Another way to maximize the potential for long-term portfolio growth through compounding is by taking advantage of tax-deferred and tax-free investment accounts.

When you invest through a traditional tax-deferred account, including individual retirement accounts (IRAs) and employer-sponsored plans, such as 401(k)s, you don’t owe income tax until you begin making withdrawals from the account, generally after you retire. Because you don’t have to pay taxes on your earnings every year, your investment compounds untaxed, significantly boosting its growth potential. In many cases, you can defer taxes on your contributions to these accounts as well, helping your account to compound even faster.

You may reap even more tax advantages with a tax-free retirement or education account, such as a Roth IRA or Roth 401(k) (if your employer offers this alternative), or a 529 college savings plan or Coverdell education savings account (ESA). As with tax-deferred accounts, you owe no tax on current income or capital gains on realized profits. In addition, your withdrawals are federally tax-free—and may be exempt from state and local income tax as well, depending on the type of account—provided you follow the rules for withdrawals.

One major consideration is the types of investments to emphasize in each type of account. For instance, you should think carefully before including any investments in a tax-deferred account that are already tax-exempt, such as municipal bonds or bond funds that invest in minus. That’s because you won’t receive any additional tax benefit and you’ll owe taxes at your regular rate on any interest earnings at withdrawal, even though that interest would have been tax exempt had you held the investments in a taxable account.

You may also want to evaluate whether to purchase annuities in your IRA since annuities are already tax deferred. In addition, the annual expenses on deferred annuities are typically higher than on mutual funds that make similar investments.

If you have bonds or other fixed income investments, apart from municipal bonds or municipal bond funds, it’s best to put them in tax-deferred or tax-free accounts.  Tax-deferred and tax-free accounts are also well-suited for growth investments, such as stock and stock funds, which may benefit most from the potential for long-term compounding. Although you will have to pay tax on your withdrawals at your regular income tax rate rather than the long-term capital gains rate, you probably anticipate that your income tax rate will lower after you retire.  While many people do fall into a lower income tax bracket in retirement, be aware that this isn’t always the case.