December 1, 2021

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

Whether you are saving, investing, spending, bequeathing, or receiving wealth, tax implications will likely follow. As such, proposals for higher taxes with little certainty on what may come of them can be nerve-wracking.

While the landscape is ever-changing, there are always tax breaks to encourage us to save toward our major life goals such as retirement, healthcare, education, emergency spending, charitable giving, and wealth transfer. It is our job to help you use these “tools of the trade.” Today, we will take a look at some of the most familiar tax breaks available. Next week, we will cover how they fit across greater wealth goals.

Saving for Retirement 

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.

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, encouraging growth by avoiding tax on realized capital gains, dividends, or interest paid.

Tax treatments for different types of retirement accounts can differ dramatically from there. For some, you can make pre-tax contributions, 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.

Saving for Healthcare Costs (HSAs)

The Healthcare Savings Account (HSA) offers a rare, triple-tax-free opportunity to help families save for current or future healthcare costs.

The mechanics are simple—you contribute to your HSA with pre-tax dollars. HSA investments then grow tax-free, and you can take tax-free withdrawals to spend the money on qualified healthcare costs. Plus, you can invest unspent HSA dollars, and still spend them on qualified healthcare costs (tax-free) years later. 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), where you 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.

Saving for Education (529 plans)

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.

Saving for Giving (DAFs)

Last but not least, a bounty of trusts, insurance policies, and other estate planning structures help families leverage existing tax breaks to transfer their wealth to future generations.

Saving for Heirs

The Donor-Advised Fund (DAF) is among the simplest 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—exceeding the current standard deduction.

We're Here to Help

With recent negotiations over the tax treatment on inherited assets, the time is coming to revisit your estate plan. In fact, whether times are turbulent or tame, there is always an array of best practices we can aim at reducing your lifetime tax bills by leveraging available tools to maximum effect.