February 2, 2024
The best approach to financial wellness is step-by-step; one good habit naturally leads to the next. If you have already established an emergency fund, eliminated high-interest-rate revolving debt, and are contributing to your 401k, you may be starting to consider what comes next. With that in mind, here is an overview of several tax-efficient saving and investing vehicles worth exploring.
Health Savings Accounts (HSAs) have become increasingly popular because they are the only investment vehicles to offer triple tax savings: contributions are made pre-tax, grow tax-free and can be spent tax-free on medical expenses. There is also no “use-it-or-lose-it" provision. Additionally, once the required cash balance has been met, all other contributions may be invested, so an HSA can be considered part emergency account and part retirement account.
To be eligible, one must participate in a high deductible health insurance plan. If your employer does not offer HSAs, not to worry. Anyone can contribute independent of a work plan and there are no income limits.
Flexible Savings Accounts (FSAs) are funded with pre-tax money that can be contributed through your paycheck and must be used during that calendar year (otherwise known as “use-it-or-lose-it"). Money spent from the account must be used for approved expenses, which depend on the type of FSA and are often for medical or dependent care. It is important to note that in general, if you lose or quit your job, you lose your FSA. Also, there are no investment options like there are with the HSA.
Roth and Traditional Individual Retirement Accounts (IRAs) are both retirement accounts that allow one to independently save for retirement. While contributions grow tax-free in both types of accounts, there are a few differences to consider.
Roth IRAs use post-tax income and allow for tax-free withdrawals after the age of 59 ½, but there is no requirement to withdraw at any time. They tend to be more popular among younger people because they are most likely in a lower tax bracket than they anticipate being in the future. There are income level limits for eligibility to participate in a Roth IRA.
Traditional IRA contributions are made pre-tax, but withdrawals made in retirement are taxed. They also have required minimum distributions (RMDs) starting at age 73. Traditional IRAs tend to be more popular among people mid-career and beyond, assuming they are in their higher-earning years.
The 529 Plan is an investment account by which one can invest post-tax money, grow it tax-free and use it tax-free to mitigate qualified education expenses. Not just for college or university anymore, 529 Plans may be used for any qualified education expenses, from kindergarten to trade school to a master's program. In a recent update to the program, funds in a 529 account can now be rolled over into a Roth IRA account for the beneficiary (within certain limits) if the beneficiary does not attend college or if they receive a scholarship that leaves them with leftover money in their plan.
Financial Know-How Program Manager
Jim joined Cape Cod 5 in 2018 and has been the Financial Know-How Program Manager since 2020. He has a degree in Psychology from Catholic University in Washington D.C. and is a graduate of the New England School of Finance, a two-year program offered by the Massachusetts Bankers Association and hosted at Babson College. Jim is an active member of the community, serving as an advisor to a local nonprofit and on the Barnstable High School Business Innovation School steering committee. He lives in Plymouth with his wife Brigid.