How Tax Reform Might Impact Your Retirement

Preparing for the “Golden Years” involves more than just putting money into a savings account; it requires sound strategies. Consider the 2017 Tax Cuts and Jobs Act as an example. Another example is the 2019 SECURE Act, which modified 401(k) savings that impacted millions of working-class individuals. Those tax reforms together could greatly alter the way you save money for retirement. Not only can they potentially affect how you invest but also when you can withdraw money and what your beneficiaries can do with the funds after your passing. Since the Tax Cuts and Jobs Act reduced income taxes, this is an excellent time to review your retirement plan . This could protect you from tax liabilities down the road once rates rebound. Some people want to convert money from a traditional IRA to a Roth IRA . However, due to tax implications, they must take precautionary measures. For others, saving more money could serve as a safeguard against the increasing cost of healthcare. It’ll also allow them to be put in a lower tax bracket.

Tax Reform for an IRA and 401(k) Account

The Tax Cuts and Jobs Act didn’t touch any vehicles used for retirement savings. But it did include some minor changes to the rules. One provision extended the time people have to pay back 401(k) loans after employment ceases. It also changed IRA conversion rules. As for the SECURE Act, this made it possible for part-time employees to participate in their employer’s retirement plans. It also expanded investment options for 401(k) account holders, including annuities, as well