Tax Efficient Savings Options

A tax efficient savings plan is one that offers tax benefits to the holder. These benefits may be tax-deferred contributions or even tax-exempt status. Tax efficient savings plans are important because they allow the holder to save thousands of dollars on contributions that will go toward education, retirement, savings, and their future. These plans are easy to use once you understand their purpose and can provide you with a great way to avoid paying unnecessary taxes.

A 401(k) is a savings plan that lets employees save for their retirement by making tax-deferred contributions. A portion of the employee's paycheck is sent directly to the 401(k) account and contributions are often matched by the employer. The money in a 401(k) is not taxed until it is withdrawn, hopefully after retirement. The benefit of this is the individual will probably be in a lower tax bracket by the time he or she retires. The 401(k) is a tax efficient savings method because the earnings from your 401(k)--dividends, interest, capital gains--are not taxable. This can give a huge benefit over years.

A 529 plan is a tax efficient savings plan that's designed to help save for college expenses. Money from a 529 plan can be used for college-related expenses like tuition, books, supplies, and fees. One tax benefit of a 529 plan is that states often allow income tax deductions for part or all of the contributions. Even better, the money grows tax-deferred and any distributions spent on college costs is exempt from taxes. In addition, contributions of a certain amount are considered gifts under federal tax laws. Any contributions of $13,000 ($65,000 over 5 years if filing single) or $26,000 ($130,000 over 5 years for those married filing jointly) count toward the gift exemption. Once you contribute the maximum amount, you are not able to make another contribution for another 5 years and have it count as a gift.

There are three ways in which you might owe taxes on your mutual fund gains. One is if you sell the shares for more than you paid. The second way is if the mutual fund gives you dividends or interest. The third way in which you might owe taxes on your mutual fund gains is if the manager of the fund makes a profit trading securities in the fund's portfolio and passes it to you in capital gains. To take advantage of tax efficient mutual funds you need to find those with a manager that is less likely to invest in companies that pay dividends. Tax efficient mutual funds structure holdings so that the smallest amount of taxable income as possible is produced for shareholders. For example, these mutual funds may invest their money in companies that don't pay dividends, or municipal bonds that are tax free. If you're looking for tax efficient mutual funds, look for those that refer to themselves as "tax managed," and funds with a low turnover rate of holdings.

Health Savings Accounts, or HSAs, are not just a tax efficient savings plan, they're tax exempt. They're designed to help you save money for one of the biggest expenses in life: medical expenses. HSAs, in addition to being tax exempt, also collect interest, making it a great way to save money for medical expenses and services. Any withdraw you make, as well as contributions and interest, is tax free as long as you use it for medical purposes. The tax savings and benefits to HSAs are something you won't find anywhere else.

"Tax Efficient Funds." A to Z Investments. http://www.atozinvestments.com/tax-efficient-mutual-funds.html

Updegrave, Walter. "Mutual Fund Tax Efficiency." Cnn.com. 24 January 2004. 28 April 2009. http://money.cnn.com/2003/09/30/pf/expert/ask_expert/