Tax Planning in Turbulent Times – Part 1: The Tools of the Tax-Planning Trade

The good and bad news about saving for retirement is how many tax-favored savings accounts exist for this purpose. There are a number of employer-sponsored plans, like the 401(k), 403(b), and SIMPLE IRA. There also are individual IRAs you establish outside of work. For both, there are traditional and Roth structures available.

In any of these types of retirement accounts, your dollars have the opportunity to grow tax-free while they remain in the account. This helps your retirement assets accumulate more quickly than if they were subject to the ongoing taxes that taxable accounts incur annually along the way (such as realized capital gains, dividends, or interest paid).

Tax treatments for different types of retirement accounts can differ dramatically from there. You can make pre-tax contributions for some, but withdrawals are taxed at ordinary income rates in the year you take them. For others, you contribute after-tax dollars, but withdrawals are tax-free—again, with some caveats. Each account type has varying rules about when, how, and how much money you can contribute and withdraw without incurring burdensome penalties or unexpected taxes owed.

The Healthcare Savings Account (HSA) offers a rare, triple-tax-free treatment to help families save for current or future healthcare costs. You contribute to your HSA with pre-tax dollars, HSA investments then grow tax-free, and you can spend the money tax-free on qualified healthcare costs. That’s a good deal. Plus, you can invest unspent HSA dollars and still spend them tax-free years later, as long as it’s on qualified healthcare costs. But again, there are some catches. Most notably, HSAs are only available as a complement to a high-deductible healthcare plan to help cover higher expected out-of-pocket expenses.

Employers also can offer Flexible Spending Accounts (FSAs), into which you and they can add pre-tax dollars to spend on out-of-pocket healthcare costs. However, FSA funds must be spent relatively quickly, so investment and tax-saving opportunities are limited.

529 plans are among the most familiar tools for catching a tax break on educational costs. You fund your 529 plan(s) with after-tax dollars. Those dollars can then grow tax-free, and the beneficiary (usually, your kids or grandkids) can spend them tax-free on qualified educational expenses.

The Donor-Advised Fund (DAF) is among the simplest but still relatively effective tools for pursuing tax breaks for your charitable giving. Instead of giving smaller amounts annually, you can establish a DAF and fund it with a larger, lump-sum contribution in one year. You then recommend DAF distributions to your charities of choice over future years. Combined with other deductibles, you might be able to take a sizeable tax write-off the year you contribute to your DAF—beyond the currently higher standard deduction. There also are many other resources for higher-end planned giving. For these, you’d typically collaborate with a team of tax, legal, and financial professionals to pursue your tax-efficient philanthropic interests.

There are also various tax-friendly incentives to facilitate general “rainy day fund” saving and offset crisis spending. These include state, federal, and municipal savings vehicles, along with targeted tax credits and tax deductions.