As you’re planning for your financial future, you’re likely making decisions about where to live, how much to save, and what type of investments meets your needs. But have you considered the tax treatment within your various accounts?
A great way to optimize the investment return within your savings and brokerage account is to utilize tax-advantaged accounts. Tax-advantaged accounts can provide tax benefits for investors no matter their current investment time horizon and typically fall into one of three categories:
Tax-deferred accounts: These accounts provide an opportunity to make pre-tax contributions that lower your taxable income during the year in which the contributions are made. Assets held within the account grow tax-deferred for your retirement, which, thanks to the power of compounding interest, can provide a significant boost to your long-term savings goals.
It’s important to note that tax-deferred assets become taxable as ordinary income when they’re withdrawn from the account. In addition, if you take a withdrawal before reaching age 59.5, you may be subject to a 10 percent early withdrawal penalty in addition to your ordinary income tax liability.
Another consideration for tax-deferred accounts is required minimum distributions (RMDs). Per current IRS law, investors with assets in tax-deferred accounts are subject to RMDs, which means you must withdraw a portion of your assets each year once reaching age 72 (73 if you reached 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.
Tax-deferred account types include:
• Traditional IRAs — Traditional IRAs are individual retirement accounts that allow you to make pre-tax contributions that grow tax-deferred for retirement.
• 401(k)s, 403(b)s, and other qualified retirement plans — 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 50 percent on the first 6 percent employees contribute to the plan.
Tax-exempt accounts: Contributions to tax-exempt accounts are made with after-tax funds, which means you pay ordinary income taxes on the amount you contribute. The growth that occurs in these accounts, along with withdrawals from the account after age 59.5, are exempt from taxes if the account has been open for at least five tax years. Paying tax on some of your assets now can be a great benefit to investors who expect to fall into a higher tax bracket or expect the government to increase ordinary income taxes rates in the future. In 2026, unless Congress takes action to preserve the lower marginal income tax rates implemented as a result of the passage of the Tax Cuts and Jobs Act, tax rates will revert back to pre-2017 levels.
Unlike tax-deferred accounts, tax-exempt accounts aren’t subject to RMDs, which means these assets can remain in the tax-advantaged account longer and potentially experience more growth. Some examples of tax-exempt accounts include Roth IRAs, Roth 401(k)s, Roth 403(b)s, and other after-tax retirement plans.
Accounts with tax-exempt withdrawals: These accounts are typically designed to help you save for a particular expense, such as healthcare or education costs. Withdrawals from these accounts are tax-exempt as long as the assets are used to pay for the intended qualifying expenses. These account types include health savings accounts (HSAs), flexible spending accounts (FSAs), and 529 education savings plans.
Saving in accounts with different tax treatments gives you the flexibility to draw retirement income from different types of accounts in order to optimize your overall tax liability. Ultimately, this practice can help maximize your retirement income while reducing your tax bill.
Katie Stephenson, JD, CFP, is a Private Wealth Manager and Partner with Creative Planning. Creative Planning is one of the nation’s largest registered investment advisory firms providing comprehensive wealth management services to ensure all elements of a client’s financial life are working together, including investments, taxes, estate planning, and risk management. For more information or to request a free, no-obligation consultation, visit CreativePlanning.com.