in it, we still owe taxes on, whether the dollar came from our contributions, was a dividend, or some kind of growth that we got in the account. It still needs to be taxed. Therefore, plan three, along with every other pre-tax account you have out there (IRAs, 403Bs, or the DCP) will have to be taxed in the future. 

-How much in taxes will I owe?

How much in taxes you’ll owe is going to come down to your income tax bracket in retirement and how much money you pull out.  For example, if in retirement, you find yourself in the 25% tax bracket, then you're going to owe 25% of every dollar you pull out of that retirement account. With plan three, you'll be taxed as you pull out and spend the money. Therefore, if you want to transfer that money to a different company retirement, that's totally fine because you only get taxed when you pull out money and spend it or put it in your own bank account. 

-Distribution

There are some things you have to be careful about, however. As you take money out of your plan 3 accounts, you're going to be taxed at your highest marginal tax rate. Now, just looking at how the current tax code is written, there’s a good chance that taxes will be higher in the future. Additionally, the fact that all the students' money is being pushed down, the taxes need to go to pay off all that debt. The thing to be careful about here is the amount of distribution you take from that pretax retirement account because what you take will count as income, which will bump your income level up. That bump may put you into a different tax bracket, especially if you take too much money out at once. To avoid this mistake and end up paying more than you need to in taxes, it's important to look at what your income bracket is and where that threshold of money is you can take out. The last thing you want to do is take too much money out, be bumped up in that tax year, and have to pay more taxes on that money.

Another thing to be careful of when you take distributions out is paying taxes on your social security. Because you're going to be increasing your income, when you take those distributions, it’ll result in having to pay more taxes on your social security. You may even have to pay more for your Medicare plan too. 

Those are just some basic points on how taxes work on the plan three account. Now, if you want to learn how to build yourself a tax-free retirement so you don't have to worry about any of the stuff we talked about today, just schedule a meeting. And remember that your future depends on what you do today!