If you are tired of paying a lot of money in taxes, there is one strategy you can adopt: funding into tax-advantaged accounts. Tax-advantaged accounts are financial accounts with tax benefits, such as exemptions, deductions, and deferrals. Even though they are long-term options, they can save thousands of dollars that go into taxes.
The best thing about saving money through this method is that it is completely legal. You can minimize your tax liability and maximize your returns. Some common tax-advantaged accounts include HSAs, IRSs, employer-sponsored retirement accounts, etc. To know more ways to reduce tax liability, hire accounting services in Troy, MI, today.
What are tax-advantaged accounts?
A tax-advantaged account is essentially a savings account that allows you to reduce your tax liability in exchange for saving money. This refers to any type of investment, savings plan, or financial account that is exempted from taxes, provides tax benefits, or is tax-deferred.
High-income earners often invest in municipal bonds (a type of tax-advantaged account) to reduce tax liability. In contrast, employees invest in retirement accounts, such as IRAs and employer-sponsored retirement plans (401(k)).
Types of IRAs (Individual Retirement Accounts) include the following:
- Traditional IRA (tax-deductible contributions, tax-deferred growth, Required Minimum Distributions)
- Roth IRA (post-tax contribution, tax-free growth, and withdrawals, no required minimum distributions)
Benefits of tax-advantaged accounts
- You have more choices.
With tax-advantaged accounts, you can choose not to pay taxes on some of your income right now and pay taxes with lower rates when you retire. Or, you can pay taxes now and retire with as little bills as possible. It is nice to have options depending on what you prefer.
- Meaningful incentives.
Money-saving, especially for the future, is a healthy habit. The government wants you to save money for the future so that you do not have to worry about your income when you retire. Putting your money into retirement accounts becomes even easier when the government exempts the funds from taxes, even if it is for a temporary time.
Understanding tax-deferred and tax-exempted
There are two types of tax-advantaged accounts: tax-deferred and tax-exempted.
Tax-deferred accounts allow you to store your money and avoid paying taxes until you withdraw the funds. However, note that you are only provided immediate relief from paying the taxes. Once you take the money out, the taxes will be calculated at ordinary rates.
On the other hand, tax-exempt accounts are more beneficial because you do not need to pay taxes once you withdraw the amount.