Key Takeaways
- There are three things to look for in a tax strategy: tax deductible, tax deferred, and tax free. A strategy will most likely not contain all three, but usually will have two of them.
- Four common tax strategies are 401ks, IRAs, HSAs, and 529 plans.
- Putting money away using any of these strategies can save you a lot of money over time versus saving money in other ways where they are subject to taxes
As the great architect Frank Lloyd Wright pointed out, many things in life we think are common sense, are not. This applies to tax advantaged strategies that are fairly common, but not always taken advantage of.
When we look at tax advantaged strategies, there are four that are the most common. In each of these strategies, we are looking for three things: tax deductible, tax deferred, and tax free. Rarely do we get all three in one strategy, but we can get two out of three. Let’s take a look at these four common tax advantaged strategies.
Number 1 – The 401k
Question: How much money per year would you have to put away at 7% return over 31 years to get to $100,000? Answer: $1,000 per year. A 401k is both tax deductible and tax deferred, so putting even just $1,000 away a year is a great strategy.
Number 2 – The IRA
If we again put away $1,000 per year, this time in a deductible IRA, we get the same result, tax deductible and tax deferred. The only difference with the Roth IRA is that it is tax deferred and tax free.
Number 3 – Health Savings Account (HSA)
These are available through employers with high deductible medical plans. Contributions to these accounts are tax deductible, the money in the account grows tax deferred, and funds can be withdrawn tax free.
Let’s say you currently have a low deductible plan that you pay $500 a month for. If you switch to the high deductible plan for $300 a month, you save $200 a month, or $2,400 a year. However, it’s deductible, and you are in a 25% tax bracket, so that’s equivalent to $3,200.
Since you are on a high deductible plan, you will pay more out of pocket when going in for medical care, but even if your medical costs run up to $2,200, you still have $1,000 available per year. Guess what? You get that same result with 7% return over 31 years of $100,000!
Number 4 – 529 College Savings Plan
Let’s say you have a 6-year-old, a 3-year-old, and a baby, and you want to put away $5,000 a year for each of them until age 18. If you put the money away in a 529 College Savings Plan, the investment is tax deferred and distributions are tax free for qualified expenses. In this instance, the difference in savings on that is $50,000 versus putting the money away elsewhere.
States That offer 529 College Savings Plan Tax Incentives
Map available at https://www.invesco.com/portal/site/us/investors/529-tools/529-state-tax-incentives-map
We’ve got four strategies here, three with $100,000 and the last with $50,000! This is all about making good, smart tax decisions about your money.
Until next time, enjoy.
Gary