Let’s sift through the number soup of financial terms

401(k)…403(b)…501(c)3…it’s easy to see why so many people are confused about the alphabet soup that is the modern financial vernacular. What was originally intended to help clarify the rules around different types of income and taxes has turned over the years into a digital jumble that can leave a lot of people scratching their heads.

Yarbrough Hunter

The good news is that only a handful of these terms are particularly relevant to most investors. Learning the basics of these can help clear up a lot of the confusion.

First, where do all these terms come from?

Each of these numbers corresponds to a different section of the Internal Revenue Code (IRC). The IRC refers to Title 26 of the United States Code, which is described in the preface as the “formal consolidation and codification of the general and permanent laws of the United States”. Title 26 covers all relevant rules regarding income taxes, gifts, estates, sales, wages, and excise duties.

Although the IRC contains nearly a dozen different categories with over a million words, a few key sections relate to retirement accounts, charities, college savings, real estate, and insurance. So, let’s take a look at each of them.

Understanding Retirement Accounts

A 401(k) is a company-sponsored retirement account that allows employees to contribute income and employers to match those contributions. There are two basic types – traditional and Roth – the main difference being how they are taxed. In a traditional 401(k), employee contributions are made before tax, which reduces the employee’s taxable income. Employee contributions to a Roth 401(k) are made with after-tax income. Therefore, withdrawals are tax-free.

A 403(b) is very similar to a 401(k) in that it allows employees to save money for retirement through payroll deductions. The main difference is that 403(b)s are designed to serve employees of public schools and tax-exempt organizations. A participant’s investment choices may also be more limited with a 403(b) than with a 401(k).

A 457 is another similar retirement savings plan. It is available to state and local government employees as well as some non-profit organizations. Like the traditional 401(k) and 403(b), it allows employees to deposit a portion of their pre-tax earnings and reduce their income taxes for the year.

A 401(a) is another employer-sponsored retirement plan that allows dollar or percentage contributions from the employer, employee, or both. They are most often used by governments and non-profit organizations.

Charities have tax categories

The 501(c)3 the classification refers to a specific tax category in the IRC for non-profit organizations. Organizations that meet the requirements for 501(c)3 status are exempt from federal income tax. Most eligible organizations fall into one of three categories: charities, churches and religious organizations, or private foundations. Organizations that qualify for the 501(c)3 designation can tell donors that all donations made to them are tax deductible.

The 501(c)4 grants tax exemption to two different social groups: organizations such as civic leagues, which are not organized for profit, but operate exclusively to promote social welfare, and local associations of employees whose income nets are devoted to charitable or educational purposes. While 501(c)4 organizations are themselves tax exempt, donations made by individuals to these groups are generally not tax deductible as a donation to a 501(c)3 organization.

Save for college

Advantageous taxation 529 Savings plans were originally designed to help pay for post-secondary education costs, but have since expanded to cover both K-12 education programs and college programs. learning. There are two main types of 529 plans: education savings plans, which operate tax-deferred and allow tax-free withdrawals (as long as they are used for eligible educational expenses), and plans Prepaid Tuition Fees, which allow users to pay current tuition fees for future attendance at designated colleges and universities. The 529 plans are sponsored by all 50 states and the District of Columbia and can be purchased either directly from a state or through a broker or financial advisor.

Business real estate

Item 1031 of the IRC provides for the deferral of federal taxes on certain real estate exchanges. It is used by business owners or investors who sell a property and reinvest the proceeds in other properties. As such, it is not available to buyers or sellers of personal homes for their own use.

Understanding Insurance

Finally, a 1035 exchange is an IRC provision that allows for the tax-free transfer of an existing annuity contract, life insurance policy, long-term care product, or similar endowment. Although the rules vary from company to company, both full and partial 1035 exchanges are allowed under the IRC. Typically, however, Section 1035 exchanges require the transaction to involve the same type of insurance product.

Navigate the numbers

As you’d expect, the Internal Revenue Code contains hundreds of other provisions and guidelines in its many categories, dealing with everything from “Miscellaneous Excise Taxes” to “Coal Industry Health Benefits.” . But the codes and plans outlined above cover the topics most relevant to most individuals and families. Still, getting lost in the sea of ​​numbers and acronyms that make up much of today’s financial terminology can be easy. So if you have any questions – whether about optimizing your tax strategy, planning for your retirement or more – contact our professional team of financial advisors today.

Hunter Yarbrough, CPA, CFP, is Executive Vice President and Financial Advisor at CapWealth. He is passionate about taking a holistic view of personal finances, including investments, taxes, retirement, education, estate planning and insurance. For more information on Hunter and CapWealth, visit capwealthgroup.com.