By: Mike Gertsema CEO and Wealth Advisor
Most people are filing their 2019 income taxes and are hoping to get a refund and not have to pay additional taxes. In 2018 the income tax code was changed, and most people know about it, but wonder if it benefited them. Nick Gertsema, AIF®, Vice President and Wealth Advisor here at GWA did a video about the income tax bracket changes that has received a lot of attention.
Bottom line: what does it all mean? From my perspective, I think current income tax changes are a game-changer in many ways. From the young people in the workforce, middle-aged people in the workforce and for people already retired.
Young People in The Workforce
Most people are investing in their company’s 401(k) with the idea it’s an income tax deduction, the money is invested for tax-deferred growth and it’s a great way to save for retirement. The question now is, is there a Roth 401(k) option, which means you’re saving the same amount of money, but it’s an after-tax contribution instead of pre-tax. What’s the difference, right?
Well, the current income tax law change may be the lowest income tax treatment most people will see in a lifetime. Paying the tax on the contribution to the Roth 401(k) now will grow income tax-deferred, but come out income tax-free after age 59 ½, when tax bracket could be considerably higher than the current law, while the pretax contribution will be taxable.
Middle Aged People in The Workforce
All the above information pertains to middle-aged people in the workforce, but if your income is much higher and your itemized deductions are gone because you’re debt-free or the income tax law changed your ability to itemize, you may need the income tax deduction.
A couple of things to think about:
- Which income tax bracket are you in and what is your effective income tax bracket or average tax rate are you paying?
- Is it lower now than it was in 2017 with the same taxable income?
- Is there a ROTH 401(k) option in your employer’s retirement plan?
- Should you be putting some of your contributions pre-tax for the deduction and a portion after-tax maximizing the benefits of the current income tax changes?
Another item to keep in mind is the Roth account must be open for 5 years before you’re able to take money out – or age 59 ½, whichever the longest period. The clock starts with the first contribution. If you’re 55 and start the ROTH option now, at age 60 the balance is available income tax-free and you have another source of income in retirement.
You’re Already Retired
Is it too late for the people that are currently retired? I don’t think so, there’s a lot of opportunity for this age group as well. If you’re retired, living off your social security, pension, and distributions from your IRA, you may be able to utilize the current income tax changes.
Things to keep in mind:
- What income tax bracket are you currently in?
- What’s your effective or average income rate?
- How much more income could you take from your IRA at the same income tax rate before going into a higher bracket to build a better cash reserve?
- This would be a good time to pay off your mortgage since you can no longer itemize with the tax code change
- Do a ROTH IRA conversion.
Using financial technology, we’re able to estimate all the information and come up with ideas and options. When people do Roth IRA conversions, they are thinking about the current income brackets working in their favor. They’re also thinking that it gives them more flexibility in retirement income – if the tax brackets go up it’s giving them a tax-free source of income.
The Surviving Spouse
Another topic that we don’t like to think about: What happens when one of the spouses passes away? Will you be in the same bracket as a Single Taxpayer and no longer Married Filing Joint?
It can be very painful because the standard deduction is cut in half when your status changes. You go up the income brackets much quicker, leaving the surviving spouse in a higher income bracket and a higher effective or average income tax rate. Doing a Roth IRA conversion now can help ease some of the income tax pain down the road.
Another consideration for the retirees is legacy planning. If you pass away with an IRA, your beneficiaries will have to pay the taxes. The options for the beneficiaries changed recently giving the beneficiaries the option of lump sum, taking the IRA over 5 years, or 10 years. The lifetime or “stretch option” is gone.
With the help of technology, retirement-planning cash flow and tax planning we’re able to discuss a lot of options for our clients to consider in a digital experience with instant results. Let’s say you and your spouse plan on leaving what’s left of your IRAs to the kids and discover Uncle Sam is getting more of the IRA than your kids are due to the projected income taxes, would you do something about it now if it was possible?
Roth Conversions for the Future
The Roth conversion is a helpful tool especially now, with better income tax treatment. We construct a strategy of taking additional distributions from the IRA on an annual basis maximizing the income tax benefits and converting distributions to the Roth IRA from 2020 to 2025. It can then grow tax-deferred and comes out income tax-free, since the current tax law is scheduled to expire in 2025, leaving us with the old tax code in 2026.
Another benefit to the beneficiaries is if they don’t need an inherited Roth IRA right away, they can take the 10-year option, letting it grow tax-deferred for the 10 years and getting potentially much more tax-free income.
Staying Steady in the Changes
The investment world is changing at a very rapid pace and with the help of technology and the support of our partners, Carson Group, we’re able to provide our clients with more value and strategies to help them.
It used to be all about investing and now it’s advising and investing. The advising can make more of a financial difference than investing, and that’s our passion as fiduciary advisors, putting your interests first.
How can we help you? Let’s get in touch today on how we can integrate income tax changes into your overall financial plan.
For a comprehensive review of your situation, always consult with a tax or legal advisor.
Converting from a traditional IRA to a Roth IRA is a taxable event. A Roth IRA offers tax free withdrawals on taxable contributions. To qualify for the tax-free and penalty-free withdrawal or earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59 ½ or due to death, disability, or a first time home purchase (up to a 10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes.