Americans worried about retirement, college costs and higher taxes – and that’s most of us – can address all three concerns with special savings accounts offering a tax advantage, as well as a chance to finance higher education needs and the golden years.
Fears of tax increases are pervasive, according to a survey of 1,336 investors conducted in December by Millionaire Corner. More than 52 percent of the investors – who range from investors with less than $100,000 in investable assets to those with $1 million or more – expect taxes to go up significantly in 2012.
These investors reported using a variety of strategies to protect themselves from anticipated tax increases, but the most popular tactic was increased contributions to employer-sponsored retirement plans, such as a 401(k). The plans are funded through employee contributions deducted from paychecks. Employers can make matching contributions, but participation varies from company to company.
A 401(k), or defined contribution plan, offers more than one tax advantage, according to the IRS. Contributions to the plan can be made on a pre-tax basis, reducing an employees’ taxable income. For 2012, the IRS allows employee contributions of up to $17,000 for workers under the age of 50. Those aged 50 and older are allowed additional catch-up contributions for a total of up to $22,500. Contributions to a traditional 401(k) accounts can be tax-deferred. The accounts grow tax free until funds are withdrawn, giving the plans a tax-sheltered status that allows greater compounding of investment gains. The IRS also allows employees to designate all or part of their contributions to a Roth 401(k). Contributions are made on an after-tax basis, but qualified distributions from the plans are tax free.
Investors wishing to gain an additional tax advantage while saving for retirement can open an Individual Retirement Account. An IRA is a personal savings plan that – like the 401(k) – can offer more than one tax advantage, according to the IRS. Investors may be able to deduct some or all of their contributions to a traditional IRA – depending on their income and whether they are receiving deductions for 401(k) contributions, says the IRS.
Amounts held in a traditional IRAs, including earnings, are not taxed until funds are withdrawn. Contributions to a Roth IRA are made on an after-tax basis, but funds grow tax free and can be withdrawn tax free.
Tax-sheltered college savings plans, known as 529 plans, allow Americans to save for college and realize a tax advantage at the same time. Contributions made to a 529 plan are not federally tax exempt, but the earnings grow tax free and withdrawals used for qualified educational purposes are not subject to taxes. Some states offer tax breaks to residents participating in in-state plans. A 529 plan, 401(k) and IRA can give investors more than one tax advantage while allowing them to meet retirement and college savings goals.