“You can never start saving too early.” Many of our clients have heard this expression, but are unsure how to actually get started working towards their financial goals. The first step is to learn more about the different types of savings accounts and how they can help you manage your investments over time.
Savings accounts typically fall into one of three categories:
- Taxable accounts
- Tax-deferred accounts
- Tax-exempt accounts
One of the key differences between these accounts is when you pay taxes. While a tax-deferred account might allow you to avoid paying taxes on your contributions, taxes are deferred to a later date. A tax-exempt account allows you to take qualified tax-free withdrawals in the future, but contributions are not tax-deductible. Your expected retirement date and financial goals will also help you determine which accounts might make the most sense for you and your family.
Read on to make sure you are getting the most out of your money.
Taxable accounts do not have restrictions on contributions or withdrawals and provide flexibility for account holders. Generally, investors are required to pay taxes on interest, dividends, and capital gains earned within a taxable account in the year they are earned.
Examples of taxable accounts include:
- Brokerage accounts
- Bank accounts (checking and savings)
- Money market accounts
Taxable accounts offer liquidity. You have the freedom to access funds in a taxable account on your own schedule. Whether you use your taxable account for retirement income, college expenses, vacations, a car or as a savings account, you generally will not pay a penalty for withdrawing funds, but taxes may apply.
Taxable accounts can be a good savings option for someone who has maxed out their non-taxable retirement contributions, or someone who has financial goals that are only a few years away. Schedule a consultation with a financial planning professional to discuss potential solutions for your savings goals.
Tax-deferred accounts allow you to invest without paying taxes on your contributions. Instead, you will be taxed on future withdrawals from the account.
Examples of tax-deferred accounts include:
- Traditional IRAs
- 401(k) and 403(b) plans
- 457 accounts
Tax-deferred accounts allow you to take advantage of compounding interest with the goal of generating more money over time. The money you put into your account up front will continue to grow tax-deferred. This is why starting to save money early can be an effective strategy for retirement planning. Even small investments can grow significantly when given enough time!
Tax-deferred accounts can be beneficial for individuals who are in a higher tax bracket now than they expect to be in retirement. This strategy can help provide the immediate benefit of tax-deferred growth, and potentially lead to paying less in taxes on those earnings after retirement.
Tax-exempt accounts provide futures tax benefits rather than tax breaks on contributions Since contributions to the account are made with after-tax dollars– meaning you have funded it with money that you have already paid taxes on– there is no immediate tax advantage.
Examples of tax-exempt accounts include:
- Roth IRA*
- Roth 401(k)*
*Only qualified withdrawals from Roth are tax-free.
Tax-exempt accounts can have several advantages. In addition to your investments growing tax-free, you will not have to pay a capital gains tax on that growth when you sell or withdraw your investments, provided the withdrawal is qualified.
Tax-exempt accounts can be beneficial for those in a low tax bracket who expect their taxes to be higher in the future.
Build Your Savings Strategy at St. Charles Financial Services
When deciding which to focus on, keep your timeframe and purpose for saving in mind. Your unique goals, lifestyle preferences and financial obligations will influence the savings strategy that is “best” for you. Some investors may also opt to diversify their portfolio as a savings strategy — maximizing their contributions to tax-deferred, tax-exempt and taxable accounts.
You don’t have to be a financial expert to make smart investments, and this is where an experienced financial planning professional can help. St. Charles Financial Services will partner with you to determine the best strategy for your current financial situation and your future goals. Our financial advisors get to know our clients and tailor plans to fit their lifestyles.
Contact SCFS to meet with a retirement planner in St. Charles.
Disclaimer: St. Charles Financial Services does not offer tax advice. Please consult your personal tax professional on all tax matters.