New Tax Laws Open Doors for Pre-Retirees

Ty A. Bernicke CFP® | Posted: November 30, 2018

Originally published on Forbes.com - Go to that article



It is estimated that 80% of individual taxpayers will end up paying less in taxes in 2018 as a result of the new tax legislation, according to the non-partisan Tax Policy Center. This temporary tax overhaul should be carefully considered if you are a retirement investor. Before describing why the new tax relief may open doors for some that may never be opened again, it is worth considering a few challenges within the economic landscape that may shape the future of taxes.

Presently, there is a school of thought that believes the path the United States is on is not sustainable due to headwinds created by the following challenges:

  1. National Debt
  2. Unfunded Liabilities
  3. Changing Demographics

National Debt

In 1945, the national debt was proportionally similar to the present when compared against the size of the economy. To reduce national debt to a more acceptable ratio, the government implemented many different strategies over the next 38 years, including increasing tax rates.
Total US Debt

Unfunded Liabilities

In addition to the money owed for our national debt, we also have not saved up for the amounts that will be paid related to Medicare and Medicaid. Medicare alone faces unfunded liabilities approaching $49 trillion, which in and of itself is an amount significantly greater than the size of the United States economy.

Changing Demographics

Baby boomers accelerating into retirement will likely create additional tax challenges.

Taxes Paid by Age
Source: irs.gov; SOI Tax Stats - Individual Income Tax Returns Publication 1304 (Complete Report)

It may not come as a surprise that people in their working years pay the bulk of individual income taxes. Tax pressure will continue to increase as the number of individuals collecting Social Security and Medicare continues to rise, while the number of baby boomers contributing taxes towards these benefits decreases as they exit the workforce. The Social Security Administration projects that in 2034 the Social Security Trust Fund reserves will be depleted, and states that the policy reforms being considered in light of this include raising taxes.

What Can You Do?

When you combine the facts that we have a historically high national debt, trillions in additional unfunded liabilities, and aging demographics, it seems reasonable to assume that after these temporary tax reductions expire, tax rates may rise in the future. If this is a concern of yours and you are one of the 80% that is seeing a tax reduction, then two options available to protect against increasing taxes just became more appealing: contributing to, and converting money into, Roth retirement accounts.

1.     Open a Roth IRA

The allure of Roth IRAs is that they provide protection from future tax increases. Some of the benefits of these accounts include:

  • tax-free growth,
  • tax-free distributions, and
  • no required minimum distributions at 70.5 years old like those required by traditional IRAs, 401k, and other pre-tax retirement plans.

Roth IRAs, when properly established, can also be inherited by your children who can take tax-free distributions from these accounts over the course of their lifetimes (provided the accounts have been established for at least 5 years).

For 2018, Roth IRAs have a contribution limit of $5,500/year if you are under age 50, to the extent of your taxable compensation. If you are 50 or older, you can contribute $6,500/year. To qualify for a full contribution to a Roth IRA, your adjusted gross income needs to be less than $120,000 if you are single, or less than $189,000 if you are married and filing a joint tax return. If you have a Roth feature in your 401k or other retirement plan at work, you likely have the ability to contribute an additional $18,500 per year, or $24,500 per year if you are 50 or older, regardless of your income.

2.     Convert an IRA to a Roth IRA

A second strategy to help protect your retirement assets from future tax increases is to convert money from a traditional IRA to a Roth IRA. When this is done, it is important to recognize that you will be paying tax on the amount converted. If you are younger than 59.5 years old you will want to make sure that you have enough money set aside in a non-retirement account to pay the tax bill, because you cannot withhold taxes from the amount converted without incurring a 10% early withdrawal penalty tax. This strategy can be especially attractive for individuals who may have an artificially low tax year when income is lower than normal or deductions are higher than normal.

What Does the Future Hold?

Converting and contributing to Roth accounts can be effective ways to protect yourself from the potential of increasing tax rates in the future. These strategies have become more appealing to those who will be recognizing tax decreases as a result of the new tax legislation.

Before implementing these options, it is important to consider the tax rate that you have now versus the tax rate that you will have when you begin taking distributions from your account. If you believe that your tax rate will go up in the future when distributions begin, you may benefit from implementing these strategies.

As with any strategy there are many variables to consider outside the scope of what could be mentioned in this article, so please seek the advice of a tax professional before implementing any technique.

About the author

Ty A. Bernicke CFP®

Ty Bernicke is the President of Bernicke Wealth Management and serves as a Senior Wealth Manager. Ty currently works with a limited number of clients that require wealth and/or investment management services. His research on investment management, retirement planning, and tax minimization strategies have been published or recognized by The Wall Street Journal, Forbes, The New York Times, Futures Magazine, and many other well-known national and international publications. Ty Bernicke and Bernicke Wealth Management give back to the community and environment through numerous charitable endeavors. Ty spends his free time with his wife, two daughters, and one son. He also likes to fish, golf, and exercise.

Certifications, Licenses, and Registrations

  • Registered Principal with Triad Advisors, LLC
  • CERTIFIED FINANCIAL PLANNER™ professional
  • Accident, Life, Health, Property, Casualty, and Variable Life/Variable Annuity Insurance Licenses

Education and Training

  • Series 7, 66, 63, 24
  • Bachelors Degree - Finance; University of Wisconsin-Eau Claire
  • College for Financial Planning graduate

Forbes Finance Council Member 2018

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