This article is largely based on a Knowledge Planet article, written by 老司机. ymlulu made some tweaks and formatting changes

Why Can Retirement Accounts Help You Save on Taxes?

On the path to financial freedom, knowing how to legally and reasonably reduce taxes is often more important than simply earning more money. For example, for most people in the middle-income bracket, roughly 30% of income goes toward contributing to national/state infrastructure and development. For people with higher incomes or those in high-tax states, the effective rate can even reach 40%–50%. In that case, after working so hard, you may only take home half of what you earned, or discover at tax time that you still owe $80,000 or $100,000 in tax due. That is really painful. For U.S. salaried workers, retirement accounts are a powerful and perfectly legal tax-saving tool.

The main advantage of retirement accounts is tax deferral or tax-free growth. That means you either do not pay tax now, or you do not pay tax when you withdraw later—the time lag in taxation can create a powerful compounding effect on wealth.

This article will show you how to use these retirement accounts to pay less tax and reach financial freedom sooner! This is only a primer; a follow-up article will discuss more advanced strategies, including backdoor Roth and mega backdoor Roth, which can save tens of thousands of dollars in taxes every year. Stay tuned!

Comparison of Mainstream U.S. Retirement Accounts

We previously introduced 401(k) plans and the basics of various IRA accounts. You can check them out at the link below.

The comparison of different accounts is shown below.

Detailed Tax-Saving Tips

1. Max Out Your 401(k) Contributions + Take Full Advantage of Employer Match

  • Among all sources of income, 401(k) is the most direct pre-tax deduction tool.
  • For example, if you earn $100,000 a year and contribute $23,000 to your 401(k), your federal taxable income immediately drops to $77,000.
  • Employer match is usually 3%–6%, which is basically a “tax-free raise,” so make sure you get the full amount.
  • Generally speaking, we believe the tax rate after retirement will be lower than your current W-2 tax rate, so deferred tax is better than paying tax now. Therefore, maxing out your 401(k) every year should be standard practice.
  • There are a few things to watch out for here. First, do not put your 401(k) into a target-date fund. That is often the company default, especially for companies whose retirement plans are managed by Vanguard. If you pay a little attention and look at historical returns, you will find that if you invest in a target-date fund, by the time you reach retirement age, financial freedom is basically out of reach. My plan administrator is Fidelity, and I can open a BrokerageLink account to invest in all kinds of stocks and ETFs, including gold and Bitcoin ETFs. I have always managed my portfolio myself, and since I started actively managing it in 2018, my annual growth has been roughly 15%–20%.
  • Trading inside a 401(k) account does not incur short-term or long-term capital gains tax, so it is ideal for freely allocating assets without worrying about taxes. For example, if you are a big options trader, you might make money without even owing enough to cover the tax bill.
  • One last reminder: if you are just starting your career, money may be tight, but try to max it out anyway. I was ignorant when I first started working and only contributed 3%—just enough to get the company match—for my first two years. Now I finally understand how painful that lesson was...

Note that for high-income earners, this amount of tax-advantaged space is obviously not enough. So if you have room in your budget, you should start thinking about the Mega Backdoor Roth strategy. We will cover that in detail in the next article.

2. Make Full Use of IRA (Individual Retirement Accounts)

  • If your employer does not offer a 401(k), you can choose a traditional IRA and enjoy a pre-tax deduction.
  • If your employer does offer a 401(k), you can also open an IRA on your own. Of course, the goal here is to use another loophole-like strategy: Backdoor Roth.
  • One especially important tool here is the Roth IRA. It is currently one of the very few accounts in the U.S. that allows tax-free growth (another is the 529 plan), so make sure to use it well and contribute the full amount if possible.
  • The reason I mention a loophole-like strategy is that Roth IRA contributions are subject to income limits. Simply put, if your annual income exceeds $100,000, you cannot directly contribute money to a Roth IRA. The government explicitly prohibits this. If you make a mistake, the contribution may be returned or you may be taxed twice, so do not take the risk.
  • So the legal workaround is Backdoor Roth. Of course, this is possible thanks to the law being passed, but because this strategy is so special, it could be restricted one day. So use it while you can and make the most of it—try to max it out every year.
  • One more thing: even Roth IRA contributions through a Backdoor still have a limit. For example, in 2025 it is $7,500. Even with Mega Backdoor added, the maximum per year is only $69,000. So the amount of tax-free growth space is very limited, which is why everyone should try to max it out every year.

