Tax Planning Opportunities
There are several tax planning opportunities within the topics covered in this chapter. Table 4.4, “Tax Advantaged Retirement, College, and Health Accounts” at the end of this section covers the various tax-advantaged savings accounts.
Best tax avoidance tactic available to taxpayers is retirement savings. Taxpayers can take advantage of the benefits provided in the tax law by investing in retirement plans.
Whether it is a deductible IRA, Roth IRA, 401(k), or other plan, the funds invested in the plans earn money tax free until withdrawn. With a Roth IRA, all funds are withdrawn tax free and with other plans, taxpayers can recoup their investments in the plans tax free. Employees, who have employers that contribute to the employees’ plan, need to take advantage of this free money.
Deduction for education expenses. Since this chapter did not cover all the ways education expenses could benefit a taxpayer, we will postpone the discussion of tax planning until after Chapter 6, Special Tax Issues and Tax Credits of this text.
Use tax benefit to pay for health costs. Many individuals go without health insurance but employees and the self-employed can use the tax deduction for Health Savings Accounts and self-employed health insurance to provide medical coverage for themselves and their families.
Example
Stan is self-employed. He buys a health insurance plan for himself and his wife and two children. The monthly cost is $400. Stan and his wife file jointly and they are in the 28% tax bracket. Stan’s net cost for health insurance is ($400 × 12) × .72 = $3,456 or $288 per month.
Example
Laura is an employee and her employer provides for catastrophic health insurance coverage at no cost. Laura, however, wants to have better coverage for herself and her young children so she takes advantage of the HSA arrangement established by her employer. Laura deposits $50 per week to the plan. For the year, Laura deposited $2,600 ($50 × 52 weeks). Since Laura is in the 25% tax bracket, her net out-of-pocket cost for the HSA is $1,950 ($2,600 × 75%) and when she withdraws funds for medical expenses, the amounts are tax free.
Table 4.4. Tax Advantaged Retirement, College, and Health Accounts
| Tax Advantaged Account | Highlights | 2008: Maximum Contribution | Eligibility | Features |
|---|---|---|---|---|
| Pretax 401(k) | Similar rules apply to 403(b) accounts for employees of nonprofits & 457 accounts for government employees | $15,500; $20,500 if 50 or older | Your employer must offer. Some plans limit contributions by higher income earners. | Pretax dollars go in; withdrawals, usually mandatory after 70½, taxed as ordinary income. Loans of up to $50,000 usually allowed. |
| Roth 401(k) | Similar rules apply to 403(b) accounts for employees of nonprofits | $15,500; $20,500 if 50 or older | Your employer must offer. No income limits. Contribution limit combined with pretax 401(k). | After tax dollars go in; withdrawals in retirement are not taxed. Roll to Roth IRA at retirement to avoid mandatory withdrawals. |
| Deductible IRA | $5,000; $6,000 if 50 or older | Singles eligibility phases out above $53,000, couples’ above $85,000, nonworking spouse above $159,000. No contributions after 70½. | Pretax dollars go in; withdrawals, usually mandatory after 70½, taxed as ordinary income. Penalty-free withdrawals for first home and college expenses. | |
| Roth IRA | $5,000; $6,000 if 50 or older | Singles’ eligibility phases out above $101,000; couples’ above $159,000. No age limit for contributions if working. | After tax dollars go in; withdrawals in retirement are not taxed and not mandatory. Can withdraw original contributions anytime without tax or penalty. | |
| Nondeductible IRA | $5,000; $6,000 if 50 or older | No income limits. No contributions after 70½. | Withdrawals are mandatory after 70½. Earnings withdrawn are taxed. | |
| 529 State College Savings Plan | $300,000 plus per child in many states. | No income limits. | No federal deduction for contributions; some states allow deductions for residents. Withdrawals for college tuition and expenses are tax free. | |
| Health Savings Account | $2,900 for individuals; $5,800 for family. | No income limits. Must have qualified high-deductible medical insurance plan. | Pretax money goes in. Withdrawals for medical expenses and retirement are tax free. |
