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The Tax Deductible Super Roth IRA

Updated on November 22, 2014
KeithTax profile image

Keith Schroeder writes The Wealthy Accountant blog with 30 years experience in the tax field. He is the tax adviser of Mr. Money Mustache.

If you ever wanted a Roth IRA tax deduction, you are in luck. You may already know that Roth IRAs grow tax-free. Unfortunately, the contributions are not deductible. A traditional IRA contribution is deductible, but the taxes are only deferred. Eventually, Uncle Sam will get his slice.

The tax code has grown massively in the last few years with more deductions, credits, and tax-free opportunities than ever before. Getting these tax advantages takes planning. By using the tax code to your advantage, you can gain tax-free income while deducting your investment.

This article will address the differences between a Roth and traditional IRA, followed by details on the new, tax deductible, Super-Roth IRA.

Traditional IRA

The traditional IRA has been around the longest. Features of the traditional IRA are:

  • Contributions can either be deductible or non-deductible, depending on your income level, or if you are covered by a retirement plan at work.
  • Grows tax deferred. Taxes are not paid until money is taken out.
  • Limited ability to withdraw funds before age 59 ½ without penalty.
  • Easy to set up.
  • Large number of investment choices.
  • If covered by a retirement plan at work, the traditional IRA contribution may not be deductible.
  • Required distribution at age 70 ½.

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Roth IRA

The Roth IRA gives more people the opportunity to invest for retirement. Features include:

  • Can contribute with a higher income level than a traditional IRA.
  • Easy to set up.
  • Large number of investment choices.
  • Can take a tax-free distribution at any age from original invested funds. Profit is subject to 10% penalty if withdrawn before age 59 ½.
  • Grows tax-free.
  • No required distributions at any age.

Health Savings Account (HSA)

Everyone wants a tax deduction up front and tax-free money out the back. The traditional IRA gives you one, the Roth the other. Your out-of-pocket investment is smaller with a tax deductible investment because the IRS lowers your tax bill, thereby increasing your refund.

Tax-free growth is more valuable than tax deferred growth. An account that grows to $100,000 tax-free is worth $100,000 to you. In a tax deferred account, the tax bill will reduce the value of the account by a third, leaving you with $65,000-70,000.

Enter the Health Savings Account (HSA), a misunderstood tax advantaged investment. The HSA combines the best features of the traditional and Roth IRA with additional opportunities for withdrawing funds.

A family can invest over $6,000 in an HSA every year and take a full tax write-off. The money grows tax-free. You can withdraw funds for medical expenses tax-free at any time. At age 65 it turns into a tax-free retirement account.

The HSA is a medical savings account available to those with high deductible health insurance. Because contributions grow tax-free, it is advantageous to pay medical bills out-of-pocket, rather than taking money from the HSA. This allows the HSA to continue its tax-free growth.

You can withdraw medical expenses at any time from an HSA. Medical bills paid for out-of-pocket are available for withdrawal from the HSA at any time, even years later, tax-free.

HSAs are not for everyone. For a medical plan to be HSA qualified, it cannot cover prescriptions. This is by far the biggest drawback. For the majority of people, the HSA is a superior way to manage medical costs and build a sizable tax-free nest egg.

Here is a review to HSA features:

  • Tax deductible contributions.
  • Tax-free growth.
  • Easy to set up.
  • Investments can include bank products and mutual funds.
  • Accessible without penalty for medical expenses and later for retirement.
  • No prescription coverage is the major drawback.

Conclusions

Unless your health is bad or you require expensive prescriptions, the Health Savings Account is your ticket to a tax deductible retirement plan that grows tax-free. The HSA is another tool to build a meaningful net worth. The tax deduction reduces the cost of each investment. You can leave contributions in the HSA to grow tax-free instead of withdrawing funds for medical expenses.

When planning your retirement, don’t forget the Health Savings Account. It is frequently overlooked as a retirement tool or for building wealth. The tax code offers ample opportunities to save on taxes now and gain tax-free wealth later. All it takes is a little planning.

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    • KeithTax profile imageAUTHOR

      Keith Schroeder 

      5 years ago from Wisconsin

      Howard, let me clarrify prescriptions and HSAs. I always say prescription plans are not allowed within an HSA, but that is a half-truth and I use it because it reduces confusion in people familiar with non-HSA prescription plans.

      Many people view a prescription benefit as a co-pay, ie. you pay $25 and the rest of the medication cost is covered. This traditional prescription plan is not allowed within an HSA.

      Prescription coverage within an HSA is treated as any other medical expense with the high deductible in force on the prescription expenses as well. You must pay for prescription costs out-of-pocket or from funds the HSA savings account. Only after medical costs, including prescriptions, exceed the high deductible, something most people will not do most years, are prescription costs covered by the insurance plan. There are no co-pays or tiers for prescriptions within an HSA as is common with non-HSA health insurance.

      Section 213 of the Internal Revenue Code outlines what expenses are allowed in an HSA. Generally, medical expenses that go on Schecule A, Itemized Deductions, are allowable expenses under an HSA.

    • Howard S. profile image

      Howard S. 

      5 years ago from Dallas, Texas, and Asia

      Can you provide a reference? I checked my plan documents and they are quite clear that the same level of prescription coverage is provided under the "Plan-HSA" as under the other plans.

    • KeithTax profile imageAUTHOR

      Keith Schroeder 

      5 years ago from Wisconsin

      I'm missing something. Presciption plans are still not allowed in a qualified HSA plan per the Internal Revenue Code and regulations. It could be a stand-alone prescription plan, but that possess problems too.

    • Howard S. profile image

      Howard S. 

      5 years ago from Dallas, Texas, and Asia

      Your answer seems to address over-the-counter meds, which wasn't really my question, but then I worded it awkwardly anyway.

      The question is about HDHP plan requirements to qualify as HSA-compatible. You said that the health plan would have to be one that exculeds prescription meds. My HDHP includes prescription coverage and allows an HSA. Since my employer has 5,000 employees, I assume they've got it figured out leagally. So I'm wondering what explains the apparent contradiction.

    • KeithTax profile imageAUTHOR

      Keith Schroeder 

      5 years ago from Wisconsin

      You are correct, Howard. Non-prescriptions are no longer covered/reimburseable by and HSA.

    • Howard S. profile image

      Howard S. 

      5 years ago from Dallas, Texas, and Asia

      Is it possible that the HDHP requirement about no prescriptions has changed since this was written? My HDHP covers prescriptions and is billed as HSA-compatible. (I've been with the plan since late 2011.)

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