The only two certainties in life are death and taxes.
It is a turn of phrase made famous by Benjamin Franklin, and a truth that we are reminded of each year. And as we all continue to move towards old age and the dream of retirement, it is important to know how to make tax-free savings work for you.
And there is nothing more important than making sure you are in good financial shape for your retirement. Luckily, there are many strategies available to us.
And as cryptocurrencies gain traction and are continually accepted as a taxable asset-class, it is just as important to consider how best to save for your future and minimize unnecessary capital gains.
This article makes a few suggestions for avoiding unnecessary taxation and savvy saving for your future.
We will briefly cover the following savings strategies:
- Roth IRA
- Roth 401(k) or Roth 403(b)
- Municipal Bonds and Funds
- Health Savings Account (HSA)
- Cash Value Life Insurance
- Canadian Tax-Free Savings Accounts
- Tax-Free Cryptocurrency Savings
As we go forward, please remember this is not specific investment advice, rather it is general information. This is a great place for any smart investor to start. But the short of it is that investments need to be tailor-made based on your needs, income, and goals.
There is no one-size-fits-all solution when it comes to investing.
Savings and Planning for Retirement
Savings and retirement planning may not be the most exciting ways to spend your money, but they are a top priority no matter who you are.
When you are organizing your finances, it is important to remember that tax-free investments are available in order to incentivize intelligent financial planning, as well as give you the freedom to design your own retirement.
But before you whip yourself into a frenzy trying to evade taxes, make sure you understand your income bracket -and perhaps your spouse’s. Because your best savings plan is not going to be the same as someone else’s.
How best to manage taxable income is going to depend in large part on if you are self-employed or an employee. It will also depend on what kind of assets you hold, and how those asset classes are taxed.
And if you are holding and trading crypto, you need to make sure that you understand how your country of taxation treats those assets.
And last but not least, know your marginal tax rate. Understanding your marginal tax rate is crucial, as this is what will dictate your income tax rate, and could affect any capital gains. I personally would talk to a certified account about marginal tax rates, because without that metric, it is difficult to act intelligently.
The majority of this article will be more relevant to those paying income tax in the United States. But regardless, each bureaucracy will have its own incentives and plans that look similar, but are called by different names and will have different maximums, etc.
A Roth IRA can take $5,500 tax-free each year, and $6,500 if you are 50 or older. It does not offer a tax deduction, but the cash will continue to grow, and the growth is tax-free. Not only are contributions tax-free, but so are withdrawals.
As with any savings account, the earlier the better with a Roth IRA because the more you can save in your Roth, the more compounded interest you will earn on your savings.
The great thing about the Roth is that it can be used in conjunction with retirement savings. So once you have contributed maximally to your other retirement and pension plans, you can continue to contribute to an IRA.
Tip: Do not use this as a savings account to draw on. The more money you can keep in your Roth, the more you will benefit from your tax-free compounded interest. Also, this is a long-term savings plan. So you should have separate savings for holidays and large purchases.
Roth 401(k) or Roth 403(b)
In addition to your Roth IRA, you can also contribute to a 401(k) or 403(b). Like your Roth IRA, your withdrawals are tax-free, however, these contributions are taxed. The benefit of these options is that you can contribute much more than to your IRA, but there is an income restriction.
There is a maximum contribution of $18 500 a year tax-free, with a $6 000 catch up for those who are 50 or older.
Municipal Bonds and Funds
If you are paying taxes in the US, then you should consider municipal bonds and funds. However, bonds are no longer in countries such as Canada and Germany, because they did not prove to be an effective investment strategy. Canadian and German bonds have since been replaced with GICs and mutual funds which are far more lucrative.
But, if you are paying taxes in the United States, then you can benefit from bonds of various kinds.
Bonds are issued by federal, state, and local governments, U.S. government agencies, as well as corporations.
There are three basic kinds of bonds: U.S. Treasury, municipal, and corporate.
Bonds are a great way to set up a tax-free investment because they were designed in part to incentivize investment in infrastructure. Municipal bonds are used to build things like roads and schools. So, any interest that is earned on your bonds is tax-free. And bonds can also be traded and sold on the secondary market.
