To encourage savings, legislators have created tax-advantaged accounts like 401ks and IRAs (Individual Retirement Accounts. To encourage investment in government projects, legislators have created tax-advantaged investments like municipal bonds. Understanding these concepts will help you determine if tax-advantaged investments are right for you.
Employer retirement plans and traditional IRAs allow most individuals to invest earnings before taxed. Many employers will match a portion of your contributions to their retirement plan. Most financial planners suggest that you invest in these plans first to increase retirement contributions.
Tax-deferred accounts allow investment gains to grow tax-free until the money is withdrawn. There are two types of tax-deferred accounts. First, are accounts funded with pre-tax income. These include employer retirement plans like 401Ks and IRAs. Second, are accounts funded with after-tax income. These include Roth IRAs and annuities.
Roth IRA accounts
Roth IRA accounts are funded with after-tax earnings, but investment returns are never taxed, not even when withdrawn.
Interest on municipal bonds is exempt from federal taxes and may be exempt from state and local taxes. Capital gains are not exempt from taxes. These investments are not appropriate for tax-advantaged accounts.