Investing has always been a means for people to grow their wealth and make their money work for them. Investors know that protecting investment earnings is important, and that often can be achieved through tax-advantaged investments.
Tax-advantaged investing, also called tax-efficient investing, allows investors to maximize the profits they can keep after taxes are filed. Investment selection and asset allocation are important factors affecting returns, but minimizing taxes and other costs is also crucial, according to the Schwab Center for Financial Research.
There are some ways for investors to keep more of their assets. A qualified financial advisor can help navigate the waters of the best tax-advantaged options. When investing on an annual basis, there are some general accounts people can use to their advantages.
• A 401(k) or 403(b): These accounts are an ideal way to get “free” money. Funds in these accounts are put away pre-tax. Because your adjusted gross income is lowered, so is your federally taxable income. In addition, some employers may match contributions up to a certain percentage. Companies also may offer Roth 401(k) plans, which differ from traditional plans in regard to when you pay taxes. With Roth plans, you pay taxes up front. When the money is eventually withdrawn, those withdrawals are tax-free.
• IRAs: Individual retirement accounts are similar to 401(k) plans in that they’re tax-deferred. However, they generally offer greater freedom in investment choices. Roth IRAs, like the Roth 401(k) plans, must be paid with after-tax dollars. But the advantages are higher contribution amounts, withdrawals that are tax-free and no mandatory withdrawals when a person reaches a certain age.
• College savings accounts: Investing in a 529 plan can be wise for parents. While money is invested after tax, it is tax-free when withdrawn for qualified higher education purposes.
• Health savings accounts: To get a tax deduction on health expenses, an HSA is the way to go. HSAs are linked to high-deductible health plans and allow account holders to use the funds for qualified spending.
Working with a financial planner can help investors maximize their investments to be as tax-efficient as possible. Financial experts understand funding limits and the timeline in which to invest for tax advantages.