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Deciding how to invest your money can be confusing, especially when you consider the tax pros and cons of each type of investment account. You have to ponder a number of factors when you make your investment choice, especially your financial needs in retirement. Whether or not you decide to use an online investing site, you’ll need to choose from taxable, tax-deferred and tax-exempt options.
Your individual or joint investments accounts are taxable. These accounts allow you to generate income by an increase in share price and the issue of dividends. When investing in brokerage accounts, you need to consider your marginal tax bracket and whether the alternative minimum tax will apply. You also need advice on how capital gains taxes will affect your investments. Capital gains and qualified dividends are taxed at a lower rate than your usual income tax, an important point to remember.
With tax-deferred investments, you are not required to pay taxes as long as your money remains in the account. Examples of these accounts are traditional IRAs and 401ks. You also receive tax benefits when you initially invest because they are pre-tax, which lowers your taxable income. Also, your income will likely be lower when you retire, so you will pay less in taxes when you remove the money.
A Roth IRA and a Roth 401k are considered tax-exempt because you do not pay taxes on your money when you withdraw it. Many investors find that option attractive since the money they see in their accounts at retirement will not be reduced by government obligations. If you find the option attractive, too, it’s easy to open an online IRA. You do not get the initial tax advantage that traditional IRAs and 401ks offer since your contribution will be after taxes. The IRS will take its share at one end of your investment or the other. You need to decide which time is most advantageous for your financial health. Or, as many experts suggest, you may invest in all of these account types to maximize tax efficiency.
A good financial planner can help you navigate these investment decisions. The good news is that all of these account types offer attractive benefits. Your current financial status and your expected retirement status are the most important factors to consider when making your decision.