- There are many tax-advantaged investment options beyond IRAs.
- Similar to Traditional and Roth IRAs, there’s Traditional and Roth 401ks.
- Then there are Simple IRAs, SEP, etc.
Pre-Tax versus Post-Tax
When it comes to tax-advantaged investment accounts, the key distinction between most of the choices that you’ll have to make come down to whether your investment contributions will be pre-tax or post-tax. Pre-tax simply means that you can invest earnings before having to pay taxes on the wage income. Post-tax means that you must first pay income taxes on the wage income, and then you can make an investment.
As we already discussed, Traditional IRA contributions are pre-tax; while Roth IRA contributions are post-tax. Many employers offer a 401k, but it is important to understand that there are two flavors of this type of tax-advantaged program as well. An employer can choose to have a Traditional 401k, where contributions are pre-tax, but also, an employer can choose to have a Roth 401k, where contributions are post-tax. And even better, the contribution limits for 401ks are higher than IRAs. For 2019, employees (under 50) can contribute up to $19,000 into a 401k (up to $25,000 if over 50 years old), while similar employees can contribute up to $6,000 into an IRA (up to $7,000 if over 50). A working couple (filing jointly) could conceivably make $50k in pre-tax or post-tax contributions (or $64k if both are over 50) by maxing out contributions to IRAs and 401ks for 2019. It’s best to consult with your tax professional about your specific situation, but the financial incentives here are quite incredible.
But Wait, There’s More
Beyond these common plans, there are many more tax-advantaged investment plans offered by the U.S. Government, but the common theme among them is whether they are funded by pre-tax or post-tax contributions. In general, pre-tax plans will be taxed similar to Traditional IRAs and Traditional 401ks; while post-tax plans will be taxed similar to Roth IRAs and Roth 401ks.
Other common pre-tax plans include 403(b) and 457 plans.
A 403(b) plan is similar to a Traditional 401k, but is generally offered to employees of schools and hospitals. A 457 plan is also similar to a Traditional 401k, but is generally offered to employees of local government employees (such as fire and police workers).
Then there are Keogh, SEP-IRA, and Simple IRA plans, where owners of firms can put in 20% of their income and 25% of employee income into a pre-tax investment account. Keogh is for sole proprietorships only; while SEP-IRA is for small businesses as well. These plans are not as common, but they are still powerful investment tools.
Finally, there are health savings plans and education savings plans. We’ll cover both of these in the next post of this series.