August 18, 2023
Meet the Tax-Advantaged Account Types!
The topic of taxes is not one that excites many people. Depending on your stage in life, the nature of your financial assets, and your system for managing them, your attitude towards taxes most likely ranges from indifferent to strongly negative. With the help of a financial advisor in Mount Pleasant who thoroughly understands different account types and their tax benefits, you can minimize the tax impact on your assets thus decrease your tax bill.
Funding the appropriate accounts and planning your investments strategically can drastically increase your tax efficiency, thus leading to lower long-term tax bills. In this blogpost, we will discuss three different types of accounts: taxable, tax-deferred, and tax-free. While there are numerous factors that go into the decision making process of which account types to use over the others, their differing tax benefits and your time horizon are the two, most common components of the decision making process.
In this context, a “taxable” account means whatever money you put into the account has already been taxed. If your investments pay out dividends or interest payments, these distributions are taxed as ordinary income that year. If your investments increase in value and you sell them, you are taxed on any gains you realize upon the sale. Thus, these accounts do not have any tax advantages. On the bright side, there is no limit on how much money you may put into them each year.
The most common tax-deferred accounts are Traditional IRAs and Traditional 401ks. These tax-deferred accounts are typically used for retirement savings. The money goes into the account without being taxed at the time of deposit, and you will not be taxed until you withdraw your money. This allows for a larger principal contribution, which means more money at work accruing interest. Once you reach age 59 1/2, you can begin to withdraw the money without any early withdrawal penalties, and the withdrawn money is taxed at your ordinary income rate. These withdrawals are most common after retirement when the person’s taxable income has declined as they are no longer working thus they find themselves in a lower tax bracket.
Roth IRAs and Roth 401ks are the most common tax-free accounts. These accounts are funded with money you have already been taxed on, and when you make a “qualified withdrawal,” you do not pay any taxes on the withdrawn amount. This provides huge benefits to those who anticipate being in a higher tax bracket later in life.
Each of these accounts has its own set of pros and cons. Which account or which combination of different accounts is right for your family? That question is obviously an extremely individual one, and without a comprehensive review of your current financial state, income, future plans, and priorities, it’s impossible to come up with the correct answer.
Working with a Certified Financial Planner™ can help you to map out the best strategy for you personally to fund each account. Get in touch with Twenty Fifty Capital to get an expert eye on your accounts, assess your tax requirements, and suggest any changes that could help you make the most of your money both now and in the future.