Tax-advantaged accounts are a way for the government to encourage long-term savings for retirement, education, or healthcare, by providing significant tax advantages to the investor. However, in return for these advantages, the government imposes strict rules to prevent misuse and ensure the funds are utilized for their intended purposes. These limitations, outlined below, govern how tax-advantaged accounts can and can’t be used, though no single account type is subject to all of the limitations below.
🛑 Limit #1: Annual Contribution Limits
All tax-advantaged accounts have specific maximum dollar amounts that can be contributed each year. These contribution limits restrict the total amount of income that can be diverted into these accounts. The specific contribution limits vary by account type and are adjusted annually by the IRS.
💵 Limitation #2: Income Limits
Certain tax-advantaged accounts have income limits that either prevent high-income earners from contributing to them (in the case of Roth accounts), or prevent high-income earners from deducting their contributions to them (in the case of traditional IRAs). These income limits effectively restrict the utility of these accounts for high income earners. The specific limits vary by account type and are adjusted annually by the IRS.
🗓️ Limitation #3: Age Limits and Early Withdrawal Penalties
Funds withdrawn from most retirement accounts before the age of 59.5 are considered “early.” These withdrawals are typically subject to ordinary income taxes plus an additional penalty (generally 10% on the taxable earnings). There are account-specific exceptions that, if followed carefully, may allow you to avoid the penalty if you need to access the money before age 59.5. But in general it is advisable to consider contributions to be off-limits until that age.
🚨 Limitation #4: Required Minimum Distributions (RMDs):
Owners of most traditional (pre-tax) retirement accounts1 are required to begin withdrawing funds at a certain age (currently age 73). This forces you to realize taxable income even if you do not need the money yet. Critically, these mandatory distributions are added to all other sources of retirement income, potentially bumping you into higher tax brackets, increasing the percentage of Social Security benefits subject to tax, and triggering higher Medicare premiums (known as IRMAA surcharges).
🏢 Limitation #5: Employer Limitations and Control
Employer-sponsored plans are only available to employees of that specific company, and are subject to the specific rules implemented by that employer. For example, the employer dictates the account provider, investment options, administrative fees, and matching contributions. However, once the employee leaves that company, they have the option to roll over their plan to an IRA.
🚫 Limitation #6: Withdrawal Limitations and Penalties
Funds withdrawn from HSA and 529 accounts must be used only for their designated purposes to maintain their tax-free status. Using funds for non-qualified purposes will result in the earnings being taxed as ordinary income and sometimes incurring an additional penalty.
Which account types have which limitations?
The following table maps the six tax limitations above to the most common types of tax-advantaged accounts:
Account Type | 🛑 Annual Contribution Limits | 💵 Income Limits | 🗓️ Age Limits and Early Withdrawal Penalties | 🚨 Required Minimum Distributions (RMDs) | 🏢 Employer Limitations and Control | 🚫 Withdrawal Limitations and Penalties |
|---|---|---|---|---|---|---|
Baseline Account Type (for comparison) | ||||||
Taxable Brokerage Account | ✅ No – There is no ceiling on how much you can invest. | ✅ No – You can contribute regardless of your income. | ✅ No – Funds can be withdrawn penalty-free at any time. | ✅ No – Funds can remains invested indefinitely. | ✅ No – Not subject to the control of your employer. | ✅ No – Funds can be used for any purpose. |
Employer-Sponsored Accounts | ||||||
Traditional 401k (403b, 457b) | ❌ Yes – Employee salary deferrals are capped. | ✅ No2 | ❌ Yes – Early withdrawals are generally taxed and penalized. | ❌ Yes – RMDs force the realization of taxable income. | ❌ Yes – Account is tied to your employer. | ✅ No |
Roth 401k (403b, 457b) | ❌ Yes – Employee salary deferrals are capped. | ✅ No | ❌ Yes – Early withdrawals of earnings (not contributions) are taxed and penalized. | ✅ No1 | ❌ Yes – Account is tied to your employer. | ✅ No |
Individual Accounts | ||||||
Traditional IRA | ❌ Yes – Contributions are capped. | ❌ Yes – Deductibility of contributions is phased out for high-income earners. | ❌ Yes – Early withdrawals are taxed and penalized, with exceptions. | ❌ Yes – RMDs force the realization of taxable income | ✅ No | ✅ No |
Roth IRA | ❌ Yes – Contributions are capped. | ❌ Yes – Contribution eligibility is phased out for high-income earners.3 | ❌ Yes – Early withdrawals of earnings (not contributions) are taxed and penalized. | ✅ No1 | ✅ No | ✅ No |
Health Savings Account (HSA) | ❌ Yes – Contributions are capped and require a high- deductible health plan. | ✅ No | ❌ Yes – Non-qualified withdrawals before age 65 are taxed and penalized. | ✅ No | ✅ No | ❌ Yes – Funds must be used for Qualified Medical Expenses to avoid being taxed. |
529 Education Plan | ❌ Yes – Contribution limits are set by each state’s program. | ✅ No | ✅ No | ✅ No | ✅ No | ❌ Yes – Funds must be used for Qualified Education Expenses to avoid taxes and penalties. |
With Great Power Comes Great Responsibility
The benefits of tax-advantaged accounts are significant, but as detailed above, come with strings attached: in exchange for powerful tax incentives, you surrender some flexibility, control, and access to your capital. Understanding these limitations is key to getting the most out of tax-advantaged accounts and avoiding costly mistakes.
- Since contributions to Roth accounts are made with after-tax money, Roth accounts are not generally subject to RMDs. However, inherited Roth accounts are subject to RMDs. ↩︎
- Starting in 2026, if an employee’s W-2 income is over a certain limit, 401k catch-up contributions (additional contributions for those over 50) must be made as Roth contributions. ↩︎
- Under certain circumstances, high income earners can still make Backdoor Roth IRA contributions even when their income exceeds the limit for direct Roth IRA contributions. ↩︎
