When it comes to investing, there are two main types – ones that are tax-advantaged and ones that are not. How do you decide which one to use? Read on to find out!
Tax-advantaged accounts come in many flavors, but overall there is always some sort of tax break, deferral or savings associated with the account. One example of these is a 401k plan that lets you put away income pre-tax and does not tax you on the growth of the investment until you use it much later. Also, different types of accounts offer different types of tax advantages. For example, Roth IRA contributions are made after tax, but the qualified withdrawals can be made tax-free.
The advantage of tax-advantaged accounts is the obvious tax savings and the disadvantage is the many rules placed on these types of accounts. For example, some tax-free educational accounts will charge you a penalty if you decide to use the money for something different from education.
The method to determine if a tax-advantaged account is right for you will depend on your unique situation. However, individuals who have the following criteria usually benefit the most:
• The higher your tax bracket, the more a tax-advantage account will help you.
• If you have a very specific goal – like saving for your children’s college education
• You prefer to put your money somewhere and let it grow without much involvement
In most cases, all individuals can benefit by having at least some tax-advantaged investments in their portfolio. Often the decision is more about what percentage those should be… 100 percent, 50 percent… 30 percent? In order to make the best decision, you have to evaluate your investment goals and current tax situation. If you want a lot of flexibility with your investments – then you will want less of them to be tax-advantaged.
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