Prepare for Major Life Expenses with Tax-Advantaged Accounts

Prepare for Major Life Expenses with Tax-Advantaged Accounts
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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. But they’re not alone. With educational and medical expenses in mind, consider the following types of tax-advantaged accounts and how you might be able to use one to help yourself or your family.

Invest your college fund in a 529 plan. Paying for college may be a little easier if you use a 529 plan. These state-sponsored accounts 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.

Even without a tax deduction for contributions, 529 plans offer other tax advantages. If the beneficiary of the account uses the money for 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.

When you open a 529 plan, you’ll choose the owner and beneficiary. As the owner, you’ll have complete control of the money. The beneficiary, often a child or grandchild, is the person going to school. Anyone can contribute to a beneficiary’s 529 plan and it could be a good gift idea if a child already has enough toys and clothes. States do however limit contributions after an account reaches a particular balance — such as $300,000.

You have several options when a beneficiary doesn’t use the money. You could save the money for later in case he or she wants to go to school or change the beneficiary to another qualified family member. You can also withdraw money for an unqualified reason, but this generally isn’t recommended.

Aside from a few exceptions, with unqualified withdrawals you’ll have to pay income tax and a 10-percent penalty on any earnings. You may also need to pay state income tax on the principal (if you got a write-off when you contributed).

Provide financial support for a disabled person using an ABLE account. Whether you’re going in for your annual physical, visiting a pediatrician with your child or getting a prenatal checkup, 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. Similar to 529 plans, they 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. 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.

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 ahead. Generally, if you have a disability you’re disqualified from some types of federal government aid, such as Supplemental Security Income (SSI), housing aid or Medicaid, if you have over $2,000 in assets. The first $100,000 in an ABLE account don’t count against the limit for non-Medicaid services, and the entire account balance doesn’t count against the Medicaid limit.

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. Check with your employer to see if they offer one of these exceptions and plan ahead before making contributions.

Bottom line: Many of us have a few shared major financial goals or necessities. Paying for higher education, covering medical-related expenses and saving for retirement are three important ones. 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.

Nathaniel Sillin directs Visa’s financial education programs. To follow Practical Money Skills on Twitter:

This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.

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