Smart decisions for the 2018 tax environment

Joe Erickson

Joe Erickson
CPA and Shareholder

Written by Joe Erickson, CPA

Tax reform: what does it mean?

Since Congress passed the Tax Cut and Jobs Act of 2017, you’re likely to find that things have shifted for your financial situation. Some of the most significant changes include the following:

  • New tax brackets: A new top rate of 37% will apply to those earning $500,000 or more. Tax brackets have shifted rates and income levels
  • Standard deductions: These will go up–they’ll now be $12,000 for individuals, $18,000 for heads of household, and $24,000 for jointly filing married couples as well as surviving spouses.
  • Personal exemption: This exemption–the amount you’re able to deduct from income for taxpayers and dependents you’ve claimed on your return–will be eliminated outright.

The deductibility of fees for financial advisors and CPAs will also be phased out for the 2018 tax year. In the past, financial advisors and CPAs have recommended taking fees out of your taxable account, because they can be itemized on your tax return (individual 1040). Now, the recommendation has shifted to account for the effects of tax reform. Financial experts recommend that you take fees out of your retirement account, instead. There are two reasons to do so:

  • It will not create a taxable event (any transaction or other action that leads to receiving income; for example, receiving a paycheck).
  • It will help to lower future required minimum distributions (the minimum amount you are required to withdraw from your retirement account) when you retire.

 Retirement planning: should you contribute to a Roth or traditional retirement account?

The new tax law means that contributing to a Roth 401(k) or Roth IRA may make more sense than a traditional 401(k) or IRA.

With the shift in tax brackets mentioned above, more people than ever are now part of a lower tax bracket. Those who earn a lower income will find that a Roth account is the more strategic option. They won’t be able to get much out of traditional accounts’ tax deductions, so adding to a Roth account and saving their earnings tax-free is a better choice.

Older and wealthier individuals (those ranging from their late 50s to 70s) can also benefit from a Roth 401(k); typically they won’t be eligible for a Roth IRA. A traditional 401(k) offers a tax deferral on growth within your account, but this is not much of a boon if your tax rates are unlikely to decline in retirement. If you’re retiring (and thus withdrawing money) fairly soon, the tax deferral on growth in a traditional account doesn’t amount to much. Using a Roth 401(k) means you’ll be paying standard income taxes on your current, initial contributions, rather than on your initial contributions and additional growth in the future.

The best retirement planning choice depends on your specific financial circumstances, particularly your current age and years to retirement, as well as your income and existing wealth. Be sure to do your research to ensure that you’ve chosen the most strategic option.

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