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In a letter penned by Benjamin Franklin in 1789, the founding father famously quipped, “… in this world nothing can be said to be certain, except death and taxes.” More than 200 years later and Franklin’s sentiment is as true as ever. While there is certainly no way to avoid taxes entirely, there are investment options to help cushion the financial blow from the certainty of taxes.

In our previous blog, we discussed three solid options for optimizing your tax refund: saving, investing, or paying off debt. Opening a traditional savings account and focusing on freeing yourself from high-interest debt are both applause-worthy goals. However, if you decide to invest your refund, there is one very important question you should consider:

Tax now or tax later?

There are a variety of long-term, retirement-focused investment options to consider, and each have tax implications that need to be carefully evaluated for your unique financial situation. For our purposes, we’ll focus on Roth versus traditional IRAs to illustrate the tax considerations you should ponder before investing your refund.

Tax Later, Please

Tax-deferred investments include traditional IRAs and employer-sponsored retirement plans such as a 401(k). These accounts allow you to invest now and pay taxes on your contribution only after you withdraw funds. One of the major advantages of a traditional IRA is that the Internal Revenue Service (IRS) allows you to deduct contributions to these accounts from your annual taxable income. The results will vary for every individual, but deducting these investments could lower your overall tax liability and bring you into a lower tax bracket, saving you money now.

There’s no avoiding taxes indefinitely. You will pay taxes on the contributions made to your traditional IRA, but not until you withdraw funds. Financial experts recommend you consider your financial outlook in retirement before investing in a traditional IRA. If you expect your retirement tax bracket to be lower than your employed tax bracket, a traditional IRA may be advantageous.

However, there are limitations.

Traditional IRAs are designed to protect your investment until you’ve reached age 59 ½. Any funds withdrawn earlier may result in federal tax penalties, on top of being taxed as earned income for that year. Additionally, there are limitations (typically $5,000) to the amount individuals can contribute annually.

Tax Now, Please

Unlike tax-deferred investment options, Roth IRA contributions are made with after-tax income and don't mandate withdrawals during the owner's lifetime. In this case, it is especially important to consider your retirement income. If you believe that in retirement you’ll be in a higher tax bracket than you are currently, it may be best to pay taxes on your IRA contributions now while you are in that lower tax bracket. For example, if you are a young professional in the earliest stages of your career, your tax bracket will likely be higher when you withdraw these funds. That scenario makes a tax-now Roth IRA contribution beneficial because it will allow you to pay taxes on your IRA contributions in a lower tax bracket.

Another major difference with Roth IRAs is the terms. Unlike traditional IRAs, Roth IRA funds can be accessed at any time with no restrictions.

There are investment options beyond traditional IRAs and Roth IRAs. Tax-later investments can include IRA share certificates, regular share certificates, or money market accounts. And tax-now investments include Roth 401(k), Roth 403(b), and Roth 457(b) investment accounts. Terms, rates, and penalties vary for each.

Due to the individual nature of financial health and retirement planning, it is vitally important that any person considering investments consult a financial expert to assess their unique financial situation.