Understanding Pre-Tax Accounts

 When it comes to investment accounts, you basically have two different types: pre-tax accounts and after-tax accounts. If you’ve settled on a pre-tax account, as many people do, or are considering opening one, it’s important to understand how this type of account works so that you can determine if it’s the best fit for your investments.  

Pre-Tax Accounts Mean Deferred Taxes

Many people think that a pre-tax account means that the money is taxed before it’s put into your account, but it’s actually quite the opposite. Money is put into a pre-tax account before any taxes are assessed. The money then gets taxed later when you make a withdrawal

If your plan is to save money for retirement and you’re likely to be in a lower income bracket once you do retire, this makes sense. If you’re earning less, your taxation should be less as well. But, if you’re likely, for whatever reason, to be in a much higher income bracket when it comes time to make a withdrawal, then you could end up paying more in taxes, which is the opposite of what you want. Thus, it’s vital to take your future, or at least the most likely future you can envision, into consideration when determining whether or not this type of account is right for you.

There Are Limits

Something else to understand is that you can’t necessarily just put all the money you want into these accounts each year. Since your deposits lower your taxable income, there are limits on how many deposits you can make. However, these limits vary based on various factors, such as the type of account. Thus, it’s always smart to choose a plan that has limits you can live with and that work for your overall investment strategy.

Ultimately, pre-tax accounts do have a number of benefits and can be a great help to many people. But, to use them to their best advantage, you will need to do some careful planning on your part. Plus, you’ll need to choose the right plan at the right time. For this reason, it’s always best to work closely with a financial professional to ensure you choose the right type of investment for you, your life, and your future plans and financial goals.