Tax-Advantaged Accounts: How to Keep More of What You Earn

IRA, Roth, 401(k), SEP: The accounts that change the math

An investor earns $100,000 in capital gains. In a regular taxable brokerage account, they could owe up to $23,800 or more in federal taxes (20% long-term capital gains rate plus 3.8% net investment income tax for higher earners), plus potential state taxes. In a Roth IRA, they owe $0. The same gains, the same investments, the same time period. The only difference is the type of account. That difference is worth tens of thousands of dollars [Internal Revenue Service, Capital Gains Tax Rates, 2024].

Over a career of investing, the cumulative tax savings from using the right account types can amount to hundreds of thousands of dollars. Yet many investors either do not use these accounts to their full potential, use the wrong type for their situation, or do not understand the tradeoffs between them.

How Taxes Reduce Investment Returns

Before understanding the solution, it helps to understand the problem.

In a regular taxable brokerage account, you pay taxes on:

Dividends: Qualified dividends are taxed at 0%, 15%, or 20% depending on your income. Non-qualified dividends are taxed as ordinary income (up to 37%). These taxes are owed every year the dividends are paid, even if you reinvest them.

Capital gains: When you sell an investment for more than you paid, the gain is taxed. Short-term gains (held less than one year) are taxed as ordinary income (up to 37%). Long-term gains (held more than one year) are taxed at 0%, 15%, or 20% depending on income.

Interest: Bond interest is taxed as ordinary income (up to 37%) with some exceptions (municipal bonds are typically exempt from federal tax).

This ongoing tax drag reduces your effective returns every year. An investment earning 7% that generates 2% in taxable distributions each year at a 20% tax rate has an after-tax return of approximately 6.6%. Over 30 years, that 0.4% annual tax drag compounds into a meaningful difference in final wealth.

The Two Tax Advantages

Tax-advantaged accounts provide one or both of two benefits:

Tax-deferred growth

Your investments grow without being taxed each year. No taxes on dividends, no taxes on capital gains from rebalancing, no taxes on interest. The full amount keeps compounding. You pay taxes later, when you withdraw the money.

Key insight: Tax deferral is valuable because the money that would have gone to taxes each year stays invested and compounds for you instead. Over 30 years, the difference between taxable and tax-deferred compounding on the same returns is substantial.

Tax-free growth

In certain accounts, your investments grow and can be withdrawn completely tax-free. No taxes ever, on contributions that were made with after-tax dollars. This is the most powerful tax advantage available.

The Major Account Types

Note: Contribution limits and income thresholds shown below are for the 2024 tax year. The IRS adjusts these annually for inflation. Always check IRS.gov for current limits.

Note: Contribution limits and income thresholds shown below are for 2024. The IRS adjusts these annually for inflation. Check irs.gov for current limits.

Traditional 401(k)

How it works: You contribute pre-tax money from your paycheck. Your taxable income is reduced by the amount you contribute. The money grows tax-deferred. You pay ordinary income tax when you withdraw in retirement.

2024 contribution limits: $23,000 per year ($30,500 if age 50+)

Employer match: Many employers match a portion of your contributions (e.g., 50% of the first 6% of salary). This is an immediate 50% return on those dollars and is the closest thing to a sure gain in investing. If your employer offers a match, contributing at least enough to get the full match should be the highest priority.

When it is best: When your tax rate today is higher than your expected tax rate in retirement. The tax deduction is worth more at a high tax rate than the taxes you will pay at a lower rate in retirement.

Required Minimum Distributions (RMDs): Starting at age 73, you must withdraw minimum amounts each year and pay taxes on them, whether you need the money or not [SECURE 2.0 Act, 2022].

Roth 401(k)

How it works: You contribute after-tax money. No tax deduction today. The money grows tax-free. Withdrawals in retirement are completely tax-free (contributions and gains).

