Tax-advantaged means any investment, financial account, or savings plan that is not taxed, has taxes delayed, or provides other tax benefits. Examples include municipal bonds, partnerships, UITs, and annuities. Tax-advantaged plans are IRAs and retirement plans like 401(k)s.
Learn more about Tax-Advantaged
Many investors and workers use tax-friendly investments and accounts based on their financial needs. People with high incomes look for tax-free income from municipal bonds, while employees save for retirement through IRAs and company retirement plans.
People often use two main ways to lower their taxes: tax-deferred and tax-exempt status. The choice between these options, or using both, depends on when you benefit from the tax savings.
Tax-Advantaged Accounts
In regular brokerage accounts, the IRS taxes investors on profits made from selling investments. But with tax-advantaged accounts, investors can defer taxes on their earnings, and sometimes avoid them altogether. Traditional IRAs and 401(k) plans are examples of tax-deferred accounts where investment earnings aren’t taxed annually.
Taxes are postponed until the person retires, allowing them to begin taking money out of the account then. They can withdraw from these accounts without a penalty once they reach 59½ years old.
Before the SECURE Act was signed into law on December 20, 2019, account holders had to start taking required minimum distributions (RMDs) from their tax-deferred retirement accounts when they reached 70½ years old. The SECURE Act changed this, allowing individuals to wait until they are 72 to start taking RMDs. It also removed the age limit for contributing to a traditional IRA, enabling working account holders to keep investing without a time limit, just like with a Roth IRA.
The rules for starting distributions changed again when Congress passed the SECURE Act 2.0 in December 2022. Now, people must start taking required minimum distributions (RMDs) when they turn 73, starting from January 1, 2023.
Conclusion
Roth IRAs and FSAs provide greater tax benefits for investors compared to tax-deferred accounts because the activities in these accounts are not taxed. Withdrawals and earnings from these accounts are tax-free, showcasing a clear tax advantage.
Governments create tax benefits to motivate people to donate money for the public good. Choosing the right tax-advantaged accounts or investments relies on an investor’s financial circumstances.