5 ways to hone retirement plans under new tax regime

Advisors


The Tax Cuts and Jobs Act passed by Congress late last year represents the most significant changes to the tax code since 1986. The changes are biggest for corporate taxpayers. C corps will see their statutory tax rate decline from 35 percent to 21 percent, and pass-through corporate entities — partnerships, sole proprietorships and S corps — where income is taxed at the individual level, will also see permanent and dramatic reductions in their tax liabilities.

The decreases in individual tax rates, on the other hand, are smaller and less certain, with rates set to revert back to current levels by 2026.

“The tax plan will help out corporations a lot more than average Americans,” said Daniel Haut, a portfolio counselor with Osborne Partners Capital Management. “Middle-class Americans itemizing their deductions may actually get hurt by tax reform.”

The rule changes regarding deductible expenses, exemptions, credits and the tax brackets pose new income-tax planning challenges for all Americans. They also have implications for retirement planning — most prominently for wealthy Americans — but for taxpayers of more modest means, as well.

Here are five strategies worth considering to improve your retirement planning in the new tax environment.

1. Move to a low-tax state. The lure of the Sunbelt for retirees got a little stronger with tax reform. The capping of the so-called SALT (state and local taxes) deductions at $10,000 will hit taxpayers in high-tax (and invariably blue) states such as California and New York particularly hard. New York Gov. Andrew Cuomo has threatened to sue the federal government over the roughly $14 billion his Department of Finance says it will cost New Yorkers annually.

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While the standard deduction on federal tax returns was nearly doubled to $12,000 for individuals, the average SALT deduction on federal returns for New Yorkers in 2015 was $22,000, according to the Tax Policy Center. In California — which also has high income-tax rates — an all-in property tax rate of 1.25 percent on a $1 million home would already put taxpayers over the $10,000 cap.

“There are a lot of benefits to living in California, but I wouldn’t be surprised to see more retirees moving to low-tax states, like Nevada or New Mexico,” said Haut, who lives in San Francisco.

2. Convert your traditional IRA to a Roth IRA. Roth IRAs provide the ultimate benefit in retirement — tax-free income. You can’t deduct your contributions to a Roth IRA, but the investment returns in the account are tax-free and so are account withdrawals (optional-not required) as long as you make them after age 59½.

“People need to diversify their tax risk,” said Ed Slott, CPA, retirement-planning expert and founder of Ed Slott & Co. in Rockville Centre, New York. “A tax-free retirement account is important over the long haul because higher rates in the future may hurt you in retirement.”

The lower marginal income-tax rates that take effect this year make the conversion of a traditional IRA to a Roth IRA significantly less expensive. With those rates potentially reverting back to current levels by 2026, paying the taxes now could be far less expensive than in retirement. “You always want to pay taxes at the lowest rate, and I think rates have hit rock bottom,” said Slott.

One major consideration: The tax bill did away with the option to undo a conversion by the tax-return date of the following year. If the market has a big downturn, you will owe tax on the full amount at conversion even if the account value drops by 30 percent before year-end. Slott suggests waiting until after Thanksgiving to make a conversion. Taxpayers could also consider converting smaller amounts over several years to reduce taxable income and potentially their marginal rates.

3. Give to charity in a smart way. The deduction for charitable donations was preserved in the tax bill, but with the standard deduction raised to $24,000 for a married couple, you’ll have to give a lot to warrant itemizing deductions.



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