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Opinion: Tips to a tax-efficient retirement

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Nobody enjoys paying taxes. The necessity is clear, but it makes sense that no one wants to pay more than their fair share each year. The good news is there are multiple ways for you to reduce your tax liability while also saving for retirement. Proper planning throughout your lifetime can help you achieve adequate retirement savings in a tax-efficient manner.

Employer-sponsored retirement plans
Employer-sponsored retirement plans are some of the most effective ways to not only save for retirement, but also to reduce your tax liability. Using plans like a 401(k), 403(b) and certain individual retirement accounts allow you to set aside income from your paycheck to be invested for your future use. The contributions made to employer-sponsored plans can be a direct reduction of your taxable income, and earnings in the account grow tax-deferred. This means tax savings in the year in which you make contributions, as well as delaying taxation of gains you may have in your account, as those monies grow in value over time.

Many plans also have started to allow for different types of contributions in regard to taxes, predominately with the introduction of Roth IRA contribution options. This gives employees additional choices that may be more beneficial based on their personal tax situation, goals and objectives.

Traditional vs. Roth 
As mentioned, there are two main paths you can choose in regard to retirement savings with respect to taxes: traditional or Roth. Traditional retirement plans and IRAs reduce your current taxable income. These contributions – in addition to the investment gains – grow tax-deferred, remaining untaxed until distributions are taken later. For many, these immediate tax savings come during your prime earning years and, therefore, at a time in which you are in a higher tax bracket than you might be in retirement.

Roth contributions, named for former Sen. William Roth, are the opposite of traditional contributions. These contributions are made with post-tax monies that also grow tax-free. Unlike traditional distributions, these can be made without taxation. This can be an effective tool for individuals in lower tax brackets who are just breaking into the workforce

Health savings account
Health savings accounts are some of the most underused tax-saving tools currently available to retirement savers. HSAs allow individuals to set aside money for the purpose of paying qualified medical expenses. These accounts function similarly to traditional IRAs in that contributions reduce current taxable income. Contributions also can be invested if not being actively used, and they grow tax-deferred. The key difference is that distributions are tax-free if they are used for qualified medical expenses. This can be a great way for individuals and families to set aside money for medical expenses both planned and unexpected.

Many employers have started offering HSAs as part of their benefit plans. This allows employees to have money taken directly from their paychecks – much like a 401(k) – and deposited into an HSA on their behalf. Even if your employer does not offer this benefit, anyone is eligible to contribute as long as they are enrolled in a high-deductible health plan.

529 plans 
Saving for college and post-secondary education expenses is one of the top concerns of working parents, as well as grandparents. A 529 plan can be an effective way to pay for your child’s future education. Contributions to these plans can qualify for state income tax deductions, and investments in the account grow tax-deferred in a similar fashion as the vehicles discussed previously. Later, distributions can be taken from this account tax-free if the monies are used to pay for qualified education expenses.

These plans also have become more flexible in recent years by introducing more cost-effective investment options and allowing distributions for different types of education expenses, such as trade schools and private primary and secondary education. The account can generally be transferred to other eligible beneficiaries if your child does not use all the monies saved.

Taxes are an important part of an in-depth financial plan – but also don’t let the potential tax liability dictate your decisions. With all these topics to consider, it is important to look at the entirety of your situation before deciding which strategies might work best for you. You may consider working with a certified financial planner to help develop a plan that encompasses these strategies based on your personal goals and objectives.

 John Davis is a senior adviser II for FORVIS LLP. He can be reached at john.k.davis@forvis.com.

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