Tax Shelters for You and Me

credit: freedigitalphotos.net by Stuart Miles

credit: freedigitalphotos.net by Stuart Miles


Last year, when the media reported that General Electric paid no corporate income taxes people were furious. During the last presidential election, there were accusations that Mitt Romney had paid no income tax for a decade. Whenever we read about tax shelters, we think of the wealthy one percenters stashing their cash in the Cayman Islands or using some complicated loophole to avoid paying taxes to Uncle Sam. But how about tax shelters for us regular Joes. Here are a few ways you can reduce the amount of taxes you have to pay.

Tax Deferred Retirement Plans (401k, 403b,457, etc)
Many people have access to a tax deferred retirement plan such as a 401K through their employer. Employer provided matching funds are not the only benefit of these plans though, there is also a tax benefit. If you participate in your traditional 401k, you can save up to $17,500 per year (2013 and 2014) in tax-deferred contributions ($23,000 if you are over 50 years old). Every dollar you contribute reduces your taxable wages, thereby lowering your taxes. Some employers offer a Roth 401k in which case, your taxes are not lowered, however, all the money in the account grows tax-free and you will not need to pay taxes on it when you withdraw from the account. With the Traditional 401k account, you lower your taxes presently, but may have to pay income tax when you withdraw from the account.

Individual Retirement Plans
If you do not have access to a 401k plan, or even if you do but prefer to invest on your own, you can open an IRA. Much like the 401K plans, you can reduce your taxable income by contributing money to a traditional IRA. If you prefer, you can open a Roth IRA account which will not lower your taxes, but will allow the money you invest to grow tax-free. The maximum contribution is $5,500 for 2013 and 2014. To learn more about IRAs and the income limits that apply, click here.

Note: If you don’t already have enough incentive to save for retirement, there is a tax credit up to $2,000 just for saving for retirement. Income limits apply. Check out this link on the IRS website for more details and to see if you qualify.

Flex spending account

Health Care
The Health Care Spending Account is an employee benefit that some employers provide which helps pay for health-related expenses with tax-free dollars. This includes medical, hospital, laboratory, prescription drug, dental, vision, and hearing expenses that are not reimbursed by your insurance or other benefit plans. The maximum contribution for 2014 is $2,500. The open enrollment deadline is right around this time in November so check if you have this benefit and take advantage of it. A lot of people don’t take advantage of this plan probably because they don’t know about it, are too lazy to submit receipts or they are scared about the “use it or lose it” aspect of it. If you have a good estimate of the medical expenses you will be spending during the upcoming year, the flex spending plan is a great deal. If by the end of the year you still have money to spend, you can buy various medical supplies that qualify such as contact solution and bandages. Drugstore.com has an entire section under the FSA tab which sells items that qualify.

Note: Health Savings Plans (HSA) which are different from the health care flex spending account is also a great way to reduce your taxes. It is not “use it or lose it” so you can leave money in your account. I’m not that familiar with this type of plan so I won’t get into it. However, you can read this Forbes article if you are interested in learning more about it.


Dependent care

For those of you with kids, the dependent care account will take some of the bite out of paying for daycare which is pretty pricy. Other expenses that are eligible for this account include babysitters (allowing you to work), nannies, summer camp, and possibly for elder care as well. You can contribute up to $5,000 in your dependent care flex spending account. For more information about eligibility and qualified expenses, click on this link.

Tax free commuter benefits
If your employer offers this benefit, it allows you to save a good amount of money on your commute to work. Commuters can use pre-tax dollars to pay for the subway, bus, train, ferry, car, or vanpool. To see how much money you can save, use this calculator.

If you are interested in reading about how real families drastically reduced their tax bill check out the following posts:
How a Family of Four with a $100,000 yearly Income Pay Only $6400 in Federal Income Tax by Brad from Richmond Savers
Six Figure Income Pay No Tax by Justin from Root of Good.

I am not a tax expert so please consult a tax professional or do your own research before making any decisions.

Do you take advantage of any of the above to reduce your taxable income?

48 thoughts on “Tax Shelters for You and Me

  1. Done by Forty

    Great list, Andrew. The 401k and IRA are great tax advantaged accounts for the average Joe.

    I’m a big fan of the HSA as it compares to the Flex Account. The idea of a use it or lose it account scares the crap out of me, and I would not mess with putting a lot of money into something that I would lose if, for some reason, I ended up being healthier than I anticipated. Seems like the incentives in that account are a bit backwards, for me.
    Done by Forty recently posted…Budget PornMy Profile

    1. livingrichcheaply@gmail.com Post author

      Thanks. Yea I don’t like the use it or lose it aspect. I think they might be looking at changing that. I generally put less in if I’m not sure if I’ll be spending it. But it works out pretty well when I can predict medical expenses ahead of time like when my wife had dental work and I had a medical procedure I knew would be schedule that year.

