Written by North Capital Administrator

Should you use tax-advantaged accounts?

With Tax Day quickly approaching, many households are forced to take a closer look at their financials. Some people are anticipating a large tax refund check, while others may be left owing thousands. Whether you are looking to begin 2019 by investing your tax refund or aiming to lower taxable income in the coming year, tax advantaged accounts can offer benefits both the short and long term.


Preparing for retirement and minimizing taxes can often go hand in hand. Here are some of the most common tax advantaged accounts to consider in your personal finance strategy:


Employer Sponsored Plan (ESP): Perhaps the most common and well known of the tax advantaged accounts are  the 401(k), 403(b) and 457. These plans are offered through employers and typically come with a match on contributions up to a certain percentage. With the contributions coming directly from your paycheck, this a simple way to save for retirement. However, there are some limitations on ESPs. Plans must be offered through employers and many plans have limited investment options that could contain large expense and management  fees. In 2019, the ESP contribution limit is $19,000. This allows participants to reduce taxable income by up to $19,000 through saving for retirement. Once participants reach the age of 59 ½, they can typically begin to withdraw from their ESP. These withdrawals or distributions are then taxed at the ordinary income tax rate at the time of distribution. If a distribution or withdrawal occurs before 59 ½, there can be an additional 10% penalty without a qualifying exemption. There is a catch up provision for ESP participants 50 years or older that allows them to contribute an additional $6,000 for a total of $25,000. 


Roth 401(k): A Roth 401(k) works similarly to a Roth IRA in regards to taxation. With a Roth 401(k), contributions are post-tax and will not lower taxable income during the year of  contributions. However, money grows tax-free in a Roth 401(k) and you do not pay additional taxes on the contributions you withdraw. Contributions withdrawn before 59 1/2 may be penalized while earnings will be taxed and penalized if withdrawn early. Deciding between a Roth 401(k) and a 401(k) largely depends on current tax rates vs expected retirement tax rates (along with some other implications and considerations). If you expect to be in a higher tax bracket during retirement, contributing to a Roth 401(k) today could help minimize tax exposure over the long term. The catch up provision for Roth 401(k)s is the same as traditional counterpart.


Traditional IRA: Traditional IRA’s work similarly to 401(k)’s in regards to taxation timing. For 2019, an individual can  make a deductible contribution up to $6,000, assuming they meet income requirements. To maximize tax advantages, an individual can contribute to both a Traditional IRA and 401(k) plan (subject to income requirements). IRA investment options are typically more diverse than 401(k) accounts, because IRA’s are not limited to the investment selections in a 401(k). Traditional IRA deductible contributions are subject to income limits. The deduction phase out for filing single is between $63,000-$73,000 in adjusted gross income (AGI) and $101,000-$121,000 for joint or a qualified widower. There is no deduction available for single filers with AGI above $73,000 or $121,000 for joint filers and qualifying widowers. Traditional IRAs allow for a catch up provision of an additional $1,000 for a total of $7,000 in contributions.


Roth IRA: Similar to a Roth 401(k), an individual can make post-tax contributions to a Roth IRA. Contributions to a Roth IRA won’t lower your tax liability today, but the account  is expected to grow tax-free. When you qualify to take distributions from your Roth IRA, you will not pay taxes on withdrawals. You can contribute to both a traditional and a Roth IRA in the same year, but total combined contributions cannot exceed $6,000 for 2019. Similar to a Traditional IRA, a Roth IRA offers a larger investment selection than its 401(k) counterpart. Roth IRA contributions  are subject to income limits. The contribution phase out for filing single is between $118,000-$133,000 in modified adjusted gross income (MAGI) and $186,000-$196,000 for joint or a qualified widower. Roth IRA contributions are not allowed for single filers with MAGI above $133,000 or $196,000 for joint filers and qualifying widowers. Roth IRAs have the same catch up provision as the Traditional IRA.


SEP/Simple IRA: These are employer sponsored IRA plans for  smaller businesses. A SEP IRA is for small businesses with less than 100 employees, while a SIMPLE IRA can be used by any size business. Only employers can contribute to a SEP IRA. This type of IRA allows employers to invest the lesser of 25% of the employees salary or $56,000. Another feature allowed by the SEP IRA is that employers can adjust contributions depending on the business’s cash flow. SIMPLE IRAs allow for employer and employee contributions. The maximum tax-deductible contribution for 2019 is $13,000 with a catch-up provision of an additional $3,000 for those 50 and above. 


Tax advantaged accounts are not limited to retirement accounts. There are certain  tax advantaged accounts that allow you to access funds before retirement for specific purposes.


Health Savings Account (HSA): HSA contributions are tax deductible and withdrawals are tax free if used for qualifying medical expenses. In order to contribute to an HSA, you have to be enrolled in a high-deductible health insurance plan. For 2019, an individual can contribute up to $3,500 to an HSA and a family can contribute up to $7,000. Unlike a Flexible Savings Account (FSA), an HSA allows you to roll over the funds year to year. 


529 Savings Plan: 529 Savings Plans are designed  to help individuals save for certain educational expenses (for yourself or a beneficiary, such as a child). These plans are sponsored by states, state agencies or educational institutions. Contribution maximums vary state by state. However, federal law allows single taxpayers to contribute up to $15,000 a year without special federal taxes applying. 529 funds can be used on tuition, mandatory fees, and room and board associated with education. Withdrawals can generally be used at any college or university. Additionally, 529 funds can now be used for tuition at any public, private or religious elementary or secondary school (up to $10,000 a year per beneficiary). 529 contributions are post-tax and grow tax free.When used for qualifying educational expenses, the funds can be withdrawn tax-free.


There are many ways for people to minimize their tax exposure, prepare for retirement and other future expenses. Navigating the different accounts, their maximums, tax benefits, eligibility and how they fit together into your overall financial strategy can be complicated. As an SEC registered investment advisor, North Capital has been assisting clients in selecting the appropriate accounts for their financial strategy for over a decade. If you have any questions regarding tax-advantaged accounts or how they can fit into your strategy, contact a licensed North Capital advisor at info@northcapital.com or visit www.northcapital.com/advisory/ to learn more.


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