The TAX CUTS & JOBS ACT is in the books. It may be seen as a benefit to individuals as well as some business structures. Whether you are for or against the tax cuts, and their impact on the country and economy, it’s best to discuss how to take advantage of the new changes.
In this article we’ll discuss 3 ways that you, as taxpayers, can take advantage of the new law, and put it to work for you and your family. While we can’t directly control tax law, we can know the rules and play the game in the most favorable way for you and your family.
Save and Pay Down Debt With Increased Take Home Pay
The new tax law keeps 7 progressive tax brackets from previous law rather than reducing them to 5 as was discussed early on in the debate. Although there are still 7 brackets to keep tabs on, tax percentages and the thresholds have changed.
Tax percentages have decreased for both individual filers, as well as married couples filing jointly. 15% becomes 12%, 25% becomes 22%, 28% becomes 24%, and so on. The result for many will be higher paychecks. Most Americans will likely see an increase in their take home pay.
Not only do tax rates decrease, the thresholds for crossing into the higher tax brackets increase. In other words, you can make more taxable income in 2018 than you could in 2017 without pushing yourself into the next higher tax bracket. This means many Americans will pay less federal income tax in the New Year.
What should you do with the increase in take home pay? We might suggest paying down any bad debt. Credit cards, auto loans, and other consumer debts can wreak havoc on your retirement lifestyle. Start paying it down now so it doesn’t follow throughout retirement.
You may also consider increasing your savings contributions for the future. It seems to be human nature to spend more as we earn more. However, if you increase savings contributions and it doesn’t affect your current lifestyle there’s a good reason to put it away for a rainy day. Rather than raise your lifestyle with the new found increase in pay, keep going as you have been and pocket the additional income for the future.
Roth Conversions Potential
In 2018 it might be a good idea to consider converting some of your IOUs to the IRS into tax-free accounts. What are IOUs to the IRS? Great question. Your 401K(s), Traditional IRAs, SEP IRAs, SIMPLE IRAs, 403(b)s, and many other tax deferred retirement savings accounts are yet-to-be-taxed. They are, in a sense, IOUs to the IRS. They are forever taxable accounts. The principal balance is taxable as regular income when withdrawn, the growth earned on your investments in these accounts will be taxed at regular income tax rates when withdrawn, and the death benefits paid to your beneficiaries will be taxed at their income tax rates. You cannot escape the inevitable. Uncle Sam will get his cut, at yet to be determined tax rates, right when you need the money the most in retirement.
Converting forever-taxed money in your IOUs to the IRS to never-taxed money just became cheaper for many Americans. Lower tax rates alone make it less expensive to pay off the federal government’s share of your retirement accounts. However, increased tax brackets have added an incentive to convert a larger portion of your retirement dollars at a reduced tax rate without crossing into the next threshold.
For example, a married couple in 2017 with a taxable income of $65,000 could have converted $10,900 to ROTH IRA money before crossing into a 25% tax bracket. They would have owed the federal government 15% tax on the converted amount, or $1,630. That same couple can convert $12,400 in 2018 before crossing into the 22% tax bracket and only pay 12% on the conversion, or $1,488.
Couples making more than $77,400 can convert some of their forever-taxed money at even steeper discounts than previous years. For example, a married couple in 2017 with a taxable income of $145,000 converting $10,000 would have paid a 25% tax on $8,100 ($2,025), and 28% tax on the next $1,900 ($532) for a total tax bill of $2,557 on the conversion. In the New Year this couple would convert the same $10,000 and only pay 22% tax on the entire amount. $2,200. That’s nearly a 14% tax savings by converting in 2018 over converting in 2017.
The next threshold for a higher tax bracket is $165,001. The next tax bracket is only 24%, still less than the 25% tax bracket in 2017 and previous years. The 24% tax bracket runs all of the way up to $315,000. Considering that in previous years the 28% bracket ran from 153,101 to $233,350, and the 33% bracket ran from $233,351 to $416,700 the new tax law is giving higher wage earners much more latitude to convert some of their forever-taxed money to never-taxed money at a significant discounted tax rate.
Capitalize On Market Gains
Long Term capital gains occur on investments held longer than 12 months. Short Term capital gains are gains on investments that you have held for 12 months or less. Short-term gains are taxed as regular income while long-term capital gains rates vary, based on your taxable income. For example, married taxpayers filing jointly pay 0% long-term capital gains until their income exceeds $77,200. From $77,201 to $479,00 the rate is 15%, and is 20% for income earners above that.
The market has been favorable, and it may be a good time to take a profit.
If your family household taxable income is less than $77,200 you may be able to take a profit on some of your long-term investments without owing any tax in 2018.
However, before you decide to take some of the gains off the top make sure you understand how capital gains affect your income tax brackets. Capital gains do get added into your taxable income and can push you into a higher tax bracket. Consult a professional before making any irrevocable moves. In order to minimize taxes, and maximize your profit from investments you’ve seen appreciate, consult a tax advisor and work with a fiduciary fee based investment advisor to determine which moves are in your best interest.
Now that we’ve discussed these three areas of interest affected by the tax law changes what can you do to make a difference for yourself and your family?
If your paycheck increased, pay off your bad debt faster. If your debt is paid off perhaps we should consider contributing to a tax-free retirement income account like a ROTH IRA. If your income exceeds the contribution limits for a ROTH IRA, there may still be a way to take advantage of a ROTH IRA, or other tax advantaged savings plan.
Consider converting some of your forever-taxed money to a ROTH IRA. It may make sense for some of your retirement dollars, while not for others. We’ll work together to determine which dollars should be converted, and how it will impact your taxes.
Allow yourself to take a profit from extraordinary market gains. This market has been favorable, and no one know exactly how long it will continue, or what a correction might look like when it comes. It may be a good time to get together to review your written retirement plan to determine if some of your investments should be sold now while someone else is willing to give you top dollar for them.