  2. DC @ Young Adult Money

    If you don’t spend the time to sit down and review what you can do to lower your taxes you are almost guaranteed to pay more than you need to. One example in my life is this is the first year we have a house and the first year we rented out part of the house. I could be lazy and claim no expenses, or I could research what I can legally write off as expenses, gather the required documentation in case of an audit, and calculate as much expense as legally possible. I will take that route this year even if it means sacrificing a Saturday afternoon.
    DC @ Young Adult Money recently posted…Double the Money, Double the FunMy Profile

    1. livingrichcheaply@gmail.com Post author

      Buying a house is a pretty good tax shelter too…though you probably should do it just for that reason. Sacrificing a Saturday afternoon is worth it when that much money is at stake.

  3. Brad @ RichmondSavers.com

    Thanks for linking to my article Andrew!

    If you’re looking for a set of articles that will knock your socks off, I suggest going to the site:

    http://www.madfientist.com/

    He is one of the absolutely smartest people around and his articles on Tax-Gain and Tax-Loss Harvesting, the Ultimate Retirement Account and Traditional IRA vs. Roth IRA should all be required reading! Just brilliant stuff…
    Brad @ RichmondSavers.com recently posted…Welcome NBC 12 ‘More Bang for Your Buck’ ViewersMy Profile

    1. livingrichcheaply@gmail.com Post author

      Yes, taxes are pretty dull and complex but it is valuable to have a good understanding of them to use it to your advantage. As for the FSA, I did notice that they relaxed the use-it-or lose it where you can carry over $500 which is pretty good. That wasn’t an option before. I think if you have a decent estimate of your expenses than it won’t go to waste. However, I think the $500 carry over is not applicable to everyone. If your plan allows a grace period for reimbursements then there is no carry over option. I’ll have to look into that. Thanks for bringing it up.

    1. livingrichcheaply@gmail.com Post author

      Yes, those are great benefits. A free metro card would be even better!

    1. livingrichcheaply@gmail.com Post author

      Hey Charles, I think write offs are valuable too, but not everyone can claim the education credit, student loan interest deduction, and mortgage deduction. If you work in a large company, they generally have the benefits I listed.

  4. Demaish @ Borrowed Cents

    Everyday I am learning something new in this personal finance blog sphere. I never knew or thought they would reduce my taxable income. But again, its just ignorance. My employer offers 403b, flex spending accounts, dependent care and even health club membership reimbursements. Unfortunately I have never taken advantage. I will definitely be making moves.
    Demaish @ Borrowed Cents recently posted…I am not saving for retirementMy Profile

    1. livingrichcheaply@gmail.com Post author

      Good! You should definitely take advantage of every benefit your employer offers! Why let it go to waste?

    1. livingrichcheaply@gmail.com Post author

      Great! In my younger days I didn’t take advantage of the benefits. I was probably too lazy and didn’t know enough about them.

    1. livingrichcheaply@gmail.com Post author

      You were thinking about opening a retirement account right? You should check out the saver’s credit and also the IRA. As for taxes for bloggers and freelancers, I hope someone has a good post on that. Not that I have any income to report for blogging…but maybe in the future!

  5. Matt Becker

    There’s so much room in the tax code to save some money, but it’s an area that often gets overlooked. The problem is really the complexity. But even something like the Saver’s credit is something that most people don’t know about and can easily save you a couple thousand per year if you have a low enough income AND manage your tax breaks properly. Good stuff Andrew.
    Matt Becker recently posted…Stop Buying Features. Start Buying Benefits.My Profile

    1. livingrichcheaply@gmail.com Post author

      Thanks Matt. You’re right. The tax code can be boring and complicated so many people don’t look into ways to save money there.

  6. Simon @ Modest Money

    Alas death and taxes are the only certain things. I guess if one can find ways and means to reduce that certainity by all means take full advantage of those options. And well, maybe once in a while its good to seek the advice of a professional, who knows, they might open one eyes to other viable moves they could be taking to reduce their tax burden.
    Simon @ Modest Money recently posted…TradeKing Review – Exclusive Review of TradeKing BrokerageMy Profile

    1. livingrichcheaply@gmail.com Post author

      So true about death and taxes. But definitely try to reduce them if possible. For more complicated issues, a good tax expert is invaluable.

  7. Daisy @ Prairie Eco Thrifter

    I’m always trying to brainstorm ways to reduce the amount of taxes (legally and legitimately, of course) that I have to pay. I’m already able to write off lots of the income I have made through the internet (commenting services, freelancing, and affiliate income) through expenses (internet, my new laptop, home office), but I try to put money in tax deductible accounts such as retirement accounts too.
    Daisy @ Prairie Eco Thrifter recently posted…Friday Links – Hate the Darkness EditionMy Profile

    1. livingrichcheaply@gmail.com Post author

      Having your own business and writing off expenses is a great way to reduce your taxable income.

  8. Fehmeen

    These are some great ways for individuals to use tax programs to their own benefit. I think the 401 and IRA are perhaps the most important because they have the added advantage of helping you save for your retirement. And let’s not forget these funds are protect from any bankruptcy cases you may have pending.
    Fehmeen recently posted…What is a 401(k) – A Simple DefinitionMy Profile

    1. livingrichcheaply@gmail.com Post author

      Yes you make a good point about them being protected from bankruptcy. Many people have access to 401ks and IRAs but do not take advantage of it!

