The Best Investment Accounts with Tax Advantages

• According to research by Charles Schwab, using a 401(k) can increase investment portfolios by 23%.
• The study compared 401(k) and taxable accounts over 20 years with an annualized return of 8%.
• Health savings accounts offer a triple tax advantage for long-term growth.

There’s nothing less exciting than thinking about taxesespecially when a bill is due.

And once you get into the first quarter of the year, there’s little that can be done to reduce your tax liability, especially if you’re a W2 employee.

That’s why thinking about deferment strategies is a great way to reduce the amount you pay in taxes and increase your net worth in the long run. But to maximize your results, you need to start with 401(k) or Traditional IRAaccording to a recent simulated study by Charles Schwab. A study showed how a 401(k) can increase the value of an investment portfolio by 23%.

The study, which was tested over 20 years, compared two investors: one using a taxable brokerage account and the other using a 401(k). With an annualized return of 8%, it was found that the latter ended with a value of $177,116, compared to a taxable bill of $144,547. Based on this scenario, it was assumed that someone taking an after-tax distribution at 24% would have a principal investment of $38,000, down from $50,000. It also assumed that taxable events would depend on the level of turnover every five years, as well as 2% qualified dividends and 6% long-term capital gains.

Charles Schwab

In a scenario where the investor uses a taxable account but does not turnover or realize gains every five years, meaning taxable events apply to only 2% of the dividends, the ending cost would be $152,392.

One caveat is that tax deferred accounts “Don’t consider every tax step throughout the investment process,” says Rob Williams, managing director of financial planning at Charles Schwab. The first point is when the money is earned and before it is invested. The second is when income and dividend payments are earned along the way. The third point is when the benefits will be realized. The first two points of taxation are covered. The last phase is not. For this process, other accounts, such as a Roth IRA for after-tax contributions, allow earnings to grow tax-free.

Roth IRAs can come in handy in retirement during years when you have a higher withdrawal rate and, in turn, fund yourself into a higher tax bracket.

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Other tax tips

Another option that people don’t think about as much is health savings accountwhich is unique, Williams noted. You must be eligible for insurance from an employer who provides it through a high-deductible health insurance policy. But they are a good additional tool that investors can use to contribute funds from their paychecks, he added.

This contributed before taxes. And if the money isn’t used for healthcare expenses, it can be saved and invested in this healthcare savings account and grow tax-free. This is tax deferment and tax evasion, he noted.

“For a health savings account, this is very important,” Williams said. “We call it the triple tax exemption. You receive no taxes when you invest the money, and no taxes on any growth or capital gains in the fund. And then when you withdraw them, you also have no taxes. “

Taxable brokerage or investment accounts are still useful because they allow you to withdraw money before retirement. This is especially convenient if you need to make a large purchase. But when using these accounts, investors should consider the assets they are buying. For example, exchange-traded funds have a lower tax burden than mutual funds, which have higher turnover and, in turn, more taxable events, Williams noted.

“Any investment or mutual fund that generates a fair amount of investment income, whether it’s interest or dividends, tends to not be very tax efficient,” Williams said.

This also means looking at how the funds distribute earnings, such as whether they are qualified dividends or regular dividends. The latter is taxed at the investor’s tax rate and, depending on its size, may not be as beneficial as a qualified dividend.