Tax planning can play a critical role in any financial strategy. However, with the Tax Cuts and Jobs Act (TCJA) set to expire at the end of 2025, there’s heightened urgency around having an effective tax strategy in place. This is especially true for Northern Virginia residents trying to align their unique financial needs and higher cost of living with our ever-changing tax laws. Fortunately, tax-advantaged savings vehicles can help make the planning process easier. These investment vehicles offer one of the most effective ways to help ease the burden while preserving your wealth.
What Are Tax-Advantaged Accounts?
Tax-advantaged accounts are financial vehicles that offer the user some form of tax benefit. Typically, these accounts are used for retirement or health savings. However, they can also be used for other savings goals. The core benefits of these accounts include:
Tax Deferral
Contributions are made on a pre-tax basis, and investment gains are not taxed in the year they are received.
Tax-Free Growth
As its name implies, investments in these accounts grow without being taxed.
Tax-Free Withdrawals
In some accounts, such as Roth IRAs, qualified withdrawals are entirely tax-free since they are funded with after-tax dollars.
Types of Accounts: IRAs, 401(k)s, HSAs, and More
There are several tax-advantaged accounts that can help contribute to a robust financial strategy. Understanding your options, as well as each vehicle’s rules and benefits, can help you create an informed plan that aligns with your personal goals. Some of the most common accounts include:
Individual Retirement Accounts (IRAs)
IRAs are one of the most popular tax-advantaged savings vehicles for retirement. They offer flexibility and significant taxation benefits, making them a popular choice for individuals looking to preserve their wealth.
There are two main types of IRAs:
- Traditional IRA: Contributions are typically deductible as long as you’re under the income limit and earnings grow tax-deferred. Withdrawals are taxed as regular income. Unless specific circumstances are met, withdrawals before age 59 ½ incur an additional 10% penalty.
- Roth IRA: Contributions are made with after-tax dollars, but withdrawals are tax-free as long as you’ve had a Roth IRA for at least five years. There are no required minimum distributions (RMDs), making this account highly attractive for those looking to manage their tax burden in retirement. Additionally, contributions can be withdrawn without tax or penalty at any time.
401(k) and Thrift Savings Plan (TSP) Accounts
These employer-sponsored retirement accounts allow for pre-tax contributions, reducing your taxable income in the year of the contribution. Some employers in Northern Virginia may also offer Roth 401(k) options, allowing for after-tax contributions but tax-free withdrawals in retirement. The maximum annual contribution limits are higher for 401(k)s than for IRAs. Finally, contributions are not limited to high earners, making them one of the most powerful tools for high-income earners to reduce their current year tax liability. Similarly, the TSP, available to federal employees and uniformed service members, offers pre-tax and Roth contribution options, potential agency matching contributions, and low administrative fees.
Health Savings Accounts (HSAs)
HSAs can be a tax-advantaged triple threat: Contributions are made on a pre-tax basis. Earnings grow tax-deferred, and withdrawals for qualified medical expenses are tax-free, including earnings. Additionally, there are no RMDs, and many plans offer investment options to savers.
HSAs with an investment option allow contributors to allocate money to various funds and other investment vehicles. For residents of Northern Virginia with high-deductible health plans, an HSA can be a valuable way to save for both short-term and long-term costs. Still, it’s important to note that while HSAs do offer potentially significant benefits, none of these advantages are guaranteed. Consulting with a professional advisor is the best way to determine if it’s the right option for your needs.
529 College Savings Plans
For anyone who needs to save for a family member’s education, a 529 plan offers tax-free growth. Additionally, withdrawals are tax-free as long as they are used for qualified educational expenses. Virginia also offers a state tax deduction for contributions to a 529 plan, making it particularly advantageous for residents of Northern Virginia.
Annuities
Annuities offer tax deferral on earnings, which means that you don’t pay taxes on the interest or investment gains until you withdraw funds. This can be advantageous for high-income earners who want to reduce their current tax burden while accumulating wealth.
