Tax-smart strategies

Choosing the right accounts to save and invest in can lead to significant tax savings over time and put more money in your pocket, both today and years down the road. But how do you know which accounts are right for you—and where do you start? 

First, keep in mind that tax-smart accounts are just one part of your overall financial plan. So the basics still apply—like setting up an emergency fund and paying down your high-interest debt. 

Once those things are in place, consider saving in this order:

• Save enough in your employer retirement plan to get the full match, if your employer offers one. With pre-tax Tooltip Money that has not yet been taxed. contributions, you'll defer taxes until retirement and reduce your current taxable income.¹ With after-tax Tooltip Money that has already been taxed. (Roth) contributions, you'll pay taxes now—but your money can potentially grow tax-free and you won't owe taxes when you withdraw it.² 
• Take advantage of a Health Savings Account (HSA). If you have an HSA tied to your high-deductible health insurance plan, consider saving there too. HSAs let you make tax-deductible contributions you can withdraw tax-free for qualified medical expenses, now or in retirement. Investments in your HSA also grow tax-free. Any investment earnings in your HSA are also tax-free, as long as you use them for qualified medical expenses.
• Max out your tax-advantaged retirement accounts. Or increase contributions 1% – 2% a year until you reach the max. If you're already contributing the max to your employer plan or don't have one, consider a traditional or Roth IRA, or both. In some cases, converting a traditional tax-deferred account Tooltip Tax-deferred contributions and earnings are not usually subject to federal, state or local taxes until you withdraw them from your retirement account.   to a Roth Tooltip Roth account contributions are made with after-tax dollars, so you pay taxes up front. But your money grows tax-free and (in most cases) you won’t owe taxes when you withdraw it in retirement. A Roth may be a good choice if you think your tax bracket will be higher in retirement than it is today.  might also make sense.³ 
• Consider a taxable brokerage account to invest even more. There's no up-front tax break, and income is taxed for the year you earned it. But if you hold assets for more than a year, you may qualify for a lower long-term capital gains tax rate. Tax-efficient investments (like certain municipal bonds) may also offer tax benefits. Losses may be deductible. And the IRS won't restrict contributions, withdrawals, or how you spend the money. 

See the difference between a traditional 401(k) and a Roth 401(k). 

Is a Roth IRA conversion right for you? Here are four reasons to consider it.  

Once you have your accounts, your next step is to put appropriate investments into each one to help minimize taxes on your investment growth and income.

In general, investment returns that tend to be taxed at a lower rate (like long-term capital gains) are better suited for taxable accounts. And investment returns that tend to be taxed at a higher rate (like short-term capital gains) are better suited for tax-advantaged accounts. 

Every investment won't be a winner. But you may be able to use investment losses to lower your tax bill by leveraging a strategy called tax-loss harvesting.⁴ Tax-loss harvesting has the potential to reduce capital gains you've made in the same year by the amount you've lost—and offset ordinary income through a deduction of up to $3,000. Any portion of your loss that is unused can be carried forward to future years.

Here are three more things to keep in mind: 

• Even if you don't have capital gains, tax-loss harvesting may reduce your taxable income by allowing you to deduct up to $3,000 in losses.
• Tax-loss harvesting can only be used with taxable accounts (like a brokerage), not with tax-deferred accounts like a 401(k) or IRA.
• Tax-loss harvesting can trigger the wash-sale rule, which can disqualify you from claiming your loss in the current tax year. This can happen if you sell a security at a loss and buy the same or a "substantially identical" security within 30 days before or after the sale.

Learn more about how tax-loss harvesting works.