Ask an Expert: Tax Shelters

401(k), Expert Q&A, Taxes
on March 11, 2014

Dear Kirk: I’ve been hearing the term “tax shelter” being thrown around a lot lately. Can you explain exactly what a tax shelter is and the easiest ways to take advantage?

Ask an Expert: Tax Shelters

Kirk Says: The simple definition of a tax shelter is anything that helps protect the money you’ve earned from being subject to federal, state or local taxes.

Some of the more common tax shelters are associated with saving for retirement. These include qualified plans like 401K Plans, SEP’s and SIMPLE’s. These qualified plans let you reduce your adjusted gross income by putting away dollars that have not been taxed yet into the plans. The money that you put into a qualified plan can continue to grow (tax deferred) until you pull it out of the plan.

Our federal government also encourages you to leave your money in the plan for retirement by assessing a 10 percent tax penalty on top of the taxes you would owe when you pull it out—if you happen to pull out the money before the age of 59 and a half years old.

A similar plan is the traditional IRA, opened by individuals. Depending on your earned income, traditional IRA contributions may even provide a tax deduction, further enhancing their benefit as a tax shelter.

A third option for sheltering money from taxes is the Roth IRA. The tax shelter a Roth IRA can provide is on the back end of its life cycle, in that it will use money that has been taxed already—but then the money grows tax-free and can be pulled out at retirement tax-free as well. As with qualified plans, there are hoops to jump through based on contribution limits and the age at which you begin to make withdrawals.

A couple of other vehicles used as tax shelters are life insurance and trusts. Life insurance proceeds pass to the beneficiaries tax-free, while permanent life insurance products act similarly to Roth IRA’s, with a wider array of contribution limits and no earned income constraints.

Trusts, on the other hand, can be used to distribute substantial estates and save on estate taxes. Many times, life insurance and irrevocable life insurance trusts are combined to pass sizable life insurance proceeds and keep these proceeds from being included in the descendant’s estate. The tax savings produced in these situations can be significant.

As always, be sure to consult with your attorney, a qualified tax advisor, an insurance professional and a financial planner to determine which products and services best meet your needs. Proper planning here can make an impact worth hundreds of thousands over a lifetime and beyond.

Kirk Gwaltney is a Chartered Financial Consultant and a Chartered Life Underwriter in Brentwood, Tenn. Learn more about him at

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Found in: 401(k), Expert Q&A, Taxes
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