Put More Money In Your Pocket, Not Uncle Sam's

Taxes are everywhere—federal, state, retail, investment, estate—and they can easily eat up over 50% of your income. That’s more than half your money going in Uncle Sam’s pockets.

Wouldn’t you like to keep more of your money in your own pockets?

Luckily, there’s a way to do just that: use tax shelters.

Now I’m not suggesting you fly to the Caymans to open a secret off-shore bank account. The tax shelters I’m talking about are completely legal. In fact, our own politicians created these special account types. The idea is to encourage investors like you and me to save money by offering us certain tax benefits.

To find out which shelters are the most common and what you need to consider when selecting one, read on. I’ll even tell you about the most widely misunderstood option, and why it’s also the best tax shelter of all.

Save Taxes Now - Tax-deferred 401(k)s and Traditional IRAs

The advantage of a 401(k) or traditional IRA is that you can save on taxes now and grow money tax-deferred. The downside is that you’ll pay taxes on this money upon withdrawal. In fact, once you turn 70½, the law requires you to start taking this money out. 

Today many companies offer a 401(k) plan and most match the first 3% - 6% of your contributions. Between the company match and the tax savings, contributing at least up to the match is a no-brainer. For those who don’t have a 401(k) at work, the traditional IRA or a self-employed IRA offers similar tax advantages. Just be sure your CPA gives you the green light before proceeding as income limits do apply.

Lastly, keep in mind that a 401(k) or IRA is a retirement savings tool. That means, with a few exceptions, you won’t be able to take this money out before age 59½. If you do, you’ll pay a 10% penalty.

Save Taxes Later - Roth IRAs

A Roth IRA lets you save after-tax money now, so you can let it grow tax-deferred and never pay taxes on that money again if you play by the rules on withdrawal. 

The real beauty is that it lets you take advantage of a lower tax rate now than you may have in retirement. Often this is the best option if you are younger, starting out in your career, or experiencing low income due to a layoff.   

What most people don’t know about the Roth IRA is that the after-tax money you contribute—what a tax professional calls your “basis”—can be accessed before age 59½ without paying a penalty. But this only applies if the Roth has been open for at least 5 years.

More Ways to Save Taxes Later - 529 Plans

529 plans—the education “gold standard”—offer tax savings for money that will be used in the future for qualified college education expenses. This includes tuition, room and board, and books. Like the Roth, you put after-tax money aside today that grows tax-deferred over many years. 

You can even move this money between family members or use it for yourself. Plus, the accounts never expire.

Save Taxes Now and Later - Health Savings Accounts

The health savings account (HSA) is a tax shelter that is both widely misunderstood and your most appealing option. That’s because it lets you save on taxes now AND later!

This type of account lets you save money for medical expenses over your lifetime. Here’s how it works:

·         You become eligible when you enroll in a high-deductible health medical plan (with a minimum annual deductible of $1,300 for individuals and $2,600 for a family).

  • There are annual contribution limits: $3,350 for individual plans and $6,650 for a family plan. 

  • Individuals over 55 can contribute another $1,000/year for catch-up. 

  • If you’re under 65 and withdraw money for a non-medical use, taxes and penalties will apply. If you’re under 65 and use HSA funds for medical expenses such as co-payments, deductibles, and other non-covered expenses, then taxes and penalties don’t apply. This makes these plans more age flexible than the retirement plans mentioned previously. 

  • HSA money can be used to pay for Medicare premiums in retirement or for insurance premiums while on COBRA.

    The money rolls over from one year to the next. 

Since many retirees will spend 30% or more of their income on medical expenses, having a sizeable HSA account as you enter retirement can be a very smart financial move. And it will save on taxes now, too, as a deduction from your current income.  

How to Get Started

Tax savings abound if you’re willing and able to shelter your money. But you need to act fast. Many of these options with annual limits in essence “expire” at the end of the year, meaning you can participate next year, but the annual amount of $18,000 in a 401K for this year of your life expires. As with many aspects of money management, procrastination is not your friend.   

Here’s what you need to do:

  • Consult an HR professional for help with logistics.

  • Discuss the options with your CPA, preferably before the 2016 tax season hits so there’s time to process the paperwork.   

Using tax shelters can help you keep more money in your pocket and set yourself up for a stable financial future. Happy saving!


All suggestions above are based on current tax law and are subject to change. Investing involves risks. This article is not intended as tax advice. Please consult with a CPA for your particular situation.