Will Individual Tax Reform Create New Opportunities?

By Allison Schmidt, Financial Advisor, CFP®, CPA

The most wonderful time of year is upon us…March Madness!  As I write this, I have the first round of the NCAA tournament on not one, but two screens to be sure to keep up with the inevitable Goliath that will be forced to step aside to let Cinderella dance.  It seemed appropriate to use the brackets and buckets theme of March to discuss the importance of managing tax brackets and income buckets.  I know it’s a little bit of a stretch, but if I am writing a financial planning article during my favorite sporting event of the year, I’m going to have to incorporate some basketball!

The recently implemented individual tax reform has given you, an investor, yet another reason to take a look at your tax situation and make sure you’re investing in the most appropriate way to take advantage of every opportunity to save a couple tax dollars.  I’ve written over the years about the importance of strategizing where to invest based on your current year income situation but wanted to explain how, for some investors, the recent tax law changes may have sweetened the deal so to speak.  Which bucket should I put my money in?

To Recap: In high income earning years, it can be important to contribute to tax-deferred accounts (401k, SEP IRA, Traditional IRA, etc) to receive a tax deduction in the current year when you’re in the higher tax bracket.  In lower earning years, it may be a good idea to contribute to either a Roth IRA or taxable account, thereby paying tax at your current tax rate, assuming your tax rate in the future when you withdraw the dollars will be higher.  (For more detailed discussion on this strategy, check out our blog post “Tips to Keep Yourself in a Lower Tax Bracket Over Time”).

Why it matters:  To take the most simplified look at this strategy, it matters because you may pay less taxes over time, keeping more of your hard earned money in your pocket or invested.  A lot of these strategies may seem insignificant on any one given year, save a couple hundred or even a couple thousand dollars here and there; however, over time these savings can be a significant increase in net after-tax income to you.  Just taking the time to assess your individual income situation each year is important to make sure you’re taking advantage of whatever that year is presenting.

Current Opportunity:  Below is an example of married filing jointly tax rates for 2017 vs 2018.  You can see two opportunities here: a decrease in rate and an increase in the size of the bracket.  For example, in 2017 the 28% tax bracket encompasses income to $233,350 compared to 2018 where the tax is reduced by 4% to 24% and encompasses income to $315,000.  If a married couple had taxable income of $300k in 2017 their average tax rate would be about 24.74%* compared to a couple with $300k of taxable income in 2018 would be about 20.19%**.  So the question becomes do you want more income taxed at that new current rate?  After assessing future taxable income, if the answer is yes then you may have an opportunity to create and build a Roth IRA via a conversion and build taxable accounts at a reduced tax expense.  Assuming, of course, this fits in with their financial and retirement income specific plan.  These rates do sunset in 2025 and will revert back to those 2017 rates (adjusted for inflation)  if they are not extended or amended.

You work hard to accumulate assets, so it only makes sense to make sure you’re getting the most out of each dollar you set aside.  Everyone’s situation is different and this certainly won’t be a strategy you use every year; however, when appropriately applied, this type of retirement income planning could set you up to build more wealth and spending power over time.

*Calculated based on 2017 tax brackets, taxable income of $300k tax due of $74,215.99.

**Calculated based on 2018 tax brackets, taxable income of $300k tax due of $60,578.42.

Securities offered through LPL Financial, Member FINRA/SIPC. Investment Advice offered through HD Wealth Strategies, a registered investment advisor and separate entity from LPL Financial. The opinions voiced in this material are for general information only and are not intended to provide specific tax advice or recommendations for any individual. We suggest that you discuss your specific tax issues with a qualified tax advisor. Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 may result in a 10% IRS penalty tax in addition to current income tax. The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change. Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regards to executing a conversion from a Traditional IRA to a Roth IRA. The converted amount is generally subject to income taxation. This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.