Make sure you max out your 401(k). Fund your Roth IRA before the April 15th deadline. Remember that contributions to Health Savings Accounts (HSAs) are deductible. Withdrawals from 529 plans are tax-free when used for qualified expenses. With all the emphasis on tax advantaged accounts, you may have overlooked the importance of Leg Two of The New Three-Legged Stool™ — your after-tax savings.
The accounts mentioned above offer excellent tax advantages and they play an important role in financial planning. However, your after-tax savings also offers tax advantages and other important benefits you may not be thinking about.
Tax Benefits - Growth oriented investments held in an after-tax account such as a traditional investment account with a brokerage firm, are taxed as capital gains. Prior to 2018, the tax brackets for long-term capital gains were closely aligned with income tax brackets. The Tax Cuts & Jobs Act (TCJA) created unique tax brackets for long-term capital gains tax. In 2020 the tax rate on long-term capital gains is 0% for taxpayers with AGI below $80,000 when married filing joint. Taxpayers with an AGI in the range $80,000 to $496,600 will pay 15%. Taxpayers with income above $496,600 ($441,450 for single filers) pay 20%.
Flexibility - Retirement accounts, HSAs, 529 accounts all contain restrictions. Restrictions on how much you can contribute and whether the contributions are tax-deductible or not. Restrictions on when you can withdraw the money may depend on your age or how the withdrawals will be used. There can be tax penalties associated with withdrawals. After-tax accounts are flexible. There are no restrictions on how much you can save each year. You won’t be penalized for taking money out of the account nor will you be forced to withdraw funds when you reach age 72.
Managing Income in Retirement - The biggest advantage to having an after-tax account is the ability to use it in connection with the other two legs of your New Three-Legged Stool. A retiree can reduce their annual tax bill by drawing income from all three legs (tax deferred, tax free and after tax) in a tax-efficient manner. Studies show a tax efficient social security and withdrawal strategy can extend the life of your portfolio. Make sure your retirement plan is using all three legs of the stool.
Originally published April 2016
