When you’re planning for your child’s future education or your own retirement, there are several smart ways to save. You might dive into the stock market, invest in income-generating real estate, or stash money in education savings accounts or retirement plans.
Understanding how these different savings vehicles are taxed is critical to making the best choice for your financial situation. Let’s start with a look at the tax treatment of IRA accounts.
💡 IRA, Roth IRA, and other Retirement Plans
Individual Retirement Account (IRA)
There are two main types of IRAs: the Traditional IRA and the Roth IRA. Despite their similar names, their tax treatments are worlds apart.
Traditional IRA – Contributions to a traditional IRA are usually tax-deductible unless you have a retirement plan at work. In that case, higher-income earners may lose the deduction. Earnings within a traditional IRA are tax-deferred—meaning you won’t pay taxes now, but you will when you take money out. If you didn’t take a deduction for contributions (whether by choice or due to restrictions), withdrawals will be partly taxable and partly tax-free.
Roth IRA – Roth IRA contributions are never tax-deductible, but the real magic happens when you withdraw. If you’ve had the account for at least five years and you’re over 59.5 years old, both contributions and earnings come out tax-free.
So, which one is best for you? It depends. If you need that tax break now, a traditional IRA may be the way to go. But if you’re fine without the immediate deduction, the Roth IRA’s tax-free withdrawals are a serious long-term win.
Retirement Plans
Whether you’re an employee or self-employed, the tax code offers a buffet of retirement plans to help you save. From 401(k)s to SEP IRAs, these plans generally allow you to defer taxes on contributions until you withdraw the funds in retirement. However, if you opt for the Roth version of a 401(k) or 457 plan, your contributions aren’t tax-deferred, but your withdrawals will be tax-free in retirement.
💡 Savings, Gains, and Withdrawals
Bank Savings
Simple but effective, money tucked into a bank savings account or CD earns interest that’s taxable in the year it’s earned. The good news? Once you’ve paid the tax, the full amount is yours to use, no strings attached.
Capital Gains
Whether from stocks, bonds, or real estate, capital gains are a big part of tax-deferred investing. Long-term capital gains, which come from assets held for over a year, are taxed at a lower rate than short-term gains. For most people, that rate is 15%, significantly lower than ordinary income tax rates.
Education Savings Accounts
Planning for college? The Coverdell Education Savings Account and the 529 Plan are your go-to tax-advantaged savings tools. While contributions aren’t tax-deductible, both plans’ earnings grow tax-deferred and are tax-free if used for qualified expenses like tuition. Start early to maximize the benefit!
Health Savings Accounts (HSA)
HSAs are a powerhouse of tax advantages if you have a high-deductible health plan. Contributions are tax-deductible, earnings grow tax-free, and withdrawals used for qualified medical expenses are also tax-free. After age 65, you can even use the funds for non-medical expenses—though you’ll pay taxes on those withdrawals.
Unqualified Withdrawals
Beware of dipping into retirement or savings accounts for non-qualified reasons. Early withdrawals can trigger hefty taxes and penalties. It’s always best to consult a tax professional before making any moves.
Navigating the world of tax-deferred investing?
Our team of experts can help you find the best strategies for your specific situation in 2024 and beyond. Let’s talk about how you can grow your savings while minimizing your tax bill—schedule a consultation with us today!