Choosing the right types of accounts is essential to building a tax-efficient investment strategy. At WealthFactor, we know that how your accounts are structured directly impacts your after-tax returns, helping you keep more of what you’ve worked to build.
The main factor in determining account types is tax treatment. Broadly, there are three ways accounts are taxed: fully taxable accounts, accounts with tax-deferred growth, and accounts with tax-free growth. Let’s take a closer look at each type and how they can work together to increase your tax efficiency.
Qualified Accounts: Tax-Deferred and Tax-Free Growth for Retirement and Education
Traditional IRA
A Traditional IRA is often the cornerstone of retirement savings. Contributions (up to the annual maximum amount per year) are generally tax-deductible, reducing your taxable income in the year of the contribution. Importantly, your investments grow tax-deferred, meaning you only pay taxes upon withdrawal and you do not pay capital gains taxes on transactions that take place within itIdeally, withdrawals happen in retirement when your income—and potentially your tax rate—is lower.
401(k)
A 401(k) is an employer-sponsored retirement plan with similar tax benefits to a Traditional IRA. The added advantage is that many employers match a portion of employee contributions, accelerating your savings.
Roth IRA
Unlike Traditional IRAs, Roth IRAs are funded with after-tax dollars. The big benefit? Withdrawals are tax-free once certain conditions are met, giving you a valuable source of tax-free income in retirement. Roth IRAs can be an important tool for those who anticipate being in a higher tax bracket in retirement and can also be a powerful estate planning tool as well. Contribution limits change over time; as of 2024, the annual maximum is $7,000 for those under age 50 and $8,000 for those aged 50 or older.
529 Savings Plan
If you’re saving for education expenses, a 529 Plan is one of the most effective tools available. These state-sponsored accounts offer tax-free growth, provided funds are used for qualifying education expenses. WealthFactor provides guidance on choosing and optimizing 529 Plans, like the Oregon College Savings Plan, to help clients achieve their educational funding goals.
Non-Qualified Accounts: Flexibility for General Investment
Taxable Brokerage Accounts
A cash account is the primary type of non-qualified account and offers maximum flexibility. Unlike retirement accounts, a cash account doesn’t have tax advantages, and capital gains or income generated within the account are taxable each year. However, this flexibility can be beneficial, especially when retirement accounts are already maximized. Cash accounts also don’t have withdrawal restrictions, making them ideal for short- or medium-term goals.
Making Your Accounts Work for You
As a general rule, it’s often best to take full advantage of tax-advantaged accounts before contributing heavily to cash accounts. This approach helps maximize tax efficiency, freeing up more resources for other goals. Ready to Maximize Your Tax Efficiency?
Not sure if your current account setup is optimal? Or perhaps you have a 401(k) with an old employer that you’re considering rolling over. WealthFactor can help you evaluate your options, structure your accounts, and create a tax-efficient investment plan tailored to your goals.
Reach out for a consultation and let’s work together to maximize your after-tax returns.
