401(k) Frequently Asked Questions


What's the difference between taxable, tax-deferred and tax-free investing?
	A taxable investment is one in which you pay taxes every year on the dividends and appreciation of investments that you sell. A simple example of a taxable investment is a regular savings account. Every year when you file your tax return, you're required to report the interest your savings account has earned and pay taxes on it. Here’s a good rule of thumb: any time you buy a stock, bond, mutual fund, money market account, etc., that is not part of a special tax-sheltered account (such as a 401(k), 403(b), IRA, etc.) it is most likely a taxable investment – and you'll be required to pay taxes on its earnings every year. A tax-deferred investment is one in which you do not have to pay taxes on the investment's earnings until you withdraw money from the account. Examples of tax-deferred investments include 401(k), 403(b), and IRA accounts. In many cases, contributions you make to tax-deferred accounts are partially, if not completely, tax deductible. Because tax-deferred accounts are designed to help people save for specific goals – such as retirement or a child's education – there are hefty penalties attached to withdrawing your money from the account too soon. A tax-free (or tax-exempt) investment is one in which you don't have to pay taxes on the income the investment earns. A municipal bond is an example of a tax-free investment. Note however, that just because an investment is called "tax-free" does not mean that you won't have to pay any taxes on it. Some tax-free investments are exempt from only federal income taxes, while others may be exempt from only state or local taxes.
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