What retirement accounts grow tax-free?

A 401 (k) plan is a tax-advantaged plan that offers a way to save for retirement. With a traditional 401 (k) plan, an employee contributes a pre-tax wage to the plan, meaning that contributions are not considered taxable income. The 401 (k) plan allows these contributions to grow tax-free until they are withdrawn in retirement. Tax-exempt accounts offer future tax benefits instead of tax breaks on contributions.

Retirement withdrawals are not taxable. Since account contributions are made with after-tax dollars, meaning they're funded with money you've already paid taxes on, there's no immediate tax advantage. The main benefit of the tax-exempt structure is that investment returns increase and can be withdrawn completely tax-free. A tax-free retirement account, or TFRA, is a retirement savings account that works in a similar way to a Roth IRA.

Taxes must be paid on contributions that go into the account. The growth of these funds is not taxable. Unlike a Roth IRA, a tax-free retirement account has no IRS-regulated retirement restrictions. If you're likely to be in a higher tax bracket when you retire, a TFRA is a great way to mitigate tax implications.

Tax-free retirement accounts also come with a feature called “floor”. Your funds in a TFRA are indexed in the market, not actually in the market. So, if the market goes up, you are credited with a profit. But if the market falls, you won't suffer losses.

Unlike many other retirement savings accounts, the TFRA is not limited by IRA restrictions, allowing access to funds. Other retirement savings vehicles tend to have limited liquidity, if any. Tax-free retirement savings accounts offer benefits for chronic, critical and terminal illnesses, similar to long-term care plans. They also have a permanent death benefit.

TFRA are specially designed life insurance plans that use tax laws to their advantage. The permanent death benefit starts on the first day the plan takes effect. Unlike qualified retirement plans, a TFRA doesn't limit contributions. However, you must comply with life insurance rules and laws.

Many people also mistakenly call traditional tax-free IRAs accounts. While it's true that the money invested in a traditional IRA can grow tax-free, the account is actually a tax-deferred account, meaning that taxes are only delayed. However, contributions to traditional IRAs and retirement plans for the self-employed, such as SEP and 401 (k) Solo IRAs, must be reported on your tax return for several reasons. You'll pay income taxes on the funds you use for Roth contributions before depositing them into your Roth account.

Or, you can convert some of your taxable accounts into Roth IRAs to pay taxes while you're in a lower category, and then watch them continue to grow tax-free. Under defined retirement rules and annual income and contribution limits, after-tax money invested in a Roth IRA or Roth 401 (k) can grow tax-free and remain tax-free when you retire in retirement. Since this is such a valuable tool for retirement planners, but not for the IRS, since the federal government loses the opportunity to tax what could become a substantial book value, there are strict rules governing how Roth IRAs can be used to remain tax-free. There is only one type of tax-free retirement account, including Roth IRAs and Roth 401 (k) plans.