Chapter 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5 Quiz


For most people, taxes are something they only think about on April 14th. Just kidding – you probably have your tax return done before then. However, do you think about taxes outside of filing your return? Smart tax planning is not just claiming all of the deductions and credits you are entitled to so that you can get a bigger refund. It also involves thinking about and engaging in methods to legally lower your tax burden throughout the year. This program will cover:

  • Retirement Plans

  • Education Plans

  • Flexible Spending Accounts and Transportation Savings Accounts

  • Investing

  • Tax Fraud

Chapter 1: Retirement Plans

Employer-Sponsored Retirement Plans
There are two basic types of employer-sponsored retirement plans: the defined benefit plan, where a certain level of benefits is promised and it is the employer’s responsibility to fund it, and the defined contribution plan, where the employee makes defined contributions and there is no guaranteed payout. The value of the plan is dependent on how much is put in and how well your investments perform. Most employers let employees determine how much they want to contribute per paycheck, and some even match all or part of their employees’ contributions. Today, defined contribution plans are much more common than defined benefit plans. An example of a defined contribution plan is the 401(k). (The 403(b) is the equivalent for employees of non-profits.)

The money that you contribute to a defined contribution plan is deducted from your paycheck pre-tax, meaning you don’t have to pay state or federal income taxes on it. While your money is invested in the plan, you don’t have to pay taxes on the earnings either. You only have to pay taxes on the withdrawals you make. The example below shows the benefits of contributing to a tax-deferred account like a defined contribution plan.

Let’s say you can save $200 pre-tax a month for retirement and expect you can earn a return of 4% annually. You have a state and federal marginal tax rate (the rate at which the last dollar earned is taxed) of 30%. If you use a defined contribution plan, the full $200 a month is invested. By the end of the year, you will have a total of $2,455 in your account and earned $44 in interest, which you do not have to pay taxes on. If you use a regular, non-tax deferred account, only $140 a month will be invested, with the other $60 being taken by taxes. By the end of the year, you will have a total of $1,711 in your account and earned $31 in interest, but these amounts drop to $1702 and $22 once you factor in the taxes you have to pay. By the end of year 30, you will have a total of $138,810 in the defined contribution plan ($97,167 after withdrawal). In contrast, you will have only $78,846 in the regular account.

Individual Retirement Accounts (IRAs)

  • Traditional IRAs
    Like with 401(k)s, you do not have to pay taxes on the contributions made to or earnings on a Traditional IRA, only the withdrawals. However, IRAs are not tied to your employer; you can open one at a variety of financial institutions, such as credit unions, banks, and mutual fund companies. In order to contribute to an IRA, you or your spouse must have earned income.

    One of the downsides of employer-sponsored plans is that the investment options are typically limited. For example, your company may only let you select between five mutual funds offered by the ABC Investment Corp. However, with an IRA, you can invest in what you want. You also do not have to worry about what to do with your IRA when you leave your job. On the other hand, you don’t have the benefit of automatic payroll deduction (or matching funds if your employer provides that), and the contribution limits are higher for employer-sponsored plans than IRAs. You can contribute to both at the same time, but contributions to a Traditional IRA are not deductible if you are covered by a retirement plan at work and your income is above a certain amount.

  • Roth IRAs
    Unlike with 401(k)s and Traditional IRAs, you do have to pay taxes on the contributions you make to a Roth IRA. However, earnings grow tax-free in the account, and you do not have to pay taxes on qualified withdrawals. Many financial experts prefer Roth IRAs to Traditional IRAs, but which one is more beneficial is largely dependent on your tax bracket now versus your tax bracket in retirement.

Plans for the Self-Employed

If you are self-employed, you can still contribute to a Traditional or Roth IRA. There are also retirement plans specifically for the self-employed and small business owners and employees, such as the Keogh plan, simplified employee pension plan (SEP plan), and savings incentive match plan for employees (SIMPLE plan). All allow you to make pre-tax contributions, and the earnings grow tax-free. The SEP plan and SIMPLE plan generally have lower administrative costs and are easier to set up, but the Keogh plan may allow larger contributions.

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