Getting serious about your money means getting serious about taxes. If you are interested in building wealth over the long term, then it is important to understand when and how your money is taxed and how that affects your savings.

In this blog, we take a look at which types of tax-efficient investing work as well as how different types of tax-advantaged accounts can help you get more out of the money you are setting aside for a house, college tuition, retirement, or other long-term savings goals.

Read on to learn how getting smart about taxes today can help you build a better tomorrow.

What Is a Tax-Advantaged Account?

Tax-advantaged accounts are designed to help people save for important goals in life like college, a mortgage, and especially for retirement. Federal and state governments consider saving for these goals to be so beneficial to you and your family’s future well-being that they are willing to reduce or eliminate taxes on money in certain types of accounts.

Usually, earnings that you set aside have already been taxed even before they made it to your paycheck. Whenever you choose to save or invest money, the interest and dividend payments are also subject to tax, normally either as an annual dividend income tax or as capital gains tax when you sell an investment.

Understanding Taxable vs. Non-Taxable Accounts

Tax-advantaged accounts aim to ensure that you are not taxed twice on the same money and that you can pay a lower rate on savings than you might normally have paid. Most tax-advantaged accounts aim to reduce the tax burden your money attracts in one of two ways:

• Tax-deferred accounts allow you to contribute money from your earnings before it is taxed. This money, plus the interest it accrues, is taxed when you withdraw it.

• Tax-exempt accounts usually accept contributions from your post-tax incomes, but allow you to withdraw and spend it tax-free, subject to certain restrictions.

Some specialized tax-exempt health and savings accounts are truly non-taxable, meaning you are able to make contributions from your pre-tax earnings and withdraw them later free of tax.

Usually, however, accounts are considered tax-exempt because all contributions are made from your post-tax income. The key difference between them is when your money is actually taxed—before it is contributed or when you withdraw it.

Depending on whether you expect to pay a higher tax rate when you are making contributions or at the time you withdraw money, a tax-exempt or tax-deferred savings or investment vehicle ensures your money is taxed at the lowest possible rate.

Related: When To Start Saving For Retirement

Tax-Efficient Investing in Action

Let’s take a look at eight key types of tax-advantaged accounts designed to help you afford health and education expenses and plan better for retirement.

1. 401(k) Plans

A 401 (k) plan is a tax-deferred retirement savings account offered by a company to its employees as part of their work benefits package. Contributions are taken from your pre-tax earnings, invested, and taxed when you withdraw them after retirement.

401(k) plans offer a straightforward way for most people to plan for retirement. As you are more likely to be taxed at a lower rate post-retirement than when you are working (unless you invest or inherit a great deal of money) they usually offer a significant tax advantage to investors.

2. Traditional IRAs

A traditional IRA (Individual Retirement Account) is a bit like a private 401(k). It’s a smart choice for most people, whether or not you have retirement benefits through your job. While contributions are made from your earned income, these can often be deducted from your taxable income for the year. Savings are not taxed until withdrawal after the age of 59½.

While there is a limit to the amount you can contribute each year, most IRAs allow you to defer taxes on at least some of your earnings provided you are in a lower tax bracket after retirement. You also have the freedom to invest the money as you see fit.

At Listerhill Credit Union we make savings for retirement easy with flexible traditional IRA savings options and generous rates to maximize your earnings. You can also consult with our investment experts about the advantages of investing in mutual funds, ETFs, and annuities.

3. Roth IRAs

A Roth IRA is a personal retirement account that allows your money to grow tax-free using contributions made from your after-tax earnings. Unlike a traditional IRA or 401(k), where taxes are deferred until withdrawal, the money you put into a Roth IRA has already been taxed.

You can withdraw your contributions and earnings tax-free after the age of 59½ provided the account has been open for at least five years. Roth IRAs make sense for people who expect to be in a higher tax bracket after they retire due to other sources of income or for those who simply prefer the certainty of tax-free withdrawals.

Talk to the retirement savings experts at Listerhill Credit Union about whether a Roth IRA is right for your financial situation. We offer both Roth IRA certificates and Roth IRA savings accounts.

4. Roth 401(k) Plans

A Roth 401(k) is a less common version of a traditional 401(k) that allows you to contribute part of your post-tax income to a plan sponsored by your employer. Your employer may also match a portion of your contributions to the plan.

While you will miss out on the tax savings offered by a traditional 401(k), you will enjoy tax-free growth and the certainty of tax-free withdrawals after age 59½. This type of plan makes sense for employees who expect to be in a higher tax bracket after retirement or who don’t want to worry about being taxed while in retirement.

5. 529 College Savings Plans

529 college savings plans are offered by states or educational institutions and are meant to help parents “hedge” against the skyrocketing cost of college education. Accounts allow contributions to grow tax-free until needed and can generally be used for a wide range of qualifying education expenses from tuition to books to technology.

Plans offered by individual colleges require that saved funds be spent on tuition at that college or institution. State funds, on the other hand, can sometimes be used to help fund education at a wide range of post-secondary institutions including two-year colleges and trade schools. Some even allow savings to be spent on K-12 education.

Some states also offer tax deductions or credits for contributions to 529 plans, potentially making this a fully tax-exempt way to save for higher education.

6. Coverdell Education Savings Accounts

Coverdell Education Savings Accounts (ESAs) offer a flexible way for families to prepare (and share) the cost of a child’s education from pre-K through to higher education. Contributions are made from the after-tax earnings of parents, grandparents, or extended family members and grow tax-free until needed for a wide range of qualified education expenses.

Coverdell ESAs do have more flexible provisions for beneficiaries with certain disabilities including a higher age limit, which makes them a potentially useful tool for families with students who have health or learning challenges.

7. Health Savings Accounts

Health Savings Accounts (HSAs) are often offered to holders of high-deductible health plans to help them manage significant out-of-pocket expenses. Contributions to an HSA are tax deductible. Savings and withdrawals are also not taxed, making this a truly non-taxable investment option with significant growth potential.

8. Flexible Spending Accounts (FSAs)

Unlike HSAs, Flexible Spending Accounts (FSAs) are typically offered by employers. They allow employees to contribute savings that can be used for qualified medical expenses. While FSA contributions allow employees to reduce their annual taxable income, these funds are owned by the employer and may be lost if not spent within a given plan year.

FSAs make good sense for busy families looking to reduce both their regular preventative medical care costs and their annual tax burden. Best of all, they can be paired with lower deductible plans that kick in to pick up where your available cash leaves off.

Tax-Smart Saving Starts With Listerhill

If you’re serious about saving for a better future then it pays to be smart about taxation. At Listerhill Credit Union, we offer a range of retirement savings options to meet our members’ needs.

Our traditional and Roth IRA savings accounts offer a simple, effective way to set money aside for retirement, no matter where you are in your career. You can also step it up with a Roth IRA 12-, 36- or 60-month certificate. By reinvesting your earnings on maturity, you’ll see your financial nest egg begin to grow.

Please reach out to a Member Advocate for help with accounts that might help you take advantage of tax savings.

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