Benefits 101: What Does "Tax-Advantaged" Mean?
In the world of benefits (as well as the world of personal finance) the term “tax-advantaged” is thrown around frequently, but very rarely defined. After all, the term seems relatively self-explanatory — but for those who are new to benefits, or who are looking for resources to help their employees, we thought we might lend a helping hand.
What Does “Tax-Advantaged” Mean?
The term tax-advantaged, at its most basic, means that something is either exempt from taxation, offers tax-related benefits, or is tax-deferred (i.e. allows interest to accumulate tax-free until collection). Generally, “tax-advantaged” can be used to describe things like savings plans, financial accounts, investments, and even certain incentive programs.
Understanding the difference between different tax-advantaged accounts is also critically important. Take, for instance, a Traditional IRA vs. a Roth IRA. Both are individual retirement accounts, and both are tax-advantaged. However, there are some key differences:
Traditional IRA: You don’t pay taxes on the money you deposit, which grows tax-deferred, but your withdrawals are subject to income tax
Roth IRA: The money you put in has already been taxed, but your money grows tax-free, as are your subsequent withdrawals
As you can see, both accounts are tax-advantaged, but some quick math should tell you that depending on your tax-bracket and your future earning potential, one option may be much better for you than the other.
What Kinds of Accounts are Tax-Advantaged?
As we mentioned above, both Roth IRAs and Traditional IRAs are famously tax-advantaged. Some other well-known tax-advantaged programs include:
Health Spending Accounts (HAS)
This is by no means an exhaustive list — in fact, it hardly scratches the surface! There are plenty of tax-advantaged accounts and plans that meet very specific needs, so don’t be afraid to do a little research and see what you qualify for.
Do Tax-Advantaged Programs/Accounts Only Benefit Individuals?
We’ll keep this one short and sweet: no — no, they don’t. In fact, tax-advantaged benefits offered through an employer often benefit both the employer and the employee.
Let’s take Flexible Spending Accounts, for example. Flexible spending accounts are tax-advantaged for employees in that the money put into the account is taken out of their paycheck pre-payroll tax. By reducing their taxable income, employees can hypothetically increase their take-home pay. Employers, on the other hand, can reduce the amount of Social Security, Medicare, and other payroll tax they’re expected to pay, since they don’t have pay tax on the employee FSA contributions.
Have any questions about demystifying the world of benefits, for yourself or your employees? Feel free to reach out to us at firstname.lastname@example.org.