Wealth planning can be fluid and complex, and retirement savings programs can provide advantages at different points in a taxpayer’s life. However, as the truism goes, “Nothing can be said to be certain, except death and taxes.” Before a taxpayer passes away, that person should explore strategies that could lower payment obligations while simultaneously saving for retirement.
While obvious strategies are, well, obvious — pay yourself first by participating in a qualified retirement plan and max out contributions, especially if there is an employer match — there are intricate programs and approaches that can mitigate tax exposure within retirement plans and wealth management accounts.
These three strategies take significant planning and exacting execution to ensure that taxpayers can take full advantage of their benefits.
The HSA triple play
Health savings accounts (HSAs), the companion savings plan for high-deductible health plans, pack a triple-tax benefit not seen in any other savings program. First, there is the upfront deduction, as contributions reduce taxable income. (Be mindful of limits based on marital status and age.)
Second, the earnings on HSA funds grow tax-deferred. Additionally, HSA funds can be invested, making them more dynamic than a traditional savings account, though not everyone takes advantage of this opportunity. The Employee Benefit Research Institute reported that only 12% of HSA funds were invested in 2021.
Finally, withdrawals are tax-free if they are used for qualified medical expenses. Also, at a certain age, based on several factors, the funds can be withdrawn for nonmedical expenses without penalty.
The added benefit of an HSA is that contributions can accumulate, and there is no annual “use it or lose it” component like financial savings accounts (FSAs) and other medical expense savings accounts.
529 plans
College is expensive and tuition climbs every year. The cost of in-state tuition and fees at public national universities has increased by about 56%, when adjusted for inflation, in the past 20 years, according to U.S. News & World Report. Congress created 529 plans decades ago to help save for the cost of higher education. However, the program has benefits beyond financing tuition.
Contributions to a 529 plan grow tax-free, and withdrawals for qualified educational expenses are not taxed. In addition, any remaining unused funds can be transferred to another qualified family beneficiary — including siblings, grandchildren or parents — without tax consequences.
There’s also an investment benefit to a 529 plan. As of this year, unused funds can be rolled over into a Roth IRA for the current beneficiary without penalty or additional taxes. There are limits and other restrictions, so check with an adviser on the rules.
The back door and the mega-back door
Most financial advisers are aware of back-door Roth IRA contributions, which allow individuals to participate in a Roth IRA even if they exceed the allowable income limit. Roth IRA contributions are currently limited to $7,000 per individual ($8,000 for those over 50). The funds grow tax-free, and withdrawals in retirement are not taxed.
So what makes the so-called mega-back-door Roth such a big deal? The high elective deferral limit is currently $69,000 (or $76,500 for those 50 and older), allowing some retirement plan participants to defer significant after-tax dollars to a traditional retirement plan and then convert those contributions to a Roth.
It’s an investment strategy that advisers working with high-income-earning clients, especially those older than 50, may find a valuable option in providing additional tax savings for those who qualify.
While the current tax season has ended, it’s never too late to implement one of the above strategies to help clients pursue a tax-efficient method of saving for retirement. It is always good to revisit potential strategies in case a client’s income or situation has changed.