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Understanding Tax-Deferred Investing

At Curran Wealth Management we value educating our clients on different investment vehicles when making important decisions for their financial future and the futures of their families. Knowing how these various savings vehicles are taxed is important for choosing the ones best suited to your particular circumstances.



Whether you are saving money for your children’s education or your retirement, there are many different options in which to do so. Some of which include, investing in the stock market, buying real estate for income and appreciation, or simply putting money away in education savings accounts or retirement plans. We offer many of these options to our clients, including IRAs, Roth IRAs, 529 college savings plans and most recently, assistance with real estate through C & W Enterprises (an affiliate of Tom Curran). This article focuses on various investment vehicles with an emphasis on tax deferred investing. Let’s begin by examining the tax nuances of IRA accounts.

Individual Retirement Account (IRA) – There are two types of IRA accounts—the traditional and the Roth—and even though they are both IRAs, there is a huge difference in their tax treatment.Traditional IRA – Contributions to a traditional IRA are generally tax-deductible unless you have a retirement plan at work, and then the IRA contribution may not be deductible if you are a higher-income taxpayer. All of the earnings from a traditional IRA are tax-deferred, meaning they are not taxable currently but will be when funds from the account are withdrawn; since the contributions were tax-deductible, everything you withdraw from the traditional IRA will be taxable.  An exception to that last statement is when you didn’t claim a deduction for money that you contributed to the IRA, either by choice or when the law didn’t allow a deduction. In this case, withdrawals from a traditional IRA would be prorated as partly taxable and partly tax-free.

Roth IRA – Roth IRA contributions are never tax-deductible, but the earnings are never taxable if the account meets a 5-year aging rule and the distributions begin after you reach age 59.5. So, which is best? Well, that depends upon your particular circumstances. If you need the tax deduction to fund the IRA, then by all means use the traditional IRA. However, if you can afford to the make a contribution without the deduction, then the Roth IRA will be the best because everything is tax-free when withdrawn, usually at retirement.

Retirement Plans – The tax code provides for a variety of retirement plans, both for employees and for self-employed individuals. These include: 401(k) deferred compensation plans, Keogh self-employed retirement plans, simplified employee plans (SEP), tax-sheltered annuity (403(b)) plans – most commonly for teachers and employees of nonprofits), and government employee plans (457) plans. For the most part, the consequences of these arrangements are the same as for a traditional IRA, allowing the amount contributed to be excluded from income (deferred), and then the distributions are fully taxable when they are taken. However, 401(k) and 457 plans may have a Roth option, under which there is no income exclusion for the contributions but the distributions at retirement are tax-free. If individuals have used both methods, the non-Roth contributions are deferred, and the earnings are fully taxable.

Bank Savings – When money is put away into a bank savings account or CD, the earnings are fully taxable in the year earned. However, after the tax on the annual earnings is paid, the full balance in the account is available, without any further tax.

Short- and Long-Term Capital Gains – Capital gains refers to the gain from the sale of capital assets – typically stocks, bonds, and real estate. Short-term capital gains are taxed at ordinary tax rates, while long-term capital gains enjoy special lower rates. For lower-income taxpayers, there is actually no tax on capital gains; for very high-income taxpayers, the capital gains rate maxes out at 20%, whereas the top regular tax rate for high-income taxpayers is 37%. However, for the average taxpayer, the capital gains rate is 15%, which provides a significant savings over the regular tax rates. To qualify for long-term treatment, the capital asset must be held for a year and a day.

Education Savings Accounts – The tax code provides two tax-advantaged plans that allow taxpayers to save for the cost of college for each eligible student: the Coverdell Education Savings Account and the Qualified Tuition Plan (frequently referred to as a Sec. 529 Plan). Neither provides tax-deductible contributions, but both plans’ earnings are tax-deferred and are tax-free if used for allowable expenses, such as tuition. Therefore, with either plan, the greatest benefit is derived by making contributions to the plan as soon as possible—even the day after a child is born—to accumulate years of investment earnings and maximize the benefits.  However, there are different limitations for the two plans, in that only $2,000 per year per student can be contributed to a Coverdell account, while huge amounts can be contributed to Sec. 529 plans, limited only by the estate-planning issues of each contributor and each state’s cap on account contributions, which goes into six figures.

Health Savings Accounts – A health savings account (HSA) can generally be established by taxpayers only if they have high-deductible health plans. The contributions are tax-deductible, the earnings accumulate tax-free, and the distributions are tax-free if used for qualified medical expenses. When part of an employer-sponsored plan, HSA contributions are excluded from the employee’s wages. Once the account owner reaches age 65, taxable but penalty-free distributions can be taken, even if they are not used to pay for medical expenses or to reimburse the taxpayer for medical expenses previously paid for out-of-pocket. Thus, these plans can serve as a combination tax-free medical reimbursement plan and taxable retirement savings arrangement. The maximum annual contribution is inflation adjusted; for 2018, it is $3,450 for self-only coverage and $6,900 for family coverage. Like other tax-advantaged plans, the key is to allow the account to grow through tax-deductible contributions and the accumulated earnings.

Unqualified Withdrawals – Be careful about making unqualified withdrawals – those that are taken before reaching retirement age, in the case of retirement plans, and those taken for unqualified expenses, in the case of education savings accounts and health savings accounts. Doing so can result in costly tax ramifications and potential penalties.

Like all things tax, nothing is simple, and a myriad of rules apply to the foregoing arrangements, so please contact this office for more information or a planning appointment.

Please consult your tax advisor or your Curran Wealth Management Relationship Manager. If you want to learn more about our options, or have questions about the various products and services we offer, please contact Curran Wealth Management.
518.391.4200 •
info@curranllc.com

The information herein is considered to be obtained from reference sources deemed reliable, but no representation or warranty is made as to its accuracy or completeness. No one connected with CIM, LLC or CIMAS, LLC can ensure tax consequences of any transaction.