June 2, 2017
College tuition, a new pair of glasses and retirement may seem unrelated, but the tax law says otherwise. By knowing how and where to save your money, you could pay for each of these expenses with tax-advantaged – or in some cases income-tax-free – money.
Individual Retirement Agreements (IRAs) and 401(k)s are perhaps the two most well-known examples of these types of accounts. But they're not alone. With educational and medical expenses in mind, consider the following types of accounts and how you might be able to use one to help yourself or your family.
Invest your college fund in a 529 plan. State-sponsored 549 plans come in two forms. Prepaid tuition plans let you lock in today's rate for in-state public schools and 529 college savings plans allow you to invest your savings based on your goals and risk tolerance. Contributions aren't a federal tax write-off, but if you invest in your state's plan, there might be a state income tax write-off.
As new parents ourselves, my wife and I made the decision to start preparing for our son's education with a 529 college savings plan. However, the state where we live doesn't offer a tax incentive. After diligently researching our options, we chose to establish the account in another state.
Many states let non-residents invest in their 529 plans and you can compare the state-based benefits, investment options, fees and contribution rules when choosing your plan. The College Savings Plans Network (CSPN) has tools to compare 529 plans by features or by state.
If the money is spent on qualified educational expenses, such as tuition, fees or school supplies, you don't pay federal income tax (and may not have to pay state income tax) on investment gains.
Provide financial support for a disabled person using an ABLE account. News of a life-changing disability could come at any time. Following the Achieving a Better Life Experience (ABLE) Act in 2014, states can now sponsor ABLE savings accounts. Like 529 plans, contributions may be tax-deductible on the state (but not federal) level and the investment earnings can be withdrawn tax-free to pay for qualified expenses related to a mental or physical disability.
Beneficiaries must meet two criteria to qualify for an ABLE account: the disability must have begun before they were 26 and it must have “marked and severe functional limitations.” Anyone can contribute to the beneficiary's ABLE account, and there is a limit on the total annual contributions – $14,000 as of 2017.
For individuals dealing with a disability and those taking care of a loved one, an ABLE account could make it easier to manage and plan finances. Generally, if you have a disability you're disqualified from some types of federal government aid if you have over $2,000 in assets. The first $100,000 in an ABLE account doesn't count against the limit for non-Medicaid services, and the entire account balance doesn't count against the Medicaid limit.
Collectively known as ABLE 2.0, several new bills may increase the annual contribution for those who have a disability and are working, increase the eligibility age to 46 and allow families to rollover money from a 529 college savings plan to an ABLE account.
Make medical expenses more affordable with an FSA. Some employers offer a Flexible Spending Account (FSA) as a benefit to their employees. Employees can fund the accounts by putting aside a portion of their paychecks. You can then spend the money on qualified medical expenses, including eye exams, glasses and dental procedures, without paying income tax.
FSA accounts have a use-it-or-lose it provision and the money you don't use could be forfeited at the end of the year. Employers could, but aren't required to, allow employees to roll over up to $500 each year or give them an additional two-and-a-half-month grace period to use the money.
Bottom line: Paying for higher education, covering medical-related expenses and saving for retirement are three important financial goals. Incorporating tax-advantaged accounts into your long-term plan could be a win-win for your wallet. You might be able to save money now by lowering your tax bill and lower your effective costs later by withdrawing and using the money for qualified expenses.
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