Life Insurance
Certain types of life insurance policies also offer tax advantages. The cash value within these policies grows tax-deferred, meaning you won’t pay taxes on the growth as long as the funds remain in the policy.
How to Optimize Benefits Under Northern Virginia Tax Laws
Beyond federal benefits, Virginia also offers some specific advantages that residents can leverage to further boost their savings. Some important considerations when developing your strategy may include:
Take Advantage of Employer-Sponsored Plans
Many high-net-worth individuals and professionals in Northern Virginia have access to employer-sponsored retirement plans. If your employer offers matching contributions to your 401(k) or TSP maximize this benefit to get the most out of your savings.
Consider Roth Conversions
For individuals who expect to be in a higher tax bracket during retirement, converting some traditional IRA or 401(k) funds into a Roth IRA can be a smart strategy. Since so many individuals in Northern Virginia have military or government pensions, their income stays high even in retirement. By opting for a Roth IRA conversion, individuals can lock in their current taxation rates, which may be lower than what they might face in retirement.
Maximize 529 Contributions
Virginia allows tax-paying residents to deduct contributions to a Virginia-sponsored 529 plan from their taxable state income. This deduction is limited to $4,000 per account per year, but any unused contributions can be carried forward indefinitely. If you’re planning for your children’s or grandchildren’s education, this can be a valuable tool to save for college and give you an immediate state income tax benefit.
Be Strategic With Required Minimum Distributions
Although not specific to Virginia residents, having a strategy for required minimum distributions is essential for anyone building tax-advantaged savings. For those with money in traditional IRAs, 401(k)s, or other qualified tax-deferred accounts, it’s essential to be proactive about required minimum distributions. Once you turn 73, you are at the “required beginning age (RBA).” This is when the IRS mandates that you begin taking RMDs from these accounts These distributions are taxed as ordinary income.
In many cases, for Northern Virginians with large IRA, 401k, or TSP balances, it may be beneficial to start taking distributions prior to your RBA. Utilizing a strategy to fill your marginal tax bracket each year (while minimizing the impact of higher income-based Medicare premiums) can often prove a powerful lifetime tax planning strategy.
Case Studies: Successful Use of Tax-Advantaged Accounts
To illustrate how Northern Virginia residents can maximize these accounts, let’s look at these hypothetical case studies.
Case Study 1: The High-Earning Professional
Sarah, a 40-year-old attorney in Fairfax, earns $250,000 per year. She maxes out her 401(k) contributions at $23,000 per year. Her employer offers a 5% match on her 401(k), which she takes full advantage of. She also contributes the maximum allowable amount to her HSA, which she uses primarily as a long-term investment vehicle, allowing the balance to grow without being taxed.
Because of her high income limit, she is not able to contribute to a Roth IRA. However, her financial advisor showed her how she can still contribute $7,000 to her Roth IRA through a back-door Roth IRA strategy.
Case Study 2: The Near-Retiree
John, a 63-year-old business owner in Alexandria, has significant savings in a traditional IRA and a 401(k). Concerned about RMDs inflating his income in retirement, he works with his financial advisor to convert a portion of his IRA into a Roth IRA, paying taxes now at a lower rate.
This strategy allows him to reduce the size of his RMDs while helping create a tax-diversified retirement income stream.
Planning for The Future: Good Life Financial Advisors of NOVA Can Help.
Tax-advantaged savings vehicles offer tremendous potential for Northern Virginia residents looking to preserve their wealth and minimize liability. By understanding the different types of accounts, maximizing contributions, and leveraging the unique advantages available in Virginia, individuals can create a savings plan tailored to your future financial vision.
At Good Life Financial Advisors of NOVA, we specialize in helping individuals navigate the complexities of saving for the future. Schedule a call to speak with a CERTIFIED FINANCIAL PLANNER™ professional at Good Life Financial Advisors of NOVA today!
We’ll have a short conversation to see if we’re a good fit for each other
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Prior to investing in a 529 Plan, investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
Annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply.
