There are tax consequences to virtually any financial move you make – whether it’s investing, saving, spending, donating, or accumulating. Those tax considerations have a direct impact on how much money you ultimately get to keep and/or give away.
Following are some of the most familiar tax breaks available as we consider life goals such as retirement, healthcare, education, charitable giving, and wealth transfer.
Saving for Retirement
There are many tax-favored savings accounts to help save for retirement. There are employer-sponsored plans, such as the 401(k), 403(b) and SIMPLE IRA. There are also individual IRAs that you can setup on your own. All of these plans include traditional and Roth structures that you can choose from, and your personal circumstances will determine which is best suited for you.
In these types of retirement accounts your dollars grow tax-free while they remain in the account. This enables your retirement assets to accumulate more quickly than if they were subject to the ongoing taxes that taxable accounts incur annually (such as realized capital gains, dividends, or interest paid).
Tax treatments for other types of retirement accounts can be significantly different. For some, you can make pre-tax contributions, but withdrawals are taxed at ordinary income rates in the year you take them. For other types of accounts, you contribute after-tax dollars, but withdrawals are tax-free but again, with some limitations. Each account type has varying rules about when, how, and the amount you can contribute and withdraw without incurring penalties or unforeseen taxes owed.
Saving for Healthcare Costs (HSAs)
The Healthcare Savings Account (HSA) offers a rare, triple-tax-free treatment to help families save for current or future healthcare costs.
A key point here is to start using and funding HSAs now, while contributing close to the annual limits if you can. But don’t tap the accounts too early. Workers who elect to pay current medical expenses from regular income can allow money in their HSAs to accumulate. The money will build up and withdrawals will come out tax-free if used for eligible medical costs. Since you make contributions to an HSA using pre-tax dollars, you also reduce your current federal tax bill. Those contributions are deductible from state income as well.
Like a 401(k) plan, the money in an HSA grows tax-free. The savings can add up. Morningstar estimates that if you save in an HSA for 30 years you could end up with nearly $100,000 more than if you had saved in a traditional 401(k) where all withdrawals are taxed as income. You could save about $120,000 more than if the money had been invested in a regular taxable account, where withdrawn earnings would be taxes at 15%, the long-term capital gains rate for most people.
With an HSA, you can make withdrawals at any time, and you won’t pay taxes on that money as long as you use it to cover medical costs. This can help you avoid withdrawing funds—and paying taxes—from a traditional 401(k) or IRA to cover health expenses.
For more about using HSAs a retirement savings vehicle click here to view Davis & Hodgdon Associates CPA’s white paper on this topic.
Employers also can offer Flexible Spending Accounts (FSAs), into which you and they can add pre-tax dollars to spend on out-of-pocket healthcare costs. However, FSA monies must be spent fairly quickly, so tax-saving opportunities are limited.
Saving for Education (529 Plans)
529 plans are a very familiar tool for receiving a tax break on educational costs. You fund your 529 plan(s) with after-tax dollars and those dollars can grow tax-free. The beneficiary can spend that money tax-free on qualified educational expenses.
For more information about this click here to read our recent blog post: “529 Plans – Save for Your Child’s Future and Save on Taxes”.
Saving for Giving (DAFs)
The Donor-Advised Fund (DAF) has been around for a while, but recently it has gained more attention as an effective tax planning tool. Instead of making smaller contributions, you can make a larger one to a DAF, which acts like a “charitable bank.” This is a great way to batch your deductions for tax-savvy giving because you are deducting the full amount in the year you fund the DAF. DAFs are established by nonprofit sponsoring organizations, so your entire contribution is available for the maximum allowable deduction in the year you make it. Plus, once you’ve funded a DAF, the sponsor typically invests the assets, and any returns they earn are tax-free. This can give your initial donation more “giving power” over time. Over time, and as the name “donor-advised fund” suggests, you get to advise the DAF’s sponsoring organization on when to grant assets, and where those grants will go.
For more information about tax savings charitable giving click here to read our blog series “Tax-Savvy Giving: Using a Donor-Advised Fund for Your Charitable Giving.”
Copper Leaf Financial develops wealth management plans that are tailored to you. When it comes to your finances it is critical that tax efficient strategies are woven throughout all your financial planning.
*Copper Leaf Financial, LLC is a SEC registered adviser associated with Davis & Hodgdon CPAs (“D&H”). For more than 30 years, D&H has provided comprehensive and timely planning with a proactive approach to tax services. Together, we combine comprehensive financial planning with the careful, tax-aware eye of the CPA to give clients the confidence to map out their financial goals. Our team, which includes licensed CPAs and Certified Financial Planner® professionals, brings an unparalleled understanding of how taxes impact your decisions about retirement, estate planning, investments, and insurance.
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This material has been authored by a 3rd party and CLF makes no representation and takes no responsibility for the accuracy of the information presented.