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Jun 11, 2021·6min

5 Modern Ways to Build Tax-Free Savings

Savings accounts are a great way to prepare for your future and ensure that a little nest egg is waiting for you in retirement. But which accounts should you pay into, and is it possible to build tax-free savings? In this guide, we’re bringing you financial wellness tips with five tax-free savings accounts you should think about getting.

The taxman cometh

Who’s excited about tax? Anyone in the back there? Nope. Ok, so no one gets all warm and fuzzy inside when the topic of tax arises. We don’t blame you, but tax is about the only certainty in life along with death. When it comes to savings, however, there are ways to avoid the dreaded tax.

You spend your entire life working hard, so why not enjoy savings tax-free when it’s time for retirement? And with these five savings accounts, you can accumulate wealth over time and enjoy it in your later years with tax benefits.

1) IRA

What is IRA?

Individual retirement accounts (IRS) have been popular for many years, and there are several types: Roth IRA, SEP, and SIMPLE. Tax deduction works differently for each one. But If we’re focusing on the traditional IRA account, you can defer taxes on contributions and investment earnings.

Withdrawals are either tax deductible in a traditional IRA or entirely tax-free if you have a Roth IRA .However, there are some strings attached. Annual contributions are limited to $6,000 a year, or $7,000 if you’re aged 50 or over. If you’re also covered by a retirement plan at work, your IRA contributions may be reduced.

Distributions taken out of the plan before the age of 59 ½ will be subject to ordinary income tax, plus a 10 percent penalty. Most people use IRA accounts to top their 401(k), so they have that little bit more in retirement.

IRA is a nutshell

Essentially, there are two types of IRAs. A traditional IRA helps money grow without paying taxes on your gains every year, as you’re deferring taxes on contributions and investment earnings until retirement, after which you pay income taxes on your earnings. A Roth IRA is after tax money that can grow tax-free and that you can access tax-free without being subject to income taxes in retirement.

2) Health Savings Account (HSA)

What is HSA?

If you’re looking for financial wellness tips for your savings accounts to safeguard you against getting sick, you might want to explore the idea of a health savings account (HSA). They offer triple tax savings, and contributions are tax-deductible and grow tax-free. Plus, withdrawals are completely tax-free when used for qualified medical expenses.

You need to participate in a high-deductible health plan to qualify for an HSA, and annual contributions are limited to $3,600 for individual coverage and $7,200 for family coverage. Withdrawals can be made at any time, and they’re not taxed as long as you use them for medical expenses.

So while it might not be your typical savings plan, it is a great way to safeguard you and your family against any potential medical issues, both in the near term and further down the line in your retirement.

HSA in a nutshell

HSAs are an intriguing option, as the contributions are tax-deductible, and money grows tax-free. Over time, you can amass money and provide a supplement to your retirement fund for use towards medical expenses.

3) In-state 529 Education Savings Plan

What is 529?

If you’ve got children and want to cover their college expenses, an in-state 529 education savings plan might work for you. Contributions are subject to annual gift tax limits, though they’re not tax-deductible. However, investment earnings aren’t taxed as long as the money is used for education expenses.

In-state 529 plans may also offer other tax breaks, depending on the state. Having investment gains exempt from tax could make a 529 plan look appealing to some, especially if you begin saving for educational expenses far in advance.

In-state 529 in a nutshell

You could use an in-state 529 to save long-term for educational expenses, benefiting from the investment earnings being tax-free when you use the money for educational purposes. However, other tax-free ways to save for education, such as life insurance, can also work as a retirement savings account.

4) Traditional 401(k) retirement plan

What is a 401(k)?

Most employers offer a traditional 401(k), and it’s often used alongside an IRA to plan for retirement. It provides you with a deduction on contributions you make to the plan, which is certainly good news.

The not-so-good news is that you will need to pay income tax from withdrawals in retirement. Yearly contributions are capped at $19,500 ($26,000 if you’re aged 50 or over). You may also find that contributions limits are adjusted over time to take inflation into account.

All contributions gained are tax-deferred and are withdrawn at ordinary income tax rates once the owner is older than 59 ½. Like an IRA, withdrawals prior are subject to a 10 percent tax penalty, as well as your usual income tax.

There’s another type of 401(k) called Roth 401(k), which is offered by a few companies. Similar to a Roth IRA, here you can contribute after-tax savings that grow and can be accessed tax-free, and therefore not have to add to your income taxes in retirement.

401(k) in a nutshell

There are two types of 401(k) plans. A traditional 401(k) plan has similar tax benefits to a traditional IRA, with taxes deferred on contributions and investment gains. However, you will still need to pay tax when you withdraw your nest egg in retirement. A Roth 401(k) is after tax money that grows and can be accessed tax-free in retirement.

5) Permanent Life Insurance

What is permanent life insurance?

Most people think of life insurance as protection and a payout for your loved ones when you pass away. However, with a permanent life insurance policy, you can also benefit from a savings account that can be accessed while you’re still alive.

That’s because it has a cash value element that grows over time. And guess what? It’s completely tax-free. You have the option of withdrawing the money or taking it out as a zero-interest loan against your policy–though when we say “loan,” you’re actually borrowing the money from yourself, and therefore don’t have to pay it back.

You take out the loan against your savings, which is paid back with your death benefit (which is the sum of your original coverage amount plus your savings growth) when you pass. Since that death benefit increases in value over time, your loved ones still receive a payout.

But anyway, back to the tax-free stuff. Let’s say you pay in for 20 years. You can withdraw the cash you’ve accumulated over that time without paying a dime in tax. Good times.

Permanent life insurance in a nutshell

Investing in a permanent life insurance policy means you can protect your loved ones when you pass while still benefiting from tax-free growth when you’re still alive.

In conclusion: Who would like some tax-free savings?

There are several options for saving tax-free in the long term, but there are usually a few asterisks attached to each plan. So if you’re looking for financial wellness tips to help you later in life, take our advice and explore the idea of permanent life insurance. It’s tax-free, can grow in value, and has a death benefit. That sounds like a pretty sweet deal to us.

Check out which permanent life insurance options might be most suitable for you and benefit from a savvy investment vehicle.

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