2024 contribution limits: Same as Traditional 401(k): $23,000 ($30,500 if age 50+). The limit is shared between Traditional and Roth contributions.

When it is best: When your tax rate today is lower than your expected tax rate in retirement, or when you want to guarantee tax-free income in retirement regardless of future tax rate changes. Also valuable for younger workers in lower tax brackets who expect their income (and tax rate) to increase significantly.

Traditional IRA

How it works: You contribute pre-tax or after-tax money (deductibility depends on income and whether you have a workplace plan). Grows tax-deferred. Withdrawals taxed as ordinary income.

2024 contribution limits: $7,000 per year ($8,000 if age 50+)

Income limits for deductibility: If you or your spouse have a workplace retirement plan, the tax deduction phases out at higher incomes. You can always contribute, but the deduction may be partial or zero above certain thresholds [IRS Publication 590-A, 2024].

Roth IRA

How it works: You contribute after-tax money. No tax deduction. Grows tax-free. Withdrawals in retirement are completely tax-free. No RMDs during your lifetime.

2024 contribution limits: $7,000 per year ($8,000 if age 50+)

Income limits for contributions: You cannot contribute directly if your modified adjusted gross income exceeds $161,000 (single) or $240,000 (married filing jointly) in 2024. However, the "backdoor Roth" strategy (contribute to a Traditional IRA, then convert) allows higher earners to fund a Roth IRA indirectly.

When it is best: The Roth IRA is often cited as one of the most flexible retirement accounts for those who qualify, though whether it is optimal depends on your current and future tax situation. Tax-free growth with no RMDs means the money can compound for your entire lifetime. Inherited Roth IRAs are generally income-tax-free to beneficiaries, though non-spouse heirs are subject to distribution timing rules under the SECURE Act (typically a 10-year distribution window). Starting a Roth IRA as early as possible maximizes the tax-free compounding benefit.

SEP IRA

How it works: Designed for self-employed individuals and small business owners. Employer (you) contributes pre-tax money. Grows tax-deferred. Withdrawals taxed as ordinary income.

2024 contribution limits: Up to 25% of net self-employment income, maximum $69,000

When it is best: When you are self-employed and want to shelter a large amount of income from taxes. The high contribution limit makes the SEP IRA far more powerful than a Traditional IRA for high-income self-employed individuals.

Health Savings Account (HSA)

How it works: Available only with a high-deductible health plan. Contributions are pre-tax, growth is tax-free, and withdrawals for qualified medical expenses are tax-free. After age 65, withdrawals for any purpose are taxed as ordinary income (like a Traditional IRA), but medical withdrawals remain tax-free.

2024 contribution limits: $4,150 individual, $8,300 family

Why it matters: The HSA is the only account that provides a tax benefit at all three stages: contribution, growth, and withdrawal. For investors who can afford to pay current medical expenses out of pocket and invest HSA contributions for the long term, the HSA functions as a stealth retirement account with unmatched tax efficiency.

The Order of Priority

Given limited dollars, where should you direct them first? A common framework:

Employer 401(k) match: Contribute enough to get the full employer match. This is an immediate, certain return.
High-interest debt payoff: If you have credit card debt or other high-interest debt (above 7-8%), paying it off provides a certain return equal to the interest rate.
Roth IRA (if eligible): Max out your Roth IRA for tax-free growth.
HSA (if eligible): Max out your HSA for triple tax advantage.
Back to 401(k): Increase 401(k) contributions up to the annual limit.
Taxable brokerage: After maxing all tax-advantaged options, invest additional savings in a taxable account.

This order is a starting point, not a universal rule. Individual circumstances (tax bracket, employer match percentage, debt levels, self-employment status) can change the optimal order.

Common Mistakes

Mistake 1: Not contributing enough to get the full employer match

An employer offering a 50% match on the first 6% of salary is giving you an immediate 50% return on those dollars. Not contributing enough to capture the full match is leaving free money on the table. No other investment reliably returns 50% in year one.

