Tax Advantaged Investment Options
Investing with tax efficiency in mind can help you keep more of your returns. Many investment accounts offer special tax benefits that can lower your taxable income in the year of contribution, defer taxes until you withdraw funds or avoid paying taxes altogether.
Strategically separating your stocks and bonds into different accounts can also help reduce the impact of taxes. Rebalancing periodically to maintain your target asset allocation may be beneficial as well.
IRAs
Using tax-advantaged investments is a great way to minimize the taxes you pay over your lifetime. This is because investments like IRAs, 529 plans and municipal bonds can shelter a portion of your investment returns from taxes, helping you keep more money invested over time.
Depending on your age, income and financial goals, you may want to focus rebalancing efforts to put more of your new money into these accounts. This can help you minimize the taxes you owe, especially as long-term capital gains rates are more favorable than short-term ones.
A financial advisor can help you navigate your options and determine which tax-advantaged investments make sense for your situation. Use SmartAsset’s free advisor matching tool to get personalized recommendations in minutes.*.
401(k)s
If your employer offers a retirement plan, saving within that account is a smart idea. Most experts recommend directing 10-15% of each paycheck to these accounts (and taking advantage of any matching funds your company may offer).
Freelancers, small business owners and people with side jobs have options for tax-advantaged savings as well, including the IRA, Simplified Employee Pension (SEP) IRA and self-employed 401(k). Municipal bonds also provide a tax benefit, since they’re exempt from federal taxes.
Consider minimizing investment fees by using exchange-traded funds or index funds that tend to have lower expense ratios than actively managed mutual funds. This can help reduce the amount of capital gains tax you’re liable for when rebalancing your portfolio. Health savings accounts also offer potential tax benefits, including the ability to deduct current contributions and withdraw money tax-free for qualified medical expenses.
403(b)s
A good financial advisor can help clients make the best use of tax-advantaged accounts. These include 401(k) plans, 529 savings plans for educational expenses and 403(b) or 457 plans for employees of non-profits, state and local government agencies.
Generally, it makes sense to hold investment returns that generate significant ordinary income (like taxable bonds and bond funds) in tax-deferred accounts while holding stocks or stock funds that generate qualified dividends in taxable accounts. Likewise, long-term capital gains receive more favorable tax treatment than short-term capital gains.
For example, a 403(b) or 457 plan is similar to a 401(k) for employees of nonprofit employers and allows contributions to be made with pre-tax dollars and grow tax deferred until withdrawn. This may be a preferred method for saving for retirement or education expenses.
457(b)s
If you’re self-employed or own a small business, you can take advantage of another tax-advantaged savings option called the SEP IRA. It works much like a traditional IRA, but only you can contribute.
A governmental 457(b) plan can be used to defer retirement income and is typically available for local, state and governmental employers that do not offer a defined benefit pension plan. The contribution limits are 25 percent of compensation or $66,000, whichever is less.
These accounts are popular for saving for education expenses, health care and retirement expenses. By deferring taxes on investment growth and realizing the benefits of tax-free withdrawals in retirement, these types of accounts can provide major advantages over taxable investments. However, there are many considerations to take into account when choosing a retirement or tax-advantaged investment plan.
HSAs
There are many ways to minimize what you owe on the money you make from your investments. One of the most effective approaches is to invest in tax-advantaged accounts. These include retirement savings accounts (401(k)s, IRAs), health savings accounts and 529 plans.
These accounts provide tax benefits that can help you reach your financial goals more quickly than if you invested in a taxable account. But it’s important to understand the differences between them.
It’s also important to know how the tax-advantaged investment options work together. It may be helpful to consult a certified accountant or financial planner to discuss your specific circumstances. That way, you can be confident that your strategy is aligned with your financial needs and goals.
