Seeing as how next Monday is tax day, I thought it would be fitting to write about taxes. This article will have little to do with income taxes, however.
Instead, I’ll be focusing on the taxability of retirement accounts and brokerage accounts.
Qualified Accounts
A qualified account is pretty much anything that has a tax advantage. Tax advantage simply means that the investments inside the account grow tax-deferred – you aren’t taxed on the growth within the account, and/or the money can be withdrawn tax-free.
There are several different kinds of qualified accounts. Instead of listing them all, I’m going to list a few of the common ones and link to an article containing all the accounts and what they’re about.
- 401k – The most common employer-sponsored retirement account. It’s not offered by all employers, but the money going into the account is pre-tax. Additionally, the money grows tax-deferred. However, when withdrawn, the money is taxable as income according to your tax bracket.
- Traditional IRA – This is an individual retirement account. This type of account is contributed to using post-tax money, but most people are able to deduct the contribution on their taxes. However, there is a level of income when you no longer qualify for that deduction. The money is taxable when withdrawn as income.
- Roth IRA – Also an individual retirement account, but with three key differences. One, the money that’s contributed is not tax-deductible. Two, the money is tax-free when withdrawn. Three, not everyone is eligible to open a Roth IRA once a certain level of income is reached.
Each of these plans has unique characteristics and rules. I encourage you to give this article a read to learn more about them. (Note: income eligibility for IRAs is listed in this article)
Non-qualified accounts
No bells or whistles. These accounts are designed to hold your cash, securities, and give you the ability to invest and trade.
Qualified accounts do the same thing, but have tax-advantages. Non-qualified accounts don’t.
There are usually two types of accounts: individual and joint. An individual account is for one person. A joint account is for two or more.
With a non-qualified account, there are two things you have to pay attention to.
- Capital gains/losses – A capital gain is when you sell an investment for more than what you paid for it and a capital loss is the exact opposite. A capital gain comes in two variations. Short-term, which is when you held an investment for less than one year and is taxed at your income tax bracket. Long-term, when you held an investment for longer than one year and is taxed at a reduced tax rate.
- Dividends/interest – These are paid by the company or fund and are taxed as income.
Tax return as savings
The last thing I wanted to talk about is your tax return and how you use it/view it. There are three types of returns. When you owe, when you break even, and when you get money back.
What I try to do, and what I generally recommend people do, is get as close to breaking even as you can. This just means you paid about the exact amount in taxes that you should have. No more, no less.
Here’s when I’m okay with people getting money back.
As a collective, we are horrible at saving money. The statistics show it. Now if you go through the year and pay more taxes than you need to and want to use that tax return as a makeshift savings account, then have at it.
My philosophy is if it helps you save money and it works for you, then do it. Some people need that type of set up.
Regular savings account don’t work for everyone because often, they are able to access the money whenever they want/need to. If you’re using your tax return as your savings vehicle, you don’t have that opportunity.
Conclusion
Love it or hate it, taxes are a part of life, and they won’t go away. There are certain strategies and certain accounts you can utilize to help make them more manageable/bearable.
If you’d like to learn more about anything discussed here and for my disclosures, visit my company’s website!
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Jacob Sensible is a financial advisor with decades of experience in the financial planning industry. His journey into finance began out of necessity, stepping up to support his grandfather during a health crisis. This period not only grounded him in the essentials of stock analysis, investment strategies, and the critical roles of insurance and trusts in asset preservation but also instilled a comprehensive understanding of financial markets and wealth management. Jacob can be reached at: jake.sensiba@mygfpartner.com.
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