Note that the $69,000 includes: employee pre-tax/Roth contributions + employer contributions + after-tax contributions (used for Mega Backdoor).

3. Open an HSA: A Health Savings Account That Is Also a Powerful Tax-Saving Tool

  • The HSA is currently the only triple tax-advantaged account: contributions are tax-free, investment growth is tax-free, and medical withdrawals are tax-free.
  • Many people overlook the fact that you can actually invest it in stocks or index funds, making it an additional retirement investment account.
  • This is also a very practical account. Although I personally do not use an HDHP (because I have kids), if I had known how flexible the HSA was when I first started working, I could have chosen an HDHP, maxed out the HSA, invested it myself, and used it in retirement completely tax-free.
  • Remember, an HSA truly offers tax-free contributions, tax-free growth, and tax-free medical withdrawals, so if you qualify, you should make full use of it. Of course, such a special account also has an annual limit. And you need to be prepared to go a year without getting sick—especially avoid the emergency room—otherwise a $6,000 deductible will be something you deeply regret.

4. Take Advantage of the “Catch-Up” Opportunity: Extra Tax Savings After Age 50

  • After you turn 50, 401(k) and IRA accounts allow you to contribute more money, known as Catch-Up Contributions.
  • I assume this is not very relevant for most people reading this, but in practice it is also a very useful way to increase retirement savings.

Real-World Example: How a Salaried Worker Earning $100,000 Can Do It

Assume you are 25 years old, single, earn $100,000 a year, and have no other deductions:

Additional Tips: Tax Strategy + Financial Freedom Go Hand in Hand

1. Use tax software such as TurboTax to maximize deductions. Of course, if your tax situation becomes too complex for TurboTax to handle, you will need a CPA.

2. Review your contribution percentage every year and automatically increase it as your income rises. Fidelity has a feature that increases your contribution rate by 1% each year, and you can decide whether to use it.

3. For investments, consider low-cost index funds to reduce investment expenses. Even among ETFs that track the same index, some have higher fees and some have lower fees. For example, both QQQ and QQQM track the Nasdaq index, but QQQ has an expense ratio of 0.2%, while QQQM is only 0.15%. Over the long run, lower-fee ETFs can make a meaningful difference in returns.
4. In the long run, Roth accounts offer greater flexibility and tax advantages.

  • Tax-free growth in a Roth IRA is a very important retirement asset, and Roth IRA withdrawals are also very flexible. You do not have to wait until age 59.5 like a 401(k), so it can be a strong help in achieving financial freedom.
  • Contribution principal: tax- and penalty-free withdrawals at any time
  • The amounts you contributed yourself (excluding investment gains) can be withdrawn anytime without taxes or penalties.
  • For example, if you contributed $25,000 over 5 years and the account value has grown to $35,000, you can withdraw that $25,000 at any time.
  • Once the 5-year holding requirement is satisfied, certain qualified withdrawals of both principal and earnings can be tax-free, such as a first-time home purchase (up to $10,000).

Conclusion

Planning is the foundation of financial freedom: progress comes from small steps.

Financial freedom is not overnight wealth; it is a system built over time through strategy, discipline, and time. Retirement accounts can help you defer taxes, grow assets, and provide for your future life. The earlier you start, the bigger the compounding snowball can grow. So remember these two points:

  1. Try to max out your 401(k) and other retirement accounts every year.
  2. Make good use of Roth IRA’s tax-free growth.

The core idea behind the following series of articles is to save taxes in the current year by contributing to retirement accounts, then withdraw and use the money later in retirement when your income drops and your tax rate is lower. These accounts can also be used for investing, so your money is still working.

The Path to Financial Freedom

Main guide

Tools and Practical Walkthroughs

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