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9 savings accounts with sweet tax breaks

savings_accounts_with_sweet_tax_breaksLooking for a tax break?

It's important to look for tax breaks wherever you can because the money you spend on taxes could be working for you instead.

The good news is, there are several to be found. It's just a matter of choosing one that fits your situation and works toward your goals. The following are several types of savings accounts that offer tax advantages to help grow your money.

1. Traditional IRA

AccountFunded WithSavings Grow Tax-FreeTax-Free WithdrawalsContribution Limits (2018)Tax Credit(2018)
Traditional IRABefore-tax $YesNo$5,500/year, or $6,500/year (age 50+)-

This form of retirement plan has been popular for decades. Benefits of a traditional IRA include deferred taxes on contributions and investment earnings. Taxes are not paid until the money is taken out of the plan.

Like most tax-advantaged plans, traditional IRAs come with some strings attached. Annual contributions are limited to $5,500 a year, or $6,500 if you are aged 50 or over by the end of the year. Most importantly, under most circumstances if you take money out of the plan before the age of 59 1/2, those distributions will be subject to ordinary income tax plus a 10 percent penalty. There are also income limits on contributions.

Who benefits:

People who are not adequately covered by a retirement plan at work, are in position to benefit from a tax deduction and are willing to commit money until they are at or close to retirement age.

How it helps:

By deferring taxes on contributions and investment earnings until retirement, a traditional IRA helps money grow tax-free and possibly may allow the account holder to benefit from being in a lower tax bracket when the money is withdrawn in retirement.


2. Roth IRA

AccountFunded WithSavings Grow Tax-FreeTax-Free WithdrawalsContribution Limits (2018)Tax Credit(2018)
Roth IRAAfter-tax $NoYes$5,500/year, or $6,500/year (age 50+)-

The difference between a Roth IRA and a traditional IRA boils down to whether you want to pay the taxman now or pay him later.

Unlike with a traditional IRA, contributions to a Roth IRA are not tax-deductible. However, money in a Roth IRA is allowed to grow tax-free and can be withdrawn without taxes once you reach age 59 1/2.

As with traditional IRAs, Roth IRA contributions are limited to $5,500 a year, or $6,500 if you are aged 50 or over by the end of the year. If you take money out of the plan before the age of 59 1/2, the portion of the withdrawal that represents investment gain might be subject to income taxes, and you might also incur a 10 percent tax penalty. There are also income limits on contributions.

Who benefits:

People who are not adequately covered by a retirement plan at work, are currently in a relatively low tax bracket and are willing to commit money until they are at or close to retirement age.

How it helps:

While a Roth IRA does not allow you to deduct contributions, it allows those after-tax contributions to grow tax-free and then be withdrawn without taxes once you reach age 59 1/2. By taxing contributions rather than withdrawals, a Roth IRA allows people who are currently in a fairly low tax bracket to pay taxes at that low rate rather than at a potentially higher rate once they reach retirement age.


3. Traditional 401(k) retirement plan

AccountFunded WithSavings Grow Tax-FreeTax-Free WithdrawalsContribution Limits (2018)Tax Credit(2018)
Traditional 401(k)Before-tax $YesNo$18,500/year, or $24,500/year (age 50+)-

A traditional 401(k) plan is a benefit offered by many employers. Eligible participants can contribute up to $18,500 (or $24,500 if you are aged 50 or over), and some employers even add a contribution on behalf of plan participants. Contributions and investment gains are tax-deferred, and can be withdrawn at ordinary income tax rates any time after the beneficiary reaches age 59 1/2. Withdrawals prior to that may be subject to a 10 percent tax penalty in addition to ordinary income tax.

Who benefits:

People whose employer offers a 401(k) plan and who are willing to commit money until they are at or close to retirement age.

