Tax- Advantaged Retirement Accounts

Tax benefits are advantageous for helping individuals lower tax liability. What’s more, tax- advantaged retirement accounts provide tax benefits in the form of tax deferrals and tax exemptions. Because taxes are one of the biggest expenses on investments, choosing the right investments and the accounts in which to hold such investments is necessary to minimize your overall tax burden. While tax-advantaged retirement accounts have strict contribution limits, they can help maximize income and limit taxes when balanced with other retirement accounts in a tax-efficient investment strategy.

Benefits of a Tax -Advantaged Retirement Account

Tax-advantaged retirement accounts offer benefits for employees. Contributions to such accounts can reduce taxable income, and contributions and investment gains are not taxable until they are withdrawn. Moreover, interest accrues over time, so small and regular contributions can grow to greater retirement savings. Payroll deductions make it easy to contribute funds to these types of accounts, and retirement assets can be carried over from one employer to the next. Bottom line, investments in tax-advantaged retirement accounts can improve employee financial security in retirement.

Types of Tax -Advantaged Retirement Accounts

• Employer sponsored 401(k) - Tax benefit is taken upfront. Contributions are made with pre-tax monies. Contribution limit is $23,000 in tax year 2024 or $30,500 for those individuals 50 or older. Required minimum distributions (RMDs) are required starting at age 73.
• Traditional IRA - Tax benefit is taken upfront. Contributions are made with pre-tax monies. Contribution limit is $7,000 for tax year 2024. Individuals age 50 or older can add an additional $1,000 per year in "catch-up". Taxes are paid when the funds are withdrawn.
• Roth IRA - Tax benefit is deferred. Contributions are made with after-tax monies. Contribution limit is $7,000 in tax year 2024. Individuals age 50 or older can add an additional $1,000 per year in "catch-up". Withdrawals in the future are tax and penalty free provided first contribution was made at least 5 years prior and the individual has reached age 59½.
• SEP IRA - Tax benefit can either be taken upfront (Traditional SEP IRA) or deferred (Roth SEP IRA). Contribution limits are the lesser of 25 percent of self-employment compensation or $69,000 in tax year 2024. Distributions can be taken at any time, but withdrawals before age 59½ are subject to a 10 percent tax penalty.
• Spousal IRA - Tax benefit is taken upfront. Contributions are made with pre-tax monies in an IRA held in the name of the nonworking spouse. Marital status must be "married" and tax filing status must be "married, filing jointly". Contribution limit is $7,000 in tax year 2024. Individuals aged 50 or older can contribute an additional $1,000. Combined contribution limit for couples both age 50 or older is up to a maximum of $16,000.

Tax-Deferred vs Tax-Exempt

The federal government approved tax-deferred savings plans for individuals as a means of promoting Americans to save for retirement. Individuals can contribute a portion of their pre-tax earnings to an investment account. Federal taxes owed by the individual will be lower each year as taxable earned income is reduced by the amounts contributed to the tax-deferred account. Furthermore, pre-tax monies can be invested according to the individual’s choice of stocks, mutual funds, bonds, certificates of deposit, and other assets. Tax- deferred plans grow over time and, after retirement, individuals can draw from the funds for income.

Withdrawals at retirement are tax-exempt and not subject to taxes when contributions are made with after-tax dollars. In this structure, withdrawals are completely tax free, hence providing a future tax benefit. Because tax benefits can occur many years in the future, ideal candidates for tax-exempt accounts are in the early stages of life when taxable income and the associated tax bracket are minimal but likely to increase in the future. While an individual may not be financially able to fund both tax-deferred and tax-exempt accounts, understanding the tax situation now and what it is expected to be in the future can help determine the tax strategy that is right to reap the most in lifetime tax benefits.