Tax-advantaged investing: Where to put your next dollar
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Key takeaways:
- Tax-deferred investments avoid “tax drag.”
- “Tax drag” is the reduction of annual growth due to taxes on interest and dividends.
As your paycheck grows, so does your discretionary spending and saving. While it is easy to spend, it is not always clear where to invest your next dollar intended for future spending.
Herein we list the various tax-deferred saving vehicles to consider. Tax-deferred investments avoid “tax drag,” or the reduction of annual growth due to taxes on interest and dividends, that impacts taxable accounts.
Though listed linearly, you will likely contribute to many of these buckets simultaneously, depending on your own personal and financial situation. For instance, people intent on saving for a down payment for a house may disproportionally direct savings toward liquid taxable accounts, such as money market funds, and less toward workplace retirement plans early in their careers. Eventually, one should be able to simultaneously employ most, if not all, of the strategies below:
- Maximize workplace retirement plan contribution up to the match. Your company’s match constitutes an incentive of “free money” to save for retirement. These accounts, such as a 401k or 403b, allow pre-tax dollars to grow tax deferred. This money is often withdrawn when one is in a lower tax bracket in retirement.
- Pay off high-interest debt, namely student loans and credit card debt.
- Maximize retirement plan contributions past the match. The limit is $23,000 in 2024 ($30,500 for people who are age 50 years and older). Your workplace may also offer a 457 or other similar deferred compensation plan with additional opportunity for tax-deferred contributions and earnings.
- Invest in a backdoor Roth IRA. Because many physicians exceed the income limits for a traditional Roth IRA (for 2024, the limits are $146,000 to $161,000 if single; $230,000 to $240,000 if married), the Backdoor Roth IRA allows one to contribute up to $7,000 post-tax for tax-free growth and tax-free withdrawal. For 2024, the limit is $8,000 for people aged 50 and older.
- Consider a health savings account (HSA) offered by some employers for those in a high-deductible health plan. HSAs are triple-tax free: contributions are pre-tax, growth is tax-deferred and distributions for qualified medical expenses are not taxed. The 2024 annual limit are $4,150 for individuals and $8,300 for family.
- Consider 529 accounts to save for higher education if you have children. The 529 accounts are funded with post-tax contributions and grow tax-deferred. Distributions for college or up to $10,000 for private high school are tax-exempt. The 2024 limits are $18,000 annual gift tax limit ($36K for a couple).
In our next blog, more to come about planning your taxable investing strategy.
For more information:
Chirag P. Shah, MD, MPH, is a soccer and Nordic ski coach, who also practices medicine and teaches in Boston. He can be reached at cshah@post.harvard.edu.
Jayanth Sridhar, MD, is an award-winning podcaster, physician and educator who is chief of ophthalmology at Olive View Medical Center in Los Angeles. He can be reached at jsridhar119@gmail.com.
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