    1. livingrichcheaply@gmail.com Post author

      Absolutely! Everyone thinks that only the rich have access to it, but if we learned more about these tax benefits, we can save a good amount of money.

  9. anna

    I constantly tell younger people in my department about health spending accounts, especially if they have big expenses coming up like a root canal or braces. Agreed it helps to get a quote prior to the Open Enrollment period, so one won’t overestimate and “lose” money if they don’t use it. Great list, Andrew!
    anna recently posted…Giving to those in needMy Profile

    1. livingrichcheaply@gmail.com Post author

      Thanks Anna. I saved a lot on medical expenses last year when my wife and I had planned medical expenses. Actually I underestimated. I’ve read that even if you overestimate slightly…the tax benefit may offset your loss, but it would still kill me!

  10. Laurie @thefrugalfarmer

    Love this, Andrew. We haven’t paid income tax in years and years. Partly, because Rick’s income is on the lower end (our max as a one-income family has been about $75k with overtime for him) and partly because we take advantage of deductions like the ones above. We also have a super smart tax guy who keeps well-educated on the laws, and can advise us of changes we should be making.
    Laurie @thefrugalfarmer recently posted…7 Money Saving Tips To Follow During Your VacationMy Profile

    1. livingrichcheaply@gmail.com Post author

      It’s great to be able to pick the brain of a super smart tax guy who knows the laws (they’re complicated!) and can advise you on how to maximize your tax savings!

  11. Holly@ClubThrifty

    We are taking advantage of all of the tax-deferred accounts we can! That’s all we can do, really. I don’t mind paying taxes…I just think everyone should pay their fair share.

    1. livingrichcheaply@gmail.com Post author

      Good! I agree. I don’t really mind paying taxes, but I’ll take all legitimate tax deductions to reduce that bill.

  12. Kim@Eyesonthedollar

    I would tell everyone to get an HSA health plan if possible. With the triple tax savings on contributions, interest, and withdrawals for medical expenses, this is an amazing vehicle for health care expenses. I’ve had one for years and have kept it in a savings account, but I am about to start investing my HSA in Vanguard funds and letting it grow. If we max it out each year and can pay for health care spending with other money, we should have enough to take care of most of our health care out of pocket costs when we are old. You can also save your receipts and reimburse yourself years in the future, tax free, if you want. I prefer that over a flex plan for health care, but if you have kids and don’t take advantage of the flex plan for daycare if you have one, that’s like paying 25% more if that’s your tax bracket.
    Kim@Eyesonthedollar recently posted…Who Pays For Long Term Care?My Profile

    1. livingrichcheaply@gmail.com Post author

      I’ve heard great things about the HSA plans for saving for retirement. I do not have access to it though. I’m definitely taking advantage of the dependent care flex plan now that I have a little one. It is a big savings!

  13. Anthony @ Thrifty Dad

    Tax free car benefits? I never heard of that. I don’t think we have something similar. I know they provide tax credits for public transport, but I think even then, it only applies to students. We have TFSA’s, which have been around for only a few years now and are similar to Roth IRA’s, which I try and take advantage of when there’s any money left over. They max out at $5,500/yr, but contribution room can be carried forward and withdrawals are completely tax-free, regardless of age, with some limits. I also take part fully in my company’s defined retirement plan, which are similar to 401ks, as I understand, where the company matches a % of income and it reduces taxable income. Other than that, my wife gains some tax advantages with her small business. But last couple of years, we’ve handed it over to an accountant. Taxes can be complicated!!
    Anthony @ Thrifty Dad recently posted…Sweat the small stuff: Why small expenses matterMy Profile

    1. livingrichcheaply@gmail.com Post author

      No tax free car benefits…that would be beneficial for me though! But if you are part of a vanpool, you might be able to benefit. Thanks for sharing the tax benefits in Canada. I haven’t used an accountant yet as we don’t really have anything complicated as of now, but may have to look into one at some point in time. Taxes are complicated! I guess it’s not just here in the US.

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  15. Joe Morgan

    Good job getting the word out on these. So many times people pass on things like 401k contributions because they think they can’t afford to have the money taken out of their paychecks, but it’s such a short-sighted view. Besides, you may even end up with more at tax time if you contribute enough to lower you income substantially.
    Joe Morgan recently posted…Is the Stock Market in a Bubble Again?My Profile

    1. livingrichcheaply@gmail.com Post author

      Thanks Joe. I think a lot of people don’t realize that they actually can afford to make those contributions as it’s often not as much as they think since it is pre-tax. Plus you can’t afford not to save for retirement. Definitely short-sighted thinking.

    1. livingrichcheaply@gmail.com Post author

      Hi Amy, thanks for your comment. I should have been more clear about that. Hiring a babysitting so you can go on a night out on the town would definitely not be a qualified expense! I’ve updated the post and included the link that you provided. Thanks again.

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