As tax time draws near, Americans are taking a second look at the impact of the new tax laws.
For many people, the day of reckoning is proving an expensive one. The tax cut put more money in their paychecks, but the amount withheld for taxes was also reduced. Now, as tax returns are being prepared, many people are finding that the tax law also impacted their deductions, especially those for state and local income and property taxes. The result is a smaller refund than expected — or none at all.
The impact is causing people to rethink their tax strategies not only for this year but for years ahead. The new calculations are turning some traditional tax strategies on their head.
For many years, financial planners and tax advisers have encouraged people to save in tax-deferred accounts such as company 401(k) plans and IRAs. The standard wisdom was that you’d be in a lower tax bracket after you retire and start withdrawing.
Now, the question is: Do you believe tax rates will remain this low in the years ahead, after you retire? Or should you be making some plans to convert your IRA and pay the taxes now or at least take larger-than-required withdrawals in the next few years, while rates may be lower than in the future?
Kelly LaVigne, vice president of advanced markets for Allianz Life, says the company’s advisers are rethinking the traditional default position of deferring taxes as long as possible. A few key principles emerge if you expect that tax brackets might rise in the future — perhaps to deal with our ballooning budget deficits. Those higher tax brackets might come when you’re well into retirement and your required distributions are proportionately higher.
LaVigne recommends being aggressive about collecting deductions now, before you retire and while you’re still earning an income. There’s more than just contributing the maximum on a pre-tax basis to your company retirement plan.
—Use a health savings account to make tax-deductible contributions that can be withdrawn tax free for qualified medical expenses that are sure to come in retirement.
—Consider opening a charitable gift fund account (at Fidelity or Vanguard) and taking a big deduction this year, while doling out your contributions to recognized charities in the future, when your income is lower, and you might be able to take the new $12,000 per person standard deduction.
—Take extra money out after retirement but in the years before age 70 1/2, when minimum distributions (RMDs) are required. This is the “sweet spot” of lower income, during the current relatively low tax rate years. You don’t have to spend that extra money. You can invest your after-tax dollars in a Roth IRA if you are still working, or perhaps in a deferred annuity that will start paying out in five or 10 years, later in your retirement. Or use an annuity that has a death benefit bonus for your heirs.
—Consider a Roth conversion. If you have a traditional IRA, you can convert to a Roth — if you pay all applicable taxes now. (You need to have the cash for taxes outside your IRA to pay those taxes for this strategy to work well.) Of course, no one wants to give the government money before it is absolutely necessary. But current tax rates are low, perhaps the lowest you’ll see in your lifetime.
The advantage of this strategy is that with a Roth you won’t be required to take an RMD, ever! And your children and grandchildren, as beneficiaries, can continue growing the account tax-free after you die — if you educate them to leave the money in the account after you’re gone!
If you haven’t paid attention to changes in the tax laws, now is the time to reconsider, not only for your current tax return but for future income planning as well. And that’s The Savage Truth.