Liz Weston, NerdWallet
You know to contribute enough to your 401(k) to get the full company match. Maybe you’ve even adjusted your withholding so you’re not giving Uncle Sam an interest-free loan.
Yet you may feel the need to do even more, especially if you’re making the last big push toward retirement. These hacks allow you to shelter more money from taxes now and when you retire. They include:
• Last-minute 529 deductions. You’ll get the most value from state-based college savings plans if you have many years for your contributions to grow. But you may be able to wring a last-minute tax benefit even if your child is about to head off to college or is already there. Most states offer deductions or credits for contributions and don’t have minimum holding periods, said Andrea Feirstein, managing director of AKF Consulting Group, which advises 529 plans. You can contribute to the plan and pull the money out shortly thereafter to pay college bills. In states that do have holding periods, such as Michigan, you may have to deposit the money one year and withdraw it the next to qualify for the deduction. You can find a complete list of tax benefits by state at SavingForCollege.com , but you should call the plan you’re considering to ask about any fees or holding periods.
• Using HSAs to supercharge your retirement savings. Health savings accounts are designed to help people pay their share of high-deductible medical insurance plans. But they offer a rare triple tax break: Your contributions are deductible going in, your money grows tax-deferred, and withdrawals are tax-free if used to pay for qualified medical services. Some financial experts are so enamored of the benefits that they recommend funding an HSA even before contributing enough to a 401(k) to get the full company match. To take full advantage of this strategy, though, HSA owners need to leave the money alone to grow, which means paying deductibles and copays out of their own pockets — and those amounts can be steep. For a family, the maximum out-of-pocket expense for 2017 is $13,100.
• Backdoor Roth contributions. Roth IRAs offer tax-free withdrawals in retirement. That’s a big deal for those with enough time to let the magic of compounding work. Would you rather pay no taxes on $5,500 today (the maximum contribution) or no taxes on many times that amount when you retire? But the ability to contribute ends when your modified adjusted gross income in 2017 exceeds $133,000 if you’re a single filer or $196,000 for married couples filing jointly. The “backdoor” Roth allows taxpayers to get around those limits. They contribute first to traditional IRAs and then convert those to Roth IRAs, since there’s no income limit on Roth conversions. Income taxes are typically owed on conversions, but the bill could be low or even zero if the taxpayer doesn’t take a deduction and doesn’t have much or any money in IRAs outside of the one being converted. (Taxes on a conversion are based on the proportion of the taxpayer’s IRA holdings that hasn’t yet been taxed.)
• Mega backdoor Roth contributions. Many people can do a backdoor Roth, but the stars really have to align for a mega version to be possible. Once again, you’re contributing after-tax money to a retirement account and then quickly converting it to a Roth vehicle. This time, though, the account you’re using is a 401(k) that allows after-tax contributions beyond the usual deferral limits of $18,000 annually, plus a $6,000 catch-up provision for people 50 and older. The IRS actually allows up to $53,000 to be contributed to a 401(k), including pretax, after-tax and employer contributions. If your 401(k) plan allows these additional options — and most don’t — that means you could put up to $35,000 more into your account. You can roll this money into a Roth IRA when you quit or retire, but there could be a lot of gains that would trigger taxes. By contrast, if you can do frequent “in-plan” conversions — rolled over in the same plan — to a Roth 401(k), or “in-service” conversions — done while you are still working — to a Roth IRA, those gains and any taxes would be minimized. It’s not clear how many 401(k) plans allow both after-tax contributions and in-plan or in-service conversions; it’s certainly not the majority. It’s worth checking with yours, though, since you could be funneling thousands or even tens of thousands of dollars more into Roths each year.
