Why Tax-Advantaged Accounts Matter

The U.S. offers special accounts that reduce or defer taxes on investment growth. Using them can significantly boost your long-term returns. Money that would otherwise go to taxes stays invested and compounds. Over decades, that difference can be substantial. (For the full mechanics of how investment income is taxed, see How to Pay Taxes on Investment Income.)

The main types are:

• 401(k) — Employer-sponsored. Often includes a match. Contributions reduce your taxable income.
• Traditional IRA — Tax deduction now, taxed when you withdraw in retirement.
• Roth IRA — No deduction now, but withdrawals are tax-free in retirement (if rules are followed).

401(k) — Start Here If You Have Access

If your employer offers a 401(k), this is usually your first stop. Many employers match a portion of your contributions—e.g., 50% of the first 6% you contribute. That's free money. Not contributing enough to get the full match is like leaving money on the table.

Contribution Limits (2025)

• Under 50: $23,000 per year
• 50 and older: $30,500 (catch-up)

Contributions reduce your taxable income. If you earn $60,000 and contribute $6,000, the IRS taxes you on $54,000.

Traditional vs Roth 401(k)

Some employers offer both. Traditional reduces taxes now; Roth means you pay tax now but withdraw tax-free later. If you're early in your career and expect a higher tax bracket in retirement, Roth can make sense. When in doubt, a mix of both works.

Traditional IRA vs Roth IRA

IRAs are individual accounts you open at a broker. They're separate from your 401(k).

Roth IRA Income Limits

Roth IRA has income limits. In 2025, if you're single and earn above ~$161,000 (or married filing jointly above ~$240,000), you may not be able to contribute directly. High earners sometimes use a backdoor Roth—contributing to a Traditional IRA and converting to Roth. This requires care; consult a tax professional.

The Order of Operations

A common strategy:

1. 401(k) up to employer match — Free money first. Never skip this.
2. Max Roth IRA (if eligible) — Tax-free growth is powerful. $7,000/year adds up.
3. Max 401(k) — More tax-deferred space. After the match, fill this before taxable.
4. Taxable brokerage — For anything beyond. Still great; you just pay taxes on gains and dividends.

To open these accounts you'll need a broker that supports IRAs. Once funded, you'll allocate the money across stocks, bonds, and ETFs inside a diversified portfolio.

Example

Sarah earns $70,000. Her employer matches 50% of the first 6% she contributes. She contributes $4,200 (6% of $70,000) to her 401(k)—her employer adds $2,100. She also contributes $7,000 to a Roth IRA. Total invested: $13,300, with $2,100 of that free.