Types of Savings Accounts: Your Guide to Tax-Efficient Retirement Savings

There are many ways to save. How can you choose the right mix of accounts that will help you maximize the way you live today and maximize what you’ll have available for retirement?

Most people understand the importance of diversifying their investments. By allocating funds to different asset classes like stocks, bonds, and alternatives, you can potentially reduce your risk of a negative outcome from any one event or investment. But how familiar are you with the different types of savings accounts and their advantages and disadvantages?

By allocating money to a mix of accounts that offer different tax treatments, you can manage how much of your retirement income will be taxed — and at what rate. The key is to select an optimal mix of accounts. You have several types to choose from, so consider working with a financial advisor to choose the right combination for you.

Taxable Accounts

Taxable accounts are standard bank and brokerage accounts funded with your earnings. These may be held individually or jointly with a spouse or partner.

• Taxation:

  Any interest or dividends earned during the year are taxed. If you sell investments and have a net gain, you owe capital gains taxes.

• Flexibility:

  You can contribute or withdraw funds without limitation or penalty and without any taxable consequences.

• No RMDs:

  These accounts are exempt from required minimum distributions (RMDs), so you're never forced to withdraw money.

Tax-Deferred Accounts

Traditional IRAs, 401(k)s, and 403(b)s are all tax-deferred accounts held individually with named beneficiaries.

• Tax Benefits:

  Contributions can reduce your taxable income in the year they are made. Accounts are funded with pre-tax dollars, saving you money upfront.

• Growth:

  Contributions and investment gains are not taxed until withdrawal, allowing the balance to grow without tax deductions.

• RMDs:

  Once you reach the age of 72, you must begin taking RMDs, which are fully taxable.

• Employer Plans:

  Some employers offer Non-Qualified Deferred Compensation Plans, allowing employees to put away a portion of their salary pre-tax, accumulating tax-free until withdrawal at retirement.

Unlike brokerage accounts, these accounts are funded with pre-tax dollars. As an example, if you are in the 25% tax bracket, for every $1,000 you contribute to your 401(k), you would save $250 in taxes. The benefits are even greater if your company matches some portion of what you save. Your HR team can provide the specific details of your plan. The additional benefit is that your contributions and any investment gains are not taxed until you make a withdrawal from the account. This allows the account balance to grow without taking anything away to pay taxes.

Once you retire, any money withdrawn from traditional IRAs, 401(k)s, or 403(b)s is taxed at your future income tax rate. For many people, that tax rate is expected to be lower in retirement than it has been during the working years.

Once you reach the age of 72, you must begin taking withdrawals from these types of accounts. These are called Required Minimum Distributions (RMDs) and are fully taxable. The intention of the RMD rule is to fully distribute the account over your life expectancy (so the government can get their money back from you!).

Some employers offer what are called Non-Qualified Deferred Compensation Plans. These plans offer individual employees the chance to take away a portion of their current salary pre-tax into an account. The money can build and accumulate free of taxes until it is withdrawn at retirement. Check with your HR team to see if you are eligible for such a plan.

Roth IRAs & 401(k)s

Roth IRAs and Roth 401(k)s are funded with after-tax dollars.

• Tax-Free Withdrawals:

  Contributions don’t reduce your current taxable income, but withdrawals in retirement are tax-free.

• No RMDs:

  T Roth IRAs and 401(k)s are not subject to RMDs during the account owner’s lifetime, allowing for flexible withdrawals.

• Beneficiary Benefits:

  T Roth accounts can be passed tax-free to beneficiaries.

While traditional IRAs are funded with pre-tax dollars, Roth IRA and Roth 401(k) contributions are made with after-tax dollars. That means your contributions won’t reduce your taxable income in the current year. The real benefit of the Roth is that money withdrawn from your account in retirement is not subject to taxes — no ordinary income tax, no capital gains — as long as you follow timing requirements. Also, Roth IRAs or 401(k)s are not subject to the Required Minimum Distributions during the account owner’s lifetime. That leaves you free to tap Roth accounts when you need the money — and let them grow when you don’t need the withdrawal. They even pass tax-free to your beneficiaries.

Health Savings Accounts (HSAs)

HSAs are valuable for saving and managing healthcare expenses, offering a triple tax benefit.

• Eligibility:

  T Available to those covered by a high-deductible health plan.

• Contributions:

  T Reduce taxable income, and account earnings grow tax-free.

• Tax-Free Withdrawals:

  T Funds used for qualified medical expenses are tax-free.

• Post-65 Benefits:

  T After age 65, remaining funds can be used for medical expenses or non-medical expenses (subject to income tax)

Health savings accounts are not usually thought of as a retirement account, but they offer a valuable (and potentially tax-smart) way to save. HSAs are not an option for everyone. You are eligible to open an HAS only if you are covered by a high-deductible health plan through your employer. The current maximum contribution is $4,150 if the employee has single health coverage and $8,300 if the employee has family coverage.

Contributions to an HSA reduce your taxable income. And like an IRA or 401(k), the earnings on your account grow tax-free. With the HSA, you are able to use the money at any time for qualified medical expenses. Any distributions for those qualifying expenses are tax-free.

That means the HSA offers a triple tax benefit — you can reduce taxable income during the years you make contributions, your savings grow tax-free, and you have the path to pay medical expenses with pre-tax dollars.

After age 65, you can use any funds remaining in your HSA for medical expenses that are not covered by your insurance or Medicare. You also have the option of using your HSA funds to pay non-medical expenses, but those withdrawals may be subject to income tax.

Choosing the Right Types of Savings Accounts for Retirement

There is no lack of alternatives for putting away funds for your future. Each account type has different rules regarding participation ages, contribution limits, investment options, and RMDs. Additionally, these rules can change with new legislation. Understanding your options is key to maximizing your retirement savings, both during your accumulation years as well as during your retirement.

Working with a financial advisor can help you navigate these complexities and tailor a strategy that meets your needs. Regularly review your plan to ensure it remains aligned with your goals and circumstances.

The advisors at OneDigital stand ready to help you determine ways to utilize the various accounts to help you maximize your future.

Connect with a OneDigital Investment Advisor to optimize your approach and safeguard your future.

Dive deeper into strategic tax planning in our comprehensive blog post: The Art of Tax Planning: Optimizing Your Investments for Lower Taxes.

Investment advice offered through OneDigital Investment Advisors LLC, an SEC-registered investment adviser and wholly-owned subsidiary of OneDigital. These materials are provided for informational and educational purposes only and do not constitute a recommendation to buy, sell, or hold any security, nor do they constitute legal, accounting, investment, or tax advice. The materials and the information provided are not designed or intended to be applicable to any person’s individual circumstances. These statements do not constitute an offer or solicitation in any jurisdiction. All included information and data are limited only to the inputs and other financial assumptions indicated.