boy making choice deciding on best option

Taxes can take a big bite out of your total investment returns. So when making your investment decisions, you’ll want to look for ways to help maximize tax benefits in addition to the usual considerations of potential investment risks and returns.

The first thing to understand is the difference between tax-deferred, after-tax, and taxable savings accounts.

Tax-deferred savings accounts, such as a traditional 401(k) or IRA, allow you to delay paying taxes until a future date. Instead of paying taxes when you contribute to these accounts, you pay taxes when you withdraw money from them, which could be 30 or 40 years down the road. Tax-deferred accounts have many benefits, including:

  • The dollars you invest may reduce your current taxes. So money you would have paid in taxes gets invested for your future instead.
  • You may be in a lower tax bracket when you withdraw the funds.
  • Your investment earnings aren’t taxed when they’re reinvested, which may help your account grow faster.

After-tax retirement accounts, such as a Roth IRA or Roth 401(k), help you create tax-free retirement income. You fund these accounts with dollars that have already been taxed. Your money then grows and can be taken out completely tax-free as long as you meet certain qualifications.1

With taxable accounts, such as bank savings accounts, certificates of deposit (CDs), and brokerage accounts, you have to pay taxes on interest and investment earnings each year. Like a Roth account, the money you put into these accounts has already been taxed.

Tax-advantaged savings accounts for retirement.

One of the best ways to save money for retirement is to use tax-advantaged (i.e., tax-deferred or tax-free) savings accounts.

  • Traditional IRA Anyone under age 70½ who earns income (or who is married to someone with earned income) can contribute up to $5,500 to an IRA in 2018. If you’re age 50 or older, you can contribute up to $6,500 in 2018. Depending on certain factors, you may be able to deduct IRA contributions to reduce current taxes. Investment earnings grow tax deferred and you’ll owe income taxes when you take withdrawals.2 Given that these rules can be complicated, it can help to consult a tax advisor.
  • Roth IRA Only people with income below certain limits can contribute to a Roth IRA. Contributions are made with after-tax dollars so there is no current tax deduction. Over time, investment earnings grow and qualified withdrawals are tax-free.3 Contribution limits are the same as traditional IRAs. If you contribute to both types of IRAs, the combined contributions cannot be more than $5,500 (or $6,500 for those age 50 and older) in 2018.
  • Employer-sponsored plans (401(k), 403(b), 457 plans) — Contributions to these plans can help reduce your current taxes. You can contribute up to $18,500 in 2018 if you’re under 50 or up to $24,500 if you’re over 50. Note, however, that both contribution limits are subject to plan rules. Investment earnings grow tax-deferred and you’ll owe taxes when you take withdrawals.4 Some employer plans also offer a Roth option, allowing you to build a source of tax-free income with the flexibility of higher contribution limits than a Roth IRA.

Tax-advantaged savings accounts for college.

  • 529 plans — College savings plans and prepaid tuition plans are tax-deferred ways to save for college. Money can be withdrawn tax-free if used for qualified education expenses. The plans are open to anyone regardless of income level. Contribution limits are high—typically over $300,000—but vary by plan.5
  • Coverdell education savings accounts — These accounts are available only to people with incomes below certain limits. If you qualify, you can contribute up to $2,000 a year per child. Contributions grow tax-deferred and withdrawals are tax free if used for qualified education expenses. Typically, balances in this account must be disbursed by the time the beneficiary is 30 years old or may be given to another family member below the age of 30.

You shouldn’t make investing decisions based only on tax considerations. But when you put your money into tax-advantaged accounts, it may allow you to keep more dollars in your own pocket and put fewer in Uncle Sam’s.


Part of this content has been contributed by Broadridge Investor Communication Solutions, Inc.
1, 3 To qualify for tax-free status, Roth funds must have been held in the account for at least 5 years and withdrawals must be made after age 59½ or after becoming disabled.
2, 4 Withdrawals before age 59½ may be subject to a 10% federal income tax penalty unless an exception applies.
5 Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans. More information about specific 529 plans is available in each issuer’s official statement, which should be read carefully before investing. Also, before investing consider whether your state offers a 529 plan that provides residents with favorable state tax benefits. The availability of tax and other benefits may be conditioned on meeting certain requirements. There is also the risk that the investments may lose money or not perform well enough to cover college costs as anticipated. For withdrawals not used for qualified higher-education expenses, earnings may be subject to taxation as ordinary income and possibly a 10% federal income tax penalty.