The Best Advice You Can Give

I read an article about five years ago. The crux of article was that in retirement between 60%-70% of retiree’s expenses are health related. I never forgot that article. What the article didn’t mention was that to pay those medical expenses, seniors had to take money out of their retirement, which was taxable, for a medical expense that would probably not be deductible. That didn’t make any sense to me, so I devised a plan.

A majority of my clients have, what is considered a “high deductible” health insurance plan. Today they are relatively healthy, and they don’t use their insurance, but I bring up that they can contribute money to a health savings account (HSA). This is usually met with resistance. The client will reply that if they don’t use the money in the plan during the year, the money will disappear. I explain to them that they are thinking of the HSA’s cousin, the flexible spending account (FSA), and any amount in the HSA that isn’t used, simply carries over forever, until used.

To qualify for an HSA, if you are single, your deductible has to be $1,350, for a family it is $2,700. If you qualify, and you are under age 50 and single, you can put up to $3,450 into your HSA. If you are under age 50, and you have a family, you can put up to $6,800 into your HSA. If you are 50 or older, there is a special $1,000 catchup contribution that you can make.

Regardless of adjusted gross income (AGI), the contribution you make to an HSA is an above the line tax deduction. Most HSA’s have a mechanism in them, that allow you to invest in mutual funds and stock. The earnings grow tax free, and when you take the money out of the plan, provided it is for medical expenses, it is tax free. If you are just thinking of the tax deduction, this is perfect for the person whose IRA contribution is either limited or not allowed for various reasons. The HSA deduction, works exactly like an IRA deduction.

If you follow my articles, you will know that for the most part, I am a big proponent of converting to C-Corporations. One reason is that in a C-Corporation, unlike an S-Corporation, you can have a health reimbursement account (HRA). The contributions to an HRA have no limits. If you don’t have employees, you could contribute as much as you want to an HRA, and the contribution is deductible to the corporation. If you have employees, what you do for yourself, you have to do for your employees. However, you can do a lesser amount for them. For instance, you can set the plan diferenciating the contribution made by the employee being married or single, years of service, etc. An HRA works just like an HSA. If you don’t use it, it simply rolls over.

About six years ago, I wrote an article for a publication and as usual, I was called crazy. I didn’t name the strategy, but the publication took it upon themselves to name it a Backdoor Roth Contribution. How this works. Let’s say you have a client that wants to put money in a Roth, but their AGI is too high, or they are covered by a retirement plan at work, and they can’t make an IRA contribution. What I came up with was this. First of all make the maximum non-deductible IRA contribution. The very next day (this is important), you convert that non-deductible Traditional IRA contribution to a Roth IRA. You are probably saying to yourself that conversions from a Traditional IRA to a Roth are taxable, and you are sort of right. In this case, you made a non-deductible contribution, so you didn’t get a tax deduction. The only taxable event would be the earnings that the contribution made before the conversion. Those earnings are taxable. However, if you convert to a Roth the very next day, hardly any earnings would have been made. The end result is that you have money in a Roth. If you keep the money there for five years, and withdrawal it, it is tax free.

Another fringe benefit to think about for C-Corporations is a flexible spending account (FSA) for dependent care. My children are 20 and 16, but I remember when they were younger. Daycare costs were about what my wife made. Eventually, she just stayed at home with our kids, until they could stay home alone. That isn’t an option for most people. However, your employer can open an FSA. If you are married filing jointly, single, or head of household, you can get $5,000, tax free, towards your daycare expenses. That won’t cover it completely, but it is better than nothing. Not to mention the $5,000 is pre-tax, which will lower your income tax burden.

Another thing that drives me crazy is this. My wife and I had our kids very early. She was 21 and I was 24. I was just out of college and starting my career. My wife and I made next to nothing. However, we made it a priority to save for our kid’s college. We are in Florida, and Florida has something called prepaid college. The plan locks in today’s tuition, for tomorrow’s education. In addition, we put $250 a month in a 529 plan for our first born. When our second child came three years later, we did the same. In order to do this, we had to forgo meals out, vacations, new clothes, cable TV. We didn’t have anything extra. I believe that our AGI in those years was between $25,000 – $35,000. When I see a client that has a kid, the first question I ask them is have you paid for college? The answer is usually, we will get around to it, or any other reason except yes. These clients make six to ten times what we made when we did it. The odds of your kid getting a full scholarship is about 2%. The parents make too much money for financial aid, so the kid is left with student loans. Not to mention, if you are self-employed, you can pay your kids a salary, and divert that amount into a college savings plan.

If you don’t, and you should, give your clients an organizer to fill out before you do a return. If you see an answer that doesn’t actually pertain to the return, make a note to follow up after tax season.

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Craig W. Smalley, MST, EA, is the Founder and CEO of CWSEAPA, PLLC. He has been admitted to practice before the Internal Revenue Service as an Enrolled Agent and has a Master’s Certificate in Taxation from UCLA. In practice since 1994, Craig is well-versed in U.S Tax Law and U.S. Tax Court cases, and specializes in individual, partnership, and corporate taxation for high-net-worth clients; entity structuring and restructuring; and representation before the IRS regarding negotiations, audits and appeals. Craig is currently a columnist for CPA Practice Advisor and AccountingWEB and has had 12 books published. His articles have been featured in publications including the Wall Street Journal, The New York Times, and Christian Science Monitor, and he has been interviewed and appeared as a featured guest on numerous radio shows and podcasts. Craig can be reached at craig@craigwsmalleyea.com.