How it helps:

A traditional 401(k) plan has similar tax benefits to a traditional IRA: taxes are deferred on both contributions and investment gains. However, they offer some advantages over IRAs. First of all, the contribution limits are much higher. Second, some 401(k) plans kick in a partial match of employee contributions. Finally, many 401(k) plans come with investment features that may be tough to obtain as an individual such as free retirement planning tools and extensive investment option menus.


4. Roth 401(k)

AccountFunded WithSavings Grow Tax-FreeTax-Free WithdrawalsContribution Limits (2018)Tax Credit(2018)
Roth 401(k)After-tax $NoYes$18,500/year, or $24,500/year (age 50+)-

Though not offered by all 401(k) plan sponsors, those that allow Roth accounts give participants the opportunity to benefit from the same tax characteristics as a Roth IRA, but with the higher contribution limits of a 401(k).

Who benefits:

Lower-tax bracket employees willing to make long-term saving commitments who are covered by a 401(k) plan at work that allows for Roth accounts.

How it helps:

For people in relatively low income tax brackets, a Roth 401(k) can create the same benefit of paying taxes now rather than after age 59 1/2 and, as components of 401(k) plans, Roth 401(k)s allow participants to contribute at higher levels.


5. In-state 529 plan

AccountFunded WithSavings Grow Tax-FreeTax-Free WithdrawalsContribution Limits (2018)Tax Credit(2018)

In-state

529 plan

After-tax $YesYes$15,000 per child (for gift tax exclusion per year)Varies by state

These plans are intended for use toward educational expenses. Contributions are subject to annual gift tax limits and are not tax-deductible, but investment earnings are not taxed as long as the money is ultimately used for eligible education expenses. In-state 529 plans may offer additional state income tax incentives.

Who benefits:

People looking to save long term for education expenses, and who could benefit from both federal and state tax relief on investment earnings.

How it helps:

Having investment gains exempt from tax makes 529 plans most beneficial for people who start saving for educational expenses far in advance. Residents of states with high income taxes may benefit especially by investing in an in-state 529 plan.


6. Out-of-state 529 plan

AccountFunded WithSavings Grow Tax-FreeTax-Free WithdrawalsContribution Limits (2018)Tax Credit(2018)
Out-of-state
529 plan
After-tax $YesYes$15,000 per child (for gift tax exclusion per year)Varies by state

You are not restricted to investing in a 529 plan sponsored in your own state. The only drawback is that you may miss out on tax incentives geared to state taxes.

Who benefits:

People looking to save long term for education who are in states with little or no state income tax.

How it helps:

Protecting investment earnings from federal income tax is especially beneficial to people who start saving for education early enough to amass significant investment earnings.


7. Coverdell Education Savings Account

AccountFunded WithSavings Grow Tax-FreeTax-Free WithdrawalsContribution Limits (2018)Tax Credit(2018)
Coverdell Education SavingsAfter-tax $YesYes$2,000/year
for combined ESAS
May claim American Opportunity and Lifetime Learning credits

The Coverdell Education Savings Account used to be the main way to save for college prior to the creation of 529 plans. Like 529 plans, money deposited into the account isn't deductible -- but investment earnings and withdrawals for eligible education expenses are tax-free. However, total contributions to Coverdell accounts on behalf of any given beneficiary cannot exceed $2,000 per tax year.

Who benefits:

Beneficiaries who are under 18 years old or designated as special-needs students at the time contributions are made to the account.

How it helps:

It allows money to grow tax free and be withdrawn without taxes as long as it is used for eligible education expenses.


8. Health Savings Account (HSA)

AccountFunded WithSavings Grow Tax-FreeTax-Free WithdrawalsContribution Limits (2018)Tax Credit(2018)
Health Savings AccountBefore-tax $YesYes$3,450 for individual HDHP coverage $6,900 for family HDHP coverage-

These accounts offer triple tax savings: contributions are tax-deductible, money grows tax-free, and withdrawals are tax-free when used for qualified medical expenses. You can also amass money in an HSA over time, providing a supplement to your retirement nest egg for use toward future medical expenses.

