Investing is a powerful tool for building wealth, but when paired with tax advantages, it becomes even more effective. Tax-advantaged investment accounts are designed to help you grow your savings while reducing your tax burden. For young investors, these accounts are especially valuable because starting early allows more time for your money to grow and compound.

What Are Tax-Advantaged Accounts?

Tax-advantaged accounts are savings or investment accounts that provide special tax benefits. These benefits typically come in one of two forms:

  • Tax-Deferred Growth – Your contributions are made pre-tax, meaning you delay paying taxes on the money until you withdraw it, often in retirement. This gives you immediate tax savings.
  • Tax-Free Earnings – You pay taxes upfront when you contribute, but any growth or gains within the account can be withdrawn tax-free later.

These tax benefits can save you significant money over time, leaving more for your financial goals. Now, let’s explore the most common tax-advantaged accounts and how they work.

1. Roth IRA (Individual Retirement Arrangement)

Why It’s Great for Young Investors:

A Roth IRA is a popular choice for young investors because contributions are made with after-tax dollars, which means you don’t get a tax deduction upfront. However, the earnings on your investments grow tax-free, and withdrawals in retirement are also tax-free. Since many young individuals are in a lower tax bracket now than they might be later, a Roth IRA can lock in today’s lower tax rates.

Key Features:

  • Contribution limit for 2023: $6,500 annually (or $7,500 if you’re 50 or older).
  • Tax-free withdrawals after age 59½ and five years of account ownership.
  • Contributions (but not investment earnings) can be withdrawn without penalty at any time for any reason, offering flexibility.

If you contribute $100 a month to a Roth IRA starting at age 25 and earn an average annual return of 7%, you could have over $240,000 by age 65. And because it’s a Roth account, that money can be withdrawn tax-free.

2. Traditional IRA

Why It’s Beneficial:

A Traditional IRA offers immediate tax savings. Contributions may be tax-deductible (depending on your income and whether you’re covered by a workplace retirement plan). This makes it a good fit if you’re focused on reducing your taxable income now and plan to be in a lower tax bracket in retirement.

Key Features:

  • Contribution limit for 2023: $6,500 annually (or $7,500 if you’re 50 or older).
  • Withdrawals are taxed as regular income in retirement.
  • You can begin withdrawing after age 59½ without penalties, but required minimum distributions (RMDs) start at age 73.

Who Should Consider It:

A Traditional IRA might be a better option than a Roth IRA if you expect to earn significantly more in the future, as you’ll benefit most when withdrawing during low-income retirement years.

3. Employer-Sponsored 401(k)

Why It’s a Powerful Option:

A 401(k) is an investment account provided by employers, and it’s one of the most effective ways to save for retirement. Contributions are made with pre-tax dollars, reducing your taxable income, and the investments grow tax-deferred. Many employers also offer matching contributions, which is essentially free money to boost your savings.

Key Features:

  • Contribution limit for 2023: $22,500 (or $30,000 if you’re 50 or older).
  • Employer match programs can significantly increase your savings.
  • Funds are taxable upon withdrawal in retirement.

How to Maximize It:

If your employer offers a match, aim to contribute enough to take full advantage of it. For instance, if your company matches up to 5% of your salary, make sure you contribute at least that amount to avoid leaving money on the table.

Imagine you’re earning $50,000 annually, and your employer matches 100% of your contributions up to 5% of your salary. By contributing $2,500, your employer would add another $2,500 to your account, effectively doubling your investment.

4. HSA (Health Savings Account)

Why It’s Unique:

An HSA is a triple tax-advantaged account available to those with a high-deductible health plan (HDHP). Contributions are tax-deductible, investments grow tax-free, and withdrawals are tax-free when used for qualified medical expenses. It’s like having a retirement fund for healthcare costs, and after age 65, you can use it for any purpose (though non-medical withdrawals are taxed).

Key Features:

  • Contribution limit for 2023: $3,850 for individuals, $7,750 for families.
  • Funds roll over year to year and never expire, making it a great long-term savings tool.
  • No required minimum distributions.

Ideal For:

Young, healthy individuals who expect future healthcare costs or want to supplement retirement savings with a flexible, tax-advantaged account.

How to Choose the Right Account

The best account for you depends on your financial situation and goals. Here are some tips to help you decide:

  • If you want tax-free growth and expect to be in a higher tax bracket later, a Roth IRA is ideal.
  • For immediate tax savings and lower income taxes now, consider a Traditional IRA or 401(k).
  • If your employer offers a matching 401(k), prioritize contributing enough to get the full match first.
  • For added flexibility and healthcare savings, pair one of these accounts with an HSA if eligible.

You might also decide to use more than one account type. For example, you could begin with your 401(k) to capture the match and then open a Roth IRA to diversify your tax benefits.

Start Early, Benefit More

Take the first step today by exploring your options, setting goals, and deciding which accounts match your needs.