Getting to Know Tax-Advantaged Savings Accounts
By Carla Fried
- PUBLISHED October 03
- 4 MINUTE READ
While you earn, plan and save, you face one a lot of challenges, but one is always a constant: taxes.
That’s why tax-advantaged savings accounts are key to achieving your financial goals. These accounts can help you minimize or avoid taxes while your money grows. They can also reduce or even eliminate the taxes you owe when you withdraw the money later in life.
Here are a few of the essential perks of tax-advantaged savings accounts:
You have more control over when to pay taxes in retirement
Contributions to a traditional 401(k) or IRA, come from your pre-tax income, which effectively reduces the amount of taxable income you report on your tax return. But when you eventually make withdrawals from a traditional account in retirement, every penny will be taxed as ordinary income.
With a Roth 401(k) or Roth IRA, you don’t get an upfront tax break on your contribution, but when you use the money in retirement, it will be 100 percent tax-free.
Anyone can open an IRA
A 401(k) retirement plans often offered through an employer, though not all offer them. But everyone is eligible to save in an IRA.
If you don’t have a workplace retirement plan, you can contribute to a Traditional IRA and the entire contribution can be deducted from your taxable income. In 2018, anyone younger than 50 years old can contribute $5,500 to an IRA, depending on their income. If you are at least 50 years old, the contribution limit can be as high as $6,500—so you can “catch up” on your contributions.
In 2018, individuals earning less than $120,000 and married couples filing a joint return below $189,000 can contribute the full $5,500/$6,500 to a Roth IRA.
These are a few ways you can take advantage of to keep the IRS from cutting into the progress you’re making toward your financial goals.
You can use them for more than just retirement
While you probably know about retirement plans with tax benefits, such as 401(k)s and IRAs. There are also tax-advantaged savings plans tied to other goals.
● Medical bills: If you have a high-deductible health insurance plan, you can contribute to a health savings account (HSA). Money you contribute to an HSA can be used to pay qualified health expenses today, or you can let the money grow and use it in future years. The money in the account grows tax-free, and withdrawals are tax-free, when used for qualified health care expenses.
“An HSA can be a great way to save more—tax free—for retirement,” said Elijah Kovar, a founding partner of Great Waters Financial, and advisory firm in Minneapolis, Minnesota. He notes that HSA accounts can also be used to pay for health care expenses in retirement.
● College expenses: Money you contribute to a 529 Plan is not taxed while invested, and if you use the money for a qualified education expense, including k-12 tuition, you will not owe any tax on your investment gains. You may also be able to claim a state tax deduction on your contributions.
This chart is a detailed look at tax-advantaged accounts. It is in the category "Decoded" and is titled "The Rundown: Tax-Advantaged Savings Options." In the "Health" section there are details about two accounts: Health Savings Accounts (HSA) and Flexible Savings Account (FSA). Health Savings Accounts have four details: One: Contributions through work made with pre-tax salary. Two: Contributions made outside of work are deductible. Three: Savings grow tax-deferred while invested. Four: Tax-free withdrawals at any time when used for qualified medical expenses. Flexible Savings Accounts have two details: One: Contributions made with pre-tax salary. Two: Withdrawals used to pay qualified expenses may be tax free. In the "Education" section, 529 Savings Plans have three details: One: Contribution to an in-state plan may be eligible for state tax breaks. Two: Account grows tax-deferred while money stays invested. Three: Withdrawals may be tax—free when used for qualified education expenses. In the "Retirement" section, there are five account types: Traditional 401(k), Roth 401(k), Traditional IRA, Roth IRA and SEP-IRA. For Traditional 401(k) there are three details: One: Contribution made with pre-tax salary. Two: Account grows tax-deferred while money is invested. Three: Income tax on 100% of withdrawals. For Roth 401(k) there are three details: One: Contributions made with after-tax salary. Two: Account grows tax-deferred while money is invested. Three: No tax on withdrawals in retirement. For Traditional IRA there are three details: One: ontribution may be eligible for tax deduction. Two: Account grows tax-deferred while money is invested. Three: Income tax on 100% of withdrawals. For Roth IRA there are three details: One: Contributions made with after-tax income. Two: Account grows tax-deferred while money is invested. Three: No tax on withdrawals in retirement. For SEP-IRA there are three details: One: Contribution eligible for tax deduction. Two: Account grows tax-deferred while money is invested. Three: Income tax on 100% of withdrawals.
Carla Fried is a freelance journalist specializing in personal finance. Her work appears in the New York Times, Money magazine, Consumer Reports and CNBC.com.