In order to participate in an HSA, you must participate in a high-deductible health plan (HDHP). Annual contributions are limited to $3,450 if you have individual HDHP coverage and $6,900 if you have family HDHP coverage.

Who benefits:

Participants in HDHPs who want to set aside money in advance for near-term and long-term medical expenses.

How it helps:

By exempting both contributions and investment earnings from income tax, HSAs provide important tax benefits. Because you can accumulate money over time for use toward future medical expenses, HSAs may not only help you save for near-term medical expenses but can also be an important supplement to your retirement savings.


9. Flexible Spending Arrangement (FSA)

AccountFunded WithSavings Grow Tax-FreeTax-Free WithdrawalsContribution Limits (2018)Tax Credit(2018)
Flexible-Spending AccountBefore-tax $YesYes$2,650 per individual-

Like HSAs, these accounts allow money to be contributed, invested and withdrawn without taxes. However, there's an important catch -- only $500 can be rolled over into the next year and any unused money is forfeited.

FSAs are employer-sponsored plans, and some employers may supplement employee contributions to them. Annual employee contributions are limited to $2,650.

Who benefits:

People whose employers offer an FSA plan and who have medical expenses that are regular enough so they can count on using the amount they contribute within the time limit.

How it helps:

People who don't itemize deductions may benefit from having tax-free money to pay for medical expenses. There is also some slight benefit to having investment earnings free from taxes, though this benefit is limited by the short-term nature of these accounts.


Other noteworthy tax breaks

This would be a good time to explain the difference between a tax deduction and a tax credit.

A tax deduction means that a portion of your income is excluded from taxation. A tax credit is money that is credited against any tax you owe.

Dollar for dollar, a tax credit is typically more valuable than a tax deduction. For example, consider a $1,000 tax deduction. Even if you were in the top tax bracket, which is 37 percent for 2018, you'd save 37 percent of that amount by having it excluded from your tax bill, or $370.

A tax credit, on the other hand, directly offsets the tax that you pay. So, a $1,000 tax credit would save you a full $1,000 on your taxes, as long as you were due to pay at least that much in taxes that year.

Retirement Savings Contribution Credit

AccountFunded WithSavings Grow Tax-FreeTax-Free WithdrawalsContribution Limits (2018)Tax Credit(2018)
-----$2,000 for single tax-filers
$4,000 for joint tax-filers

The saver's credit, formally known as the Retirement Savings Contribution Credit, gives lower earners a tax credit equal to a portion of the contributions they make to an eligible retirement savings plan. That portion ranges from 10 percent to 50 percent, depending on how much you earn. The maximum credit is $2,000 for single tax-filers and $4,000 for joint filers.

It's like an extra bonus for saving -- you not only get the regular tax advantage that goes with a retirement plan contribution, but you get a tax credit as well.

Who benefits:

People with limited incomes (less than $63,000 a year for joint tax-filers or less than $31,500 a year for individual filers) who contribute to an eligible retirement plan.

How it helps:

People in lower tax brackets don't get as much of a tax break by making contributions to IRAs, 401(k)s, or other retirement plans, but the saver's credit makes up for that by kicking in an amount equal to part of your retirement plan contribution as a credit against any tax you owe that year.


Any of the above tax-advantaged savings plans might come in handy at tax-filing time, but really the best time to think about them is throughout the year. After all, you might not be able to come up with a meaningful savings contribution at the last minute when you are filing your taxes. However, if you contribute steadily to one of these tax-advantaged plans throughout the year, you might find yourself with a much more useful deduction at tax time.

More resources on saving for college

Want to understand the whole process of saving for college? Visit our College Savings Guide

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Need more information on 529 plans? Read: 6 things to consider before opening a 529 plan

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More resources on saving for medical expenses

Health savings accounts vs. flexible spending accounts

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