While this tax season is behind us (unless you filed an extension), it’s not too early to begin looking at how you can optimize your tax strategy for next year.
As you're mapping out your financial journey, you're undoubtedly making critical decisions about your living situation, savings targets, and investment strategies. Amidst all these considerations, it’s important to take a deep dive into how taxes can impact the growth and withdrawals from your diverse array of accounts.
One powerful method to enhance your investment returns is by leveraging tax-advantaged accounts. These specialized accounts offer tax benefits tailored to investors across different time horizons and preferences, typically falling into three primary categories:
These accounts allow you to make contributions with pre-tax dollars, thereby reducing your taxable income in the year of contribution. Assets within these accounts grow tax-deferred, potentially providing a significant boost to your long-term savings objectives. It's crucial to note that withdrawals from these accounts are taxed as ordinary income, with potential early withdrawal penalties before age 59 1/2 and mandatory distributions (RMDs) starting at a certain age, currently 72 (73 if you reach age 72 after December 31, 2022). As a result of the passage of the SECURE 2.0 act, the age at which RMDs must begin will be pushed to age 75 for investors born in 1960 or later.
Examples include:
Traditional IRAs - Traditional IRAs are individual retirement accounts that allow you to make pre-tax contributions that grow tax-deferred for retirement
Employer-sponsored retirement plans like 401(k)s - These are employer-sponsored plans that offer employees an opportunity to set aside pre-tax savings for retirement. Many employer-sponsored plans offer the added benefit of matching a percentage of employees’ contributions to the plan. For example, an employer may offer to match 100% on the first 3% employees contribute to the plan.
Contributions to these accounts are made with after-tax funds, meaning you pay taxes on the contribution amount upfront. However, the growth and withdrawals from these accounts after age 59 1/2 are exempt from taxes if the account has been open for at least five tax years. This can be particularly advantageous for investors anticipating higher future tax brackets or changes in tax legislation.
Examples include:
Roth IRAs - Roth IRAs allow you to pay taxes on your contributions in the current year in exchange for tax-exempt growth and tax-exempt withdrawals in retirement (if the account has been open for at least five tax years).
Roth 401(k)s - Many employers offer their employees an opportunity to make after-tax contributions to an employer-sponsored retirement plan. Like Roth IRAs, these accounts allow you to pay taxes on your contributions now in exchange for tax-exempt withdrawals in retirement.
These accounts are designed to save for specific expenses, such as healthcare or education costs. Withdrawals from these accounts are tax-exempt as long as the funds are used for qualifying expenses.
Examples include:
Health Savings Accounts (HSAs) for medical expenses - These accounts have three distinct advantages: Pre-tax contributions that lower your taxable income in the year they’re made, tax-exempt growth within the account, and lastly, tax-exempt withdrawals when funds are used to pay for qualified medical expenses.
529 education savings plans - 529 plans provide a tax-advantaged way to save for a loved one’s education expenses. Although contributions to a 529 account aren’t tax-deductible at a federal level, many states offer income tax deductions on contributions to the state’s plan. If you happen to reside in one of the nine 529 tax parity states (Arizona, Arkansas, Kansas, Maine, Minnesota, Missouri, Montana, Ohio or Pennsylvania), you can make contributions to an out-of-state 529 plan and still qualify for state income tax deductions. Contributions grow tax-deferred within the account, and withdrawals are tax-exempt when used to pay for qualified education expenses, such as tuition, books, school supplies, and room and board.
Understanding the intricacies of these accounts is vital for crafting a tax-efficient investment strategy that aligns with your financial objectives. By strategically utilizing accounts with different tax treatments, you can minimize your overall tax liability while maximizing your retirement income.
If you're seeking guidance on navigating tax-advantaged investments, GatePass is here for you. Our experienced teams are dedicated to understanding your unique financial situation, goals, and challenges to provide tailored solutions that meet your needs.
For more information, please schedule a call with a member of our team.
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