Place your eggs, er, money into different tax baskets
Sunday, March 31, 2013
I hope it's been, and continues to be, a wonderful day, regardless of how you celebrate this Sunday.
If you have young kids, you likely have been dying eggs, hunting eggs and now are looking for ways to consume the eggs.
It's also a good time to think about taxes, not only your current tax return, which is due in just a couple of weeks, but also some tax planning.
Photo by Gabriele Corno
So on this egg-centric day, today's Daily Tax Tip looks at ways to spread your tax planning eggs across different baskets.
Specifically, you should examine ways to take advantage of tax-deferred, tax-free and taxable accounts. Each offers advantages for different times of your life and/or your personal financial situations.
You are probably most familiar with these from retirement accounts, such as traditional IRAs and traditional 401(k) workplace plans, also known as as 403(b) plans for workers at nonprofits and 457(b) plans for government employees.
You put money into these accounts before taxes are calculated. That means you get a bit of tax savings up front. And if you can deduct your contribution to a traditional IRA, you cut your tax bill more.
Flexible spending accounts (FSAs) also offer tax savings now. You side part of your paycheck via payroll deductions before taxes are taken out. Then you use the FSA money to pay eligible health care expenses such as office visit and prescription drug copays, braces, glasses, contact lenses, Lasik surgery and the like.
A Health Savings Accounts (HSA) also lets you to set aside non-taxable income to pay for your eligible health care expenses. But in order to participate in an HSA, you must meet certain criteria.
IRS Publication 969 has info on FSAs, HSAs and other tax-favored medical savings options. IRS Publication 502 has details on eligible medical expenses. And you also should check out an FSA calculator or HSA calculator to see what the plans might mean to you.
If you're looking for a tax break today, then look into pretax accounts. The tax-deferred retirement savings are especially good if you expect you'll be in a lower tax bracket once you leave the 9-to-5 grind.
Never owing tax is ideal. A couple of retirement accounts offer this goal.
With a Roth IRA or Roth 401(k) workplace savings account, you won't have to pay taxes on the money, both your contributions and their earnings, when you take it out in retirement.
But to get that benefit, you put already taxed money into the Roth plan.
Roth accounts typically are the retirement plan of choice for younger workers. They also are appealing if you anticipate being in a higher tax bracket in the future or are just worried that taxes will go up in the future.
With a Roth IRA, you also can get to your money sooner. You can tap your Roth contributions at any time without paying any penalties.
While a Roth IRA shouldn't be viewed as an emergency savings account (you need to set up a separate such account for unexpected expenses), it is handy if you truly do find yourself in a dire financial situation.
There's also a tax-free account for college costs.
Every state has a 529 savings plan to help cover ever-increasing higher education expenses. Your contributions to a 529, and you can pick one in another state if it works better for your school plans, are not tax deductible on your federal tax return. But investment in the plan grows tax-deferred, and distributions to pay for the beneficiary's college costs come out federally tax-free.
The tax-free treatment was made permanent with the Pension Protection Act of 2006.
Yes, taxable accounts do have a place in your financial world. Everyone needs money outside of retirement accounts, such as for the emergency situations noted earlier.
CDs or money market funds, while offering paltry interest rates right now, are easily accessible for immediate or short-term needs. The earnings on these investments are taxed at your ordinary income tax rate.
But for goals down the road, consider equity investments. Yes, I know the market is booming, meaning that you'll be buying in high. The market will, however, go down; then up again; then down again.
If you're investing for the long term, those ups and downs will sort themselves out. And if you reinvest your earnings, you'll end up buying some more holdings at lower (and, OK, higher; remember that sorting out deal) prices.
The best thing, though, is when you do cash in your long-term assets -- those are the ones you've owned for more than a year -- you'll pay lower capital gains tax rates.
So consider spreading your eggs money across these three tax baskets. It will better serve your many financial needs and should help with your tax bills, too.You also might find these items of interest:
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