Mistake 2: Choosing between Traditional and Roth without considering tax brackets

The Traditional vs. Roth decision is fundamentally a bet on your future tax rate. If you are in a high bracket now and expect to be in a lower one in retirement, Traditional is often better. If you are in a low bracket now (early career, lower income years), Roth is often better because you pay taxes at a low rate and withdraw tax-free at what may be a higher rate later.

Many advisors now recommend having both Traditional and Roth accounts to create tax diversification in retirement: the ability to draw from taxable, tax-deferred, and tax-free sources to optimize your tax situation each year.

Mistake 3: Not starting early because the contribution amounts seem small

A 22-year-old contributing $200 per month to a Roth IRA at 7% returns will have approximately $525,000 in tax-free money at age 65. Every year of delay reduces the final amount significantly. The contribution felt small. The result is not.

Mistake 4: Treating retirement accounts as untouchable in all circumstances

While early withdrawals generally carry penalties (10% plus taxes for Traditional accounts before age 59.5), Roth IRA contributions (not gains) can be withdrawn at any time without penalty. This makes the Roth IRA more flexible than many people realize. Additionally, exceptions exist for first-time home purchases, qualified education expenses, and certain hardships [IRS Publication 590-B].

Mistake 5: Ignoring state tax implications

Some states have no income tax (Florida, Texas, Nevada, etc.). Others tax retirement income fully. Where you live during your working years and where you retire can significantly affect whether Traditional or Roth accounts are more beneficial.

What This Means for You

Tax-advantaged accounts do not change what you invest in. They change how much of your returns you get to keep. The same index fund in a taxable account and in a Roth IRA produces the same gross returns. But the after-tax outcome is dramatically different over decades.

Understanding which accounts are available to you, what the contribution limits are, and whether Traditional or Roth is more advantageous given your current and expected future tax situation is one of the most impactful financial decisions you can make. It does not require picking stocks or timing markets. It requires understanding the tax code and using it to your advantage.

Key Takeaways

Tax-advantaged accounts (401(k), IRA, Roth IRA, SEP IRA, HSA) allow your investments to grow without the annual drag of taxes on dividends, capital gains, and interest.
The choice between Traditional (tax-deferred) and Roth (tax-free) accounts depends on whether your tax rate is higher now or expected to be higher in retirement.
Always contribute enough to your employer's 401(k) to capture the full match. This is an immediate, certain return that no other investment provides.
The Roth IRA offers unique flexibility: tax-free growth, no RMDs, and contributions can be withdrawn penalty-free at any time. Whether it is the best choice depends on your current and expected future tax bracket.
Start contributing to tax-advantaged accounts as early as possible. The tax savings compound over time, the same way investment returns do.

Try the Fee Impact Calculator to understand how costs (including taxes) erode your returns over time.

MyAvere provides tools and education, not investment advice. Always consult a qualified financial professional for personalized guidance.

References

Internal Revenue Service. Publication 590-A: Contributions to Individual Retirement Arrangements. 2024. https://www.irs.gov/publications/p590a
Internal Revenue Service. Publication 590-B: Distributions from Individual Retirement Arrangements. 2024. https://www.irs.gov/publications/p590b
Internal Revenue Service. Capital Gains Tax Rates, 2024. https://www.irs.gov/taxtopics/tc409
Internal Revenue Service. Retirement Topics: Contributions. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-contributions
SECURE 2.0 Act of 2022. Required Minimum Distribution provisions. https://www.congress.gov/bill/117th-congress/house-bill/2617
Vanguard Group. "How America Saves." Annual report on defined contribution plan data, 2024. https://institutional.vanguard.com/content/dam/inst/iig-transformation/has/2024/pdf/has-2024-executive-summary.pdf
Fidelity Investments. "Retirement Savings Assessment." 2024. https://www.fidelity.com/viewpoints/retirement/how-much-do-i-need-to-retire