Grow Your Money (Not Your Tax Bill) with These Tax-Advantaged Accounts

In general, retirement accounts are tax-advantaged, allowing you to save for retirement and pay less in taxes, either now or when you retire. However, there are a number of smart ways to build wealth before you retire that are tax-free.

Part of the reluctance to join a retirement plan may be a lack of understanding of the benefits they can bring, now and in the future. Here’s what you need to know about the different types of tax-advantaged investments available. 

401(k)s are company-sponsored retirement plans offered by many employers. They are tax-deferred, meaning that any contributions made from your paycheck will reduce your reportable income and possibly what you owe in taxes. You only have to pay taxes when you withdraw your 401(k) funds in retirement. By then, your tax bracket may be lower than when you were employed, potentially reducing what you owe.

You can contribute up to $23,000 to your 401(k) in 2024, with an additional $7,500 as a catch-up contribution if you’re over age 50.

401(k) plans have many similarities to 403(b) plans. The main difference is that 403(b) plans are available to employees of public schools, churches, or non-profit organizations rather than to employees of for-profit companies. 

These plans are also tax-deferred, meaning you put pre-tax money into the account and don’t have to pay taxes on either the contributions or the earnings until you take money out in retirement. Like the 401(k), you can contribute up to $23,000 to your 403(b) for the 2024 tax year.

Having both an individual retirement account (IRA) and a 401(k) can make things a little complicated. IRAs allow you to contribute pre-tax money, just like a 401(k), and that money is then invested and grows tax-free until money is withdrawn. However, unlike a 401(k), you can only contribute $7,000 to your IRA in 2024, or $8,000 if you’re over age 50.

Contributions to an IRA are tax-deductible up to $7,000. But if you have an employer-sponsored plan like a 401(k) and a traditional IRA, the tax-deductible amount may change. You can take the full deduction if your modified adjusted gross income (AGI) is less than $77,000 in 2024 if you’re filing as a single person or less than $123,000 if you’re filing jointly. The deduction amount may be reduced or eliminated if you go over those thresholds.

Roth 401(k) plans differ from traditional 401(k) plans because, while they are still offered through an employer, they are funded with after-tax dollars. When you invest in a Roth 401(k), you use the money in your paycheck after your taxes have been withheld. When you reach 59 1/2 and have had the account for more than five years, you can withdraw both the contributions and the earnings tax-free.

A Roth 401(k) can make an excellent companion to a traditional 401(k), since one is tax-deferred, giving you a benefit now, while the other grows tax-free, benefitting you in retirement. While your total contribution to both can’t exceed $23,000 per year, you can split your yearly contributions across both accounts.

Roth IRAs have the same contribution limits as traditional IRAs ($7,000 in 2024), but the tax advantage is different. Roth IRAs are funded with after-tax money like the Roth 401(k) instead of pre-tax dollars.

Since you’ve already paid taxes, your money can be withdrawn tax-free, as long as you meet certain requirements. This includes reaching the age 59 1/2 and having the account for at least five years before you withdraw funds. You can also take out contributions throughout your life without paying a penalty or taxes, although you will lose the advantage of compound interest.

Additionally, Roth IRAs have an earned income limit. If your earned income is more than $161,000 in 2024 for single filers or $240,000 for married people filing jointly, you aren’t eligible to contribute to a Roth IRA.

Roth IRAs can be a great option if you expect your tax bracket to be higher in retirement; since you’ve already paid taxes when the money goes in, you don’t have to pay taxes on either the contributions or gains when you make an approved withdrawal.

529 plans are tax-advantaged savings plans that encourage people to save for educational expenses. Sponsored by states, state agencies, or educational institutions, 529 plans offer parents, grandparents, or relatives a way to save for a child’s education while also potentially getting a tax deduction. You don’t have to invest in the 529 of the state you reside in, but you may lose some offered tax deductions or matching grants if you invest in a different state’s plan.

529 plans generally grow tax-free if the money is used on qualifying educational expenses, but make sure you understand the rules of any plan before you start investing in one.

A health savings account (HSA) is a tax-advantaged account that lets you save pre-tax money to pay for qualified medical expenses. Unfortunately, not everyone can get an HSA, so check if your plan offers one if you have a high-deductible health plan (HDHP) through your employer or the Health Insurance Marketplace.

HSAs are tax-advantaged because the money grows tax-free and may not be taxable when withdrawn if spent on approved medical expenses. HSAs allow you to contribute $4,150 for an individual or $8,300 for a family in 2024, and any unused money rolls over from year to year.

Additionally, you always own your HSA, so if you have one through your employer and leave your job, that account comes with you and can continue to grow until you reach retirement age.

Municipal bonds can be a helpful option to consider as you think about how to invest money for retirement. These are bonds issued by counties, municipalities, or states to build roads, schools, or other public works projects. Municipal bonds pay a specified amount of interest over the term you choose and often have maturity rates that range from two to five years up to 30 years. They are generally tax-free at the federal level and may also be free of state income tax.

Be sure to speak with a tax professional before investing in municipal bonds since there can be significant differences between them. Depending on what you buy, you may have to pay state and local taxes too.

Annuities can be an excellent way to ensure you have guaranteed income in retirement and may offer some tax advantages. A qualified annuity is funded with pre-tax dollars from a 401(k) or IRA. Since you haven’t paid taxes on the contribution, any annuity payments you receive are taxable.

If you purchased an annuity with a Roth IRA or Roth 401(k) (i.e., with after-tax money), those annuity payments would likely be tax-free since you have already paid taxes on the contributions. Annuity requirements can get complicated, so consult a professional financial planner for assistance.

If you’re self-employed, you probably don’t have access to a traditional retirement account like a 401(k) or 403(b). However, you might be eligible for a one-participant, or a solo 401(k). This account mimics the traditional 401(k) and is designed for a business owner with no employees.

Solo 401(k)s also let you choose the type of funds you save. You can pick a traditional 401(k), funded with pretax dollars, and pay taxes on that money in retirement. Alternately, you could choose a Roth 401(k), which doesn’t offer the initial tax break but offers tax-free distributions in retirement. Because of the tax perks, this type of account has quite a few rules, so consult with a tax professional to make sure you’ve covered all of your bases.

In 2024, solo 401(k) owners can contribute up to $69,000 (with a catch-up contribution of an additional $7,500 if you’re 50 or older) if you meet specific requirements.

There are many different types of retirement accounts that offer tax advantages to help you grow your wealth. Having both tax-deferred and tax-free accounts can help ensure you can effectively use your retirement funds. Be sure to research the types of accounts you may already have and talk to a tax professional or financial advisor to help find any holes in your retirement planning.