Financial Advice On Tax Advantaged Accounts

Summary

• The shining gem of this account is the double tax advantage. It is available to anyone covered under a high deductible health plan.
• The 529 Plan is used for educational savings and has some flexible features. It is available to all regardless of income.
• The IRA is really the equivalent to the 401K with it’s pre-tax dollars and tax-free growth until distribution.
• Finally, “Back Door” Roth IRA: This is a loophole that has been around for many years as long as you, or your financial advisor, are willing to do some administrative work.

With tax season upon us, we are all thinking of ways to maximize tax deductions and increase our savings. Utilizing tax advantaged accounts is one of the best ways to keep your dollars funneled to where you want them to go. Here are four keys account types that everyone can use, well, almost everyone: The Health Savings Account (HSA), the 529 Plan, the IRA, and the “backdoor” Roth IRA.

Health Savings Account (HSA)

The shining gem of this account is the double tax advantage. It is available to anyone covered under a high deductible health plan. You can put in pre-tax dollars up to $3600 for singles and $7200 for families (2021), invest, let it grow tax-free, and when taken out to be used for medical purposes there is no tax! The secret is to choose a high deductible plan with your employer and maximize your contribution every year.

529 Plan (Educational savings)

The 529 Plan is used for educational savings and has some flexible features. It is available to all regardless of income. The limit on contributions varies from state to state but ranges from $235K to $529K. While your initial contributions are not tax deductible, any growth is tax-free as long as distributions are used for educational expenses. Many people think of this fund as only useful for parents who want to save for their child’s college education, but, a 529 can fund elementary and high school tuition as well as college tuition and room/board. Best yet, if the beneficiary does not use the full amount, it can be changed to someone else in the immediate family such as a parent or sibling.

Individual Retirement Account (IRA)

The IRA is really the equivalent to the 401K with it’s pre-tax dollars and tax-free growth until distribution. The benefit to this account over a 401K is the much greater investment options and oftentimes lower fees, especially if you are no longer working for the employer who offered the 401K. This account is available to anyone if rolling over from a 401K and to most if opening a new account without a rollover. Contributions to this account are tax deductible, but completely phased out at income levels exceeding $76,000 (in 2021) for single filers and $125,000 (in 2021) for joint filers. Rollovers are always permitted regardless of income.

Finally, “Back Door” Roth IRA.

There is an income limit to contribute to a Roth IRA. Single people with a 2020 adjusted gross income (AGI) that’s greater than $140,000, and married couples filing jointly who made more than $208,000, cannot make a direct contribution to a Roth IRA. Backdoor Roth IRA conversions let you circumvent these limits. This is a loophole that has been around for many years as long as you, or your financial advisor, are willing to do some administrative work.

A backdoor Roth IRA works like this: You open a new traditional IRA, make nondeductible contributions to it (where there is no income limit), then convert it into a Roth IRA. Then, anyone can convert traditional IRAs to Roth IRAs, regardless of annual income size. Now, you have tax advantaged investment growth for the rest of your life!

Sarah & Ujae Kang

Founders of UAK Diversified Wealth Management

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