Taxes are a big cost, but takes priority after getting your spending in control and learning about index funds. You want to pay all the taxes that you owe, but you need to take advantage of all tax advantaged accounts.
401k and 401k equivalents delay paying taxes which allows your full amount of money earned to continue to grow until you take it out of the account.
One advantage for people but especially those retiring early is that once you quit your day job then you can control how much you are taxed by how much you withdraw from the account. Income taxes generally are at different tiers and the more you make then the more are taxed at the higher tiers. Therefore, it important to spread out how much you withdraw year to year.
Roth accounts are funded with taxed dollars and the funds grows tax free and when you withdraw them then you can do so tax free. We talked briefly about them in a previous post titled “Roth IRA’s; Available to Almost All and an Extremely Powerful and Important Tool.”
Its important to understand the differences of Roth IRA’s and traditional retirements tools and it is best to use a little of both to control how much you are taxed in any year.
Hypothetical Mary needs 50k to live on a year. If federal taxes increases dramatically after 40k then Mary should withdraw 40k from her regular 401k and the rest from her Roth account. Doing this she will only be taxed on her initial 40k and stay at the lower amount.
Another thing to keep in mind is that it is almost always better to delay taxes or grow you money tax free if possible using retirement accounts. Though retirement accounts generally have rules about taking funds out early, some retirement accounts have ways of accessing the money early even if you are young. For example, with a Roth IRA you can withdraw contributions early, but not earnings and with a 401k you can use a strategy called a Roth IRA ladder to access the funds early without penalty.
Millionaire Librarian 