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Overlooked Tax Planning Opportunities

August 27, 2018

I am frequently asked about various tax saving ideas and schemes.  Often these ideas are overheard at cocktail parties, read on Facebook or from a cousin’s neighbors accountant.  The reality is that most of these schemes are not real and often are illegal.  There really are no magic bullets and if it sounds too good to be true….  That does not mean there aren’t underutilized tax savings strategies.  These are a few of those that I feel are worth further exploration:

ROTH IRAs

Most clients contribute to a 401(k) or similar retirement vehicle through work and often think that is all they can do.  In fact, taxpayers can always, always, always make IRA contributions (assuming the taxpayer has sufficient earned income).  That IRA contribution may not be tax deductible but is still always allowable.  One flavor of IRA is the ROTH IRA which disallows a deduction on the contribution but future qualifying withdrawals are tax free…even the growth!  So if you made one $6,500 contribution that grew to $20,000 over time, the growth of $13,500 is never taxed (again assuming distributions are qualifying).  That could produce a huge tax free windfall in retirement to supplement other income streams.  ROTH IRAs are especially attractive for young investors or those that are earning substantially less than they expect to earn in future years.  If you are ineligible to make ROTH contributions, there are legal ways to make “back door” contributions as well.

Health Savings Accounts (HSA)

Arguably the least understood and most tax beneficial contribution type is to a HSA.  Assuming the taxpayer qualifies, the contribution is tax deductible but any qualifying distribution (basically for medical purposes) is tax free.  Nowhere else in the tax code does a taxpayer receive a tax deduction at the point of contribution and never pay tax on the distribution.  HSAs are NOT “use it or lose it” accounts.  Rather, unused HSA balances are carried forward and eligible for future use.  I’ve seen various studies that state that a large portion of an individual’s lifetime medical expenses come in the last 36 months of their life.  Having potentially tax-free funds at your disposal is a huge benefit for those that have accumulated a HSA balance.  And if you are secure in your medical costs through retirement, HSA funds can be withdrawn after 65 for disqualifying distributions (basically non medical purposes) with the individual paying taxes on those distribution much like a standard IRA distribution.  If you are eligible for HSA contributions, I STRONGLY encourage their usage.

529 Plans

I wouldn’t say 529 plans are misunderstood so much as underutilized.  The basics are that contributions are made and any growth is never taxed (assuming funds are used for qualifying education purposes).  Qualifying expenses include:

  • Tuition
  • Room and Board (paid directly to the institution)
  • Technology Items
  • Books and Supplies

Anyone with a teenager knows how incredibly expensive college costs have become.  A new bonus: 529 proceeds may be used for private high school or elementary schools with the same tax free benefit.

In addition to the future benefit, many states offer a state tax deduction in the year of contribution.  Generally the contribution must be to the plan adopted by the state the taxpayer lives.  For example, if I make a contribution for one (or both) of my daughters and utilize the MD College Savings Plan (managed by T Rowe Price) I receive a deduction on my MD resident income tax return.  Roughly 30 other states have similar deductions including PA, NY and VA.  This can be especially attractive for a grandparent who wants to fund multiple grandchildren’s 529s in a single year.

These are 3 of the bigger tax advantaged vehicles that I see clients overlook.  If you would like to discuss these further, please do not hesitate to contact us.