The one minor drawback is that bonds sold by Treasuries have a very slow, long-term yield. That means that are really only effective as a very long-term investment strategy. However, they are a very safe investment because they are backed by the government treasury. As such, there is only a very small chance that they will default.
However, the City of Detroit however, is an example where they did in fact default on their bonds.
Hold those Bonds
Remember, municipal bonds are the safest more reliable long-term investment. But they are really only ever going to demonstrate their value if you hold them for 20 to 30 years. Again, this is in part because of the beauty of compounding interest.
The only real challenge is being patient!
Health Savings Account (HSA)
Again, if you are in the US, then you are probably paying for your health insurance. If that is the case, then there are many ways to use this to your advantage. The idea behind a Health Savings Account is to use the money you save in it for future health expenses.
There are many expenses and costs that are exempt from taxation.
It is possible to receive deductions for:
- Contributions to a Health Savings Account
- Medicare premiums
- The interest growth from your savings
- And, when spent on health expenses, then withdrawals are also tax-free
Also, if you are in a position to wait to reimburse yourself for your health care expenses until retirement age, then you can benefit from increased interest gains. You can do this by waiting to pay yourself back for medical expenses for a later date. That way there is more money to earn interest in the account, and if you wait until you are retired, then you will not be taxed on withdrawals.
The caveat with an HSA is that you must have a health insurance plan that supports these contributions and withdrawals. So make sure you speak to your provider about what they offer so that you will not be penalized
Finally, there is a maximum of annual contributions. If you are under 55 you can contribute $3450, and if you are over 55 you can contribute a maximum of $4450 per year.
Cash Value Life Insurance
Life insurance policies can also create another asset class for tax planning and retirement. There are a few major caveats here. Life insurance policies will depend on a myriad of variables.
For starters, if you aren’t earning enough, or do not have enough assets to protect, then a life insurance policy may not be wise. If that is the case, then consider some of the other options.
Secondly, the cost of your life insurance plan will vary greatly on your age and occupation.
Finally, you will not get a tax deduction for your premiums.
But the money that you invest in the plan will grow tax-free. And if you are looking at early retirement then there are plans that will help you because they have tax free withdrawals before age 60.
Life insurance is a great option to explore as you can more likely find a plan that is better suited to your needs than any of the other tax-free savings options.
Individual Pension Plans
Make sure to use your personal pensions plans. Again, these plans are a little more complicated and so it might be wise to talk to an expert. The reason being that the contributions and withdrawals you can make without penalization will again vary greatly depending on your income and tax bracket.
However, personal pension plans are a great way to offload taxable income and save for your future.
Make sure you understand the plan and taxation because some plans will allow for tax-free withdrawals. However, many pension plans are taxable income upon withdrawal.
Canadian Tax-Free Savings Accounts
Finally, if you are paying Canadian taxes, then a TSFA is easily the easiest and safest way to go. TSFAs are tax-free in and tax-free out. The basic allowing tax deduction is $5000 CAD a year, with some exceptions for more based on other criteria.
This is a great first place to dump your cash before you start contributing to other tax-free savings plans.
Tip: If you are eligible, open a TSFA today! Even if you do not have 5 grand to sock away right now, the account is infinitely accumulative. That means you could contribute $2000 this year, and $8000 next year. You can contribute an accumulative amount of $5000 for every year the account is open.
They are also free and easy to set up, and any Canadian banking institution will offer a TSFA.
Tax-Free Cryptocurrency Savings
So how do these translate to cryptocurrencies? To begin, make sure you know how your country of taxation treats crypto-assets. This is going to vary, but most developed nations acknowledge cryptocurrencies as some form of a valuable taxable digital asset.
You must also determine if your crypto-assets are deemed a business expense, or if they are additional assets.
Currently, crypto-assets are most likely to fall under capital gains taxation policies.
Nevertheless, the important take away is that crypto-assets are being recognized for their value. So, just like your bonds and pension plans, think about what assets you will hold and which ones you will continue to trade.
Either way, some of your capital earned from your crypto-assets might best be put into an American ROTH or Canadian TSFA.
If there are two things you take from this article I hope it is:
- One, it is never too early to start saving.
- And two, find a way to take advantage of tax-free compounded interest programs!