Tax-Sheltered Investments: Types of Accounts, Benefits & Tips (2024)

FAQs

What is a tax-sheltered investment account? ›

A tax-sheltered investment is an asset or a portfolio of assets that is purchased or structured to reduce your income tax liabilities in a legal way. The most common tax-sheltered investments are vehicles that were created by the Internal Revenue Service (IRS) to encourage saving for retirement.

Qualified retirement accounts, certain insurance products, partnerships, municipal bonds, and real estate investments are all examples of potential tax shelters.

A tax shelter provides a way to lower your taxable income and, in turn, the tax you pay. There are many ways to lower your taxes, including deductions, credits, and contributing to tax- advantaged accounts. You can use tax shelters to lower your annual income tax and capital gains taxes.

Examples of tax-advantages accounts are IRAs, 529 college savings plans, health savings accounts (HSAs) and 401(k) plans.

Withdrawing funds prior to age 59½ incurs a 10% early withdrawal penalty levied by the IRS. No 10% penalty for early withdrawal. Attainment of age 59½ qualifies as a distributable event that permits you to withdraw funds from your account.

403(b) Plans and Tax Deferral

If you are separated from service, you can begin withdrawing funds, without penalty, at age 59½. Once you reach age 73*, there are minimum withdrawals you must take known as required minimum distributions (RMDs).

The Internal Revenue Service makes a distinction between tax sheltering (which encompasses legal forms of reducing tax liability, like retirement plans) and “abusive” tax sheltering (including tax evasion, which is illegal).

The maximum amount of elective deferrals an employee can contribute annually to a 403(b) is generally the lesser of: 100% of includible compensation; or. $23,000 in 2024 ($22,500 in 2023; $20,500 in 2022; $19,500 in 2021 and in 2020; $19,000 in 2019) (subject to annual cost-of-living increases).

What is the penalty for tax shelter? ›

Penalties associated with reportable transactions

§ 301.6700 Promoting Abusive Tax Shelters The penalty is for a promoter of an abusive tax shelter and is generally equal to $1,000 for each organization or sale of an abusive plan or arrangement (or, if lesser, 100 percent of the income derived from the activity).

And while some of those include "tax-later"/tax-deferred vehicles where you make tax-deferred contributions but then are taxed when you take the money out, "tax-never"/tax-exempt accounts let your money grow without any federal income tax on your investment returns—these accounts are considered tax-free.

The best known tax-advantaged account is the 401(k), which Congress created back in 1978, but there are now lots of other accounts offering tax benefits—from Health Savings Accounts for healthcare to 529 college savings plans for education, plus a number of other retirement options.

Each allows plan holders to contribute a portion of their salary each year up to a maximum ($23,000 in 2024 and $22,500 in 2023). Also called 403(b) plans, TSAs are designed for employees of churches, non-profits, and public schools while 401(k)s are established by for-profit corporations.

Simply put, a tax-advantaged investment is any type of investment, account, or savings plan that offers notable tax benefits to the investor. These investments allow you to minimize the amount of taxes you pay, either by deferring, reducing, or, in some cases, completely avoiding them.

With a Roth IRA, you contribute after-tax dollars, your money grows tax-free, and you can generally make tax- and penalty-free withdrawals after age 59½. With a Traditional IRA, you contribute pre- or after-tax dollars, your money grows tax-deferred, and withdrawals are taxed as current income after age 59½.