Taxes can easily make a deep gash in earnings, profits, revenues, or in whichever other format that you may realize additional income. However, there are ways to make that gash just a little less deep. Specifically, there are certain savings accounts that can lead to tax deferred or tax-free savings.
Breaking it Down
There are 3 major types of savings accounts that someone can use to make their tax burden a little lighter. These 3 tools include (i) an investment retirement account (an IRA), (ii) a 401k and (iii) a health savings account (an HSA).
- Investment Retirement Account (IRA) – An IRA is an account designed to build retirement savings. It is essentially a savings account that can be used to purchase investments such as mutual funds, stocks and private equity and debt investments. On the tax savings end, it provides a way of deferring tax dollars. If you set up a traditional IRA, contributions are tax deductible up to IRS imposed limits, and income taxes are not owed until withdrawal of funds. If you set up a Roth IRA, although contributions are not tax deductible, you can withdraw money tax-free in retirement.
- 401Ks – With a 401K, an employer contributes a set amount. Like a traditional IRA, you don’t pay taxes on the amount until it is withdrawn. Also like a traditional IRA, there is a maximum amount that may be contributed; however, this maximum amount is significantly higher than that the IRS imposed limits for an IRA.
- Health Savings Account (HSA) – An HSA is a medical savings account available to persons with a high deductible health plan. Funds contributed are not subject to federal income tax, and all funds withdrawn for medical expenses are tax-free.
Although the above are the most common savings accounts that carry the tax benefit advantages, there are also other, less discussed retirement plans, and variations on the 3 above, that also carry tax advantages. These include:
- Simplified Employee Pension Plan (SEP Plan) – An SEP Plan is a traditional IRA owned by the employee but set up by the employer. These can also be used by the self-employed. Contributions are tax-free until distributed.
- 403(b) – A 403(b) plan is a plan similar to a 401k plan but is offered to employees by non-profit groups, public schools and other tax-exempt organizations. It is a tax-sheltered annuity where income from investment is tax-free until distribution.
- 457(b) – A 457(b) plan is only offered by state and local governments and certain tax-exempt organizations. With a 457(b) plan, employees can contribute through payroll deductions, contributions are not taxed until distribution and any earnings are tax-deferred. This plan is referred to as a deferred-compensation plan.
- Designated Roth Account – A designated Roth account is a separate account created under a 401(k), 403(b) or 457(b) plan where money is contributed from taxed income. With a designated Roth account, qualified distributions are tax-free.
- Defined Benefit Plans – A defined benefit plan is a is a traditional pension plan established by an employer where contributions are made by employers and may or may not be made by the employee. Contributions are generally tax-free, and distributions are annuities, a portion of which may be taxable, depending on factors such as total income.
- Profit Sharing Plans – Employer contributions to a profit sharing plan are considered tax-free income for employees. Only employers may voluntarily and in their discretion make contributions to a profit sharing plan. Any withdrawals made by an employee from a profit sharing plan are taxable income with an additional 10% tax penalty which may apply before the age of 59 ½.
- Money Purchase Plan – Unlike a prof it sharing plan, employer contributions to a money purchase plan are set contributions, and employees may or may not contribute. Contributions are generally tax-free, distributions are taxed and early withdrawals are not permitted.
Of course, there are many more tax advantages that you can take through the structuring of your personal and business assets and investments. The above just scratches the surface and primarily focuses on retirement accounts. Both a CPA and an attorney are recommended to help you set up the right tax structure for your assets and investments. Please call Dodson Legal Group at 844-4DODSON for a consultation to discuss legal structures suited to the protection of your assets and investments.