Investment Account Tax Rules Every Tech Professional Should Know
Investing Choices: Understanding Tax Structures
We have many choices when investing. Today, we will examine the different ways that taxes may apply to an account: now, in the future, and never again.
Taxed Now
Your typical savings and brokerage accounts are the “taxed now” accounts. All earnings, like realized gains and losses, go straight to your income tax filings each year. These accounts usually include:
- Savings accounts
- Checking accounts
- Regular brokerage accounts
The good news is there is no tax penalty for moving these funds around or spending them. We call these accounts “Taxable Accounts." Most of the balance is after-tax. You paid tax on this money before adding it to the account, like when you receive your paycheck.
Taxed in the Future
The government will tax your retirement accounts “in the future." This includes:
- Traditional 401(k)
- Traditional IRA
- Employer-offered “non-qualified” plans
When you withdraw money from these accounts, the tax authorities see it as income on your tax return. If you take out money before age 59½, you may have to pay a 10 percent tax penalty.
Never Taxed Again
Roth IRA and Roth 401(k) accounts are the elusive “never taxed again” variety. Why are they never taxed again? Because you pay income tax on the deposits you make into these accounts. Once you’ve paid tax on the way in, there is no future tax on either the balance or the earnings.
The rules depend on how you fund the account. Usually, you can't withdraw earnings for at least 5 years or until you turn 59½. If you do, you'll face a 10 percent penalty.
Roth accounts are popular. They let you earn money without ever paying taxes on those earnings.
Conclusion
Now that you've considered the options, do you think it's better to pay more taxes now to avoid a bigger bill later? Should you divide your money among all three types of accounts? Do you have a plan to balance your savings across these three types?