How the New Tax Law Affects Retirement Savings Strategies

Community Manager
Community Manager
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shutterstock_576678016, 2.jpgIn early drafts of the recently enacted tax reform bill, there was a lot of talk about potential changes to retirement contributions. But little actually changed when all was said and done. Proposals to eliminate the deductibility of contributions to retirement plans and to lower the cap on retirement plan savings never made it through in the final bill.

 

Retirement plan contribution limits

We still have the same retirement plan tools and techniques at our disposal. Salary deferral contribution limits to retirement plans in 2018 are as follow:

  • TSP, 401(k), 403(b), 457, and SARSEP – Lesser of $18,500 or 100% of participant’s compensation, with an extra $6,000 allowed as a catch-up for contributors ages 50 or over
  • Traditional and Roth IRAs – Lesser of $5,500 or 100% of earned income, with a catch-up limit of $1,000 for ages 50+
  • Simple IRA – Lesser of $12,500 or 100% of participant’s compensation, plus a catch-up limit of $3,000 for ages 50+
  • SEP IRA – Lesser of $55,000 or 25% of participant’s compensation

New opportunities

There are no real changes to the types of retirement accounts. However, most Americans now have a lower tax rate. If you find yourself with more money in your pocket as a result of the TCJA, consider taking advantage of retirement savings opportunities:

 

Act now. The new lower rates are set to expire after 2025.

 

Consider saving money in a Roth account, if eligible. Since deductions may not be as valuable under the new tax rates, it’s a good time to reevaluate your mix of retirement vehicles. Roth contributions aren’t subject to an immediate tax deduction, but qualified distributions from Roth accounts won’t be taxed later.

 

Roth vs Traditional

As an example, let’s look at Jack and Jill, who are twins. Both are single; both make $40,000 per year; both save $4,000 per year into a retirement account; both take the standard deduction on their tax returns; both will retire in 30 years; both will earn a constant 6% return on their retirement savings; and both will be in the 15% tax bracket at retirement.

The only financial difference between the twins is that Jack prefers to get his tax deduction now by saving into a traditional IRA, and Jill prefers a tax-free distribution later by saving into a Roth IRA.

 

  • More money in their pockets – Despite their preference for retirement savings vehicles, both Jack and Jill could see their taxes go down in 2018 by about $1,600 compared to last year — a great opportunity to save!
  • In the end, Jill’s Roth is worth more – Under the old pre-2017 tax rates, and using our assumptions, there is no difference between the traditional IRA and the Roth IRA strategies 30 years from now, on an after-tax basis. However, under the new tax law, Jill’s Roth IRA strategy outperforms Jack’s Traditional IRA strategy. That’s because the new lower tax rates don’t offer as much benefit to the Traditional (deductible) IRA used by Jack.

USAA is here to help by providing additional information and guidance on your specific financial needs and goals as we evaluate the impact of the tax bill in 2018 and beyond. We’re committed to helping you make smart financial decisions all along the way.

 

Visit USAA’s Free Calculators & Online Planners for information and resources. You can also speak with an advisor by calling 800-531-8722.

 

The contents of this document are not intended to be, and are not, legal or tax advice. The applicable tax law is complex, the penalties for noncompliance are severe and the applicable tax law of your state may differ from federal tax law. Therefore, you should consult your tax and legal advisors regarding your specific situation.

 

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2 Comments
jdnc
Occasional Visitor

I follow your assumptions totally, HOWEVER, I think you need to do a little more analysis and think about adding this to your example of Roth vs. Traditional IRA.  Some individuals may have an even bigger  advantage than placing all of their money in the Roth by investing in Both a traditional and a Roth IRA.    Consider this, Jack has both a Roth & Traditional IRA.  He waits until 70 1/2 to start withdrawls.  He invests the money he saves from the traditional IRA tax savings in an index fund and he saves that money for retirement also.  Then when he starts his RMDs at age 70.5 he takes half from his Roth and the other half he takes as withdraws as a QCD from his Tradtional IRA donating to his church and other 401 (c) 3 charities.  This will lower his AGI and taxable income thus saving more on taxes.  AND, maybe even helping him to shift to a lower tax bracket?     

Community Manager
Community Manager

To: jdnc

 

Thanks for writing in and raising a good point about managing your tax burden during the distribution phase of retirement. Often- times, folks enter retirement without a plan regarding how taxes will affect them, and sometimes it can take a multi-pronged strategy to achieve the desired results. The use of Qualified Charitable Distributions (QCDs) may be part of a viable tactic for those with charitable inclinations and that can afford to do without the income. There are multiple strategies that may be available to folks nearing or living in retirement that can help balance the various retirement wants and needs, such as: lifetime  income, liquidity, growth as an inflation hedge, charitable intent, and legacy planning. One cautionary comment however: Don’t let the tax tail wag the dog; and be sure to seek out good advice that takes into consideration all of one’s retirement needs.