Having a savings account is a great way to keep your hard-earned money safe and use it for future payments. It is low-risk, offers great liquidity while also allowing you to earn a decent interest as an additional income source.
But the interest you earn from your regular savings accounts is taxable at the same rate as your primary income. Depending on yearly income, you may end up paying anywhere between 10-37% tax on your savings account earnings.
Your bank will send you a 1099 form for interest earned from your savings account in a year if you have earned more than $10 in interest. If it is less than $10, you still need to report it to the IRS on your tax forms along with other sources of your income and pay taxes on it.
However, there are a few ways to avoid paying tax on your savings account income while continuing to grow your funds. Adam Valdez, a trusted tax accountant in San Antonio shared a money-building tip to reduce the tax amount you owe to the IRS every year.
By wisely splitting your money into specific savings plans, you can allow your hard-earned money to grow with minimal risks and avoid paying tax on it too. Here’s how.
4 Types of Savings Accounts That Reduce Your Tax Burden
1. Open an IRA Account.
One of the key financial goals of having a savings account is retirement planning. IRA i.e Individual Retirement Account is savings accounts specially made for this purpose that also offers you tax benefits.
There are two common types of IRAs- traditional IRA and Roth IRA. You can contribute your pre-tax income to a traditional IRA account and pay a lower tax when you finally make a withdrawal during your retirement.
Also, contributions up to $6000 per year($7000 if you are over 50) will be deductible from your taxable income. Contributions to Roth IRA accounts are pre-taxed but withdrawals you make after 59 ½ years will be tax-free.
2. Invest in a 401K Plan
401k is an employer-sponsored saving plan where a part of your paycheck directly goes into your retirement savings. You do not have to pay tax on money that you contribute to traditional 401k until you withdraw them.
And at that point, you will likely find yourself in a lower income tax bracket and end up paying tax at a lower rate. Your employer may also make contributions to this savings account making it more advantageous than putting money in a regular savings account.
3. Start an HSA
If you have a high deductible health insurance plan, you can set aside money for your healthcare expenses into a Health Savings Account(HSA). Not only will you avoid paying tax on the earnings generated but yearly contributions up to $3600 will be deductible from your taxable income too.
And as long as you take out money for qualified medical expenses, your withdrawals will be tax-free too. Plus, your employer can contribute to your HSA for covering your medical bills just like they contribute towards your 401k for retirement savings.
4. Opt for 529 Plan.
Saving money for your kid’s educational expenses? Then you may want to start a 529 plan to reduce your tax burden. This is a state-sponsored savings plan that helps you set aside money for K-12 and college fees while earning tax-free income on it. Of course, withdrawals are tax-free as long as they are made for eligible purposes.
If you live in San Antonio or surrounding areas and need a tax accountant to help with your tax planning, you can consult Adam Valdez CPA. It is a family-owned business established in 1970 that specializes in income tax preparation, estate planning, payroll services and bookkeeping services in San Antonio, Texas.