Don't Mess With Taxes

Happy Easter weekend to all who celebrate.

I've always enjoyed the more secular activities, like my neighborhood's annual Easter egg hunt. I always get a kick out of watching the youngsters scramble to fill their baskets with colorful eggs.

Today’s hunts feature multi-hued plastic eggs, which is a good change from the targets of my childhood.

I still remember finding stinky spoiled real, dyed eggs that were overlooked during the original quest. And yes, in my (geezer alert!) day, parents actually hid the eggs, instead of just scattering them across open areas. I also remember my mother not being thrilled when I brought the old eggs home.

My Easter nostalgia also got me thinking about how an egg-cellent (sorry, not sorry) old saying can apply to developing a personal tax strategy.

I’m talking about not putting all your eggs, er, tax breaks into one basket. Instead, take advantage of using a variety of tax-advantaged planning baskets.

Specifically, examine ways to maximize tax-deferred, tax-free, and taxable options. Each offers benefits for different times of life and/or your personal financial and tax situations.

Tax-deferred advantages: You are probably most familiar with these from retirement accounts, such as traditional IRAs and traditional 401(k) workplace plans, also known 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 by claiming the amount as an above-the-line deduction on your tax return.

The tax deduction is a big lure. But eventually you’ll have to pay tax on the contributions and earnings. In a traditional IRA, this means required minimum distributions, or RMDs. That still could work if you are in a lower tax bracket when you start taking money out of a tax-deferred retirement account.

Tax-free is always good: Those future tax bills are why many people opt for tax-free retirement plans. That’s what you’ll get in a Roth IRA or Roth 401(k) workplace savings account.

With the Roth versions, your contributions are made with already-taxed dollars, so you won't have to pay taxes on the money, both contributions and their earnings, when you take it out in retirement.

Roth accounts typically are the retirement plan of choice for younger workers, who get the benefit of tax-free growth throughout their lifetime. Roth IRAs and 401(k)s 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 already-taxed Roth contributions at any time without paying any penalties. And you won’t face RMDs when you’re older.

If you have a traditional IRA, and are dreading the eventual tax bill, you can convert it to a Roth. You don’t have to move all the tax-deferred money at once. You can do a partial conversion.

You also can move some traditional IRA to a Roth IRA in a year when you’re a lower tax bracket. That will mean that the tax you must pay on converted traditional IRA funds won’t be as much of a financial burden.

There also are tax-free account options for medical and educational purposes.

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, grow tax-deferred. However distributions to pay for qualifying college costs are federally tax-free.

Over the years Congress has expanded the funds' uses beyond eligible college costs. They now can help pay expenses incurred for K-12 classes, as well as cover apprenticeships and student loan repayment.

On the health care front, there are a couple of similar tax-free accounts.

Flexible spending accounts (FSAs) are workplace benefits where you set aside part of your paycheck via payroll deductions before your paycheck’s taxes are calculated. Then you use the FSA money, with no additional cost to you, to pay eligible health care expenses. These are such things as doctor 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, notably having a high deductible health plan (HDHP).

In addition, HSA offer other tax benefits noted in my post HSAs, the champion when it comes to tax break multitasking.

Taxable accounts still valuable: Taxable accounts do have a place in financial and tax plans. Everyone needs money outside of retirement accounts, such as for the emergency situations noted earlier.

CDs or money market funds 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 especially scary right now, careening day to day depending on Trump administration tariff whims. But there are some bargains for those looking for assets they will hold for the long term.

And long-term is the key. Not only will that extended time period offer you some cushion against inevitable future market ups and downs, it could help in the end if you automatically reinvest earnings. Over the years, those who’ve held assets during market fluctuations tended to come out ahead of those who sold in down markets and then bought later after things stabilized.

But your patience is really rewarded when you ultimately cash in your long-term assets, which are those you've owned for more than a year. You'll pay lower capital gains tax rates on any of those sale profits. That means a tax of 0 percent, 15 percent, or 20 percent depending on your tax bracket, instead or ordinary taxes that range from 10 percent to 37 percent.

So, consider including these three baskets that offer different tax advantages. Utilizing them in tandem and adjusting as your lifestyle, financial needs, and tax circumstances change should serve you well.

You also might find these items of interest:

• Tax Day is done. Now what? Plenty!
• Tax-saving HSA & HRA contribution limits go up in 2025
• Law changes, inflation boost benefits of tax-favored retirement plans, especially for older workers

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