June 1, 2015 3:20 pm

Let Uncle Sam Help You Save for the Future

There are many current needs—health care premiums; mortgage payments—that use up our hard-earned dollars, making it challenging for many people to save money for future needs. Fortunately, Uncle Sam can help by providing tax breaks supporting certain types of savings for education, retirement, and health care.

Education savings

Consider using a special education savings vehicle—a 529 savings plan or Coverdell education savings account—to set aside money for education. While there’s no federal tax deduction for making contributions (there may be state income tax deductions or credits), earnings grow on a tax-deferred basis and withdrawals for qualified education expenses are tax free. Watch for contribution limits:

  • 529 plans. Limits are set by the plan and vary from state to state. The limits are fixed for a lifetime (i.e., per beneficiary) and can range up to $400,000 or more. As a practical matter, however, a contribution in any one year for a beneficiary is limited because of federal gift tax rules. A contribution to a 529 plan is free from federal gift tax only up to five times the annual gift tax exclusion (e.g., for 2015 it is $70,000, which is five times $14,000) unless the contributor wants to use up some of his/her lifetime exemption amount (e.g., $5.43 million in 2015).
  • Coverdell ESAs. Annual contributions on behalf of a beneficiary are capped at $2,000. And there are income limits that curtail who is eligible to make contributions.

Retirement savings

Social Security, which is forced savings for retirement, may not provide the type of retirement income you hope for. To ensure a secure financial future, you should save through a qualified retirement plan. Tax incentive can help:

  • 401(k) or similar plan. While an employee’s contributions are not deductible, they are excluded from income, producing current tax savings (self-employed individuals who, by definition, don’t have salary from which to make a contribution, can deduct contributions they make to a 401(k) plan). There is no tax on earnings while your money is in the plan; you’ll be taxed on distributions.
  • IRAs. If you aren’t covered by a qualified retirement plan or, if covered, your income is below set limits, you can make tax deductible contributions to your IRA. Earnings are tax deferred; distributions are taxable.
  • Roth IRAs. Contributions aren’t tax deductible, but earnings can grow and become tax free. What’s more, there are no required lifetime distributions, so if you don’t need the savings for your retirement, you can leave them to heirs.

Note: If your income is below set limits, you may also qualify for the retirement saver’s credit.

Health care savings

Today’s health insurance policies don’t cover everything; in addition to premiums you’re responsible for co-payments, deductibles, and expenses excluded from the policies. To cover your out-of-pocket expenses, consider a health savings account (HSA). These plans allow for annual tax-deductible contributions. Earnings on contributions are tax deferred, and distributions for qualified medical expenses (which don’t include premiums) are tax free; only distributions for non-medical purposes are taxable. HSAs can only be used if you have a high deductible health plan (HDHP), which is usually a bronze plan in the parlance of the government exchanges.  Note: Once you turn age 65 and qualify for Medicare, you are no longer eligible to fund an HSA.

Conclusion

Take advantage of tax breaks to help you save for the expenses you may face in the future. You don’t have to save up to the annual contribution limits; you can save annually just as much as you can afford.

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Tax Glossary

Annualized rate

A rate for a period of less than a year computed as though for a full year.

More terms