Taxable, tax-deferred and tax-exempt accounts
Also called tax buckets
How an account is taxed: on money going in, on growth each year, or on withdrawals, usually grouped as taxable, tax-deferred and tax-free.
What it means
Investment accounts fall into three broad tax groups. Taxable accounts, such as regular brokerage and savings accounts, use after-tax money and owe tax each year on interest, dividends and realized gains. Tax-deferred accounts, such as traditional IRAs and 401(k)s, often give a deduction or pre-tax contribution now, and withdrawals are taxed as ordinary income later.
Tax-free accounts, such as Roth IRAs and Roth 401(k)s, take after-tax money but allow qualified withdrawals, including growth, without tax. HSAs can be triple tax-advantaged when used for qualified medical costs. Holding money in more than one group gives flexibility to manage taxable income in retirement.
Example
Suppose someone has $10,000 of pre-tax earnings and a 24% tax rate now and later. Put in a traditional account and doubled, it becomes $20,000, or $15,200 after tax. Taxed first, $7,600 goes into a Roth and doubles to the same $15,200, tax-free.
How it’s used
- Choosing between traditional and Roth contributions
- Planning which accounts to draw from in retirement
- Placing investments across accounts
Good to know
- When tax rates are the same now and later, traditional and Roth accounts come out even; the difference comes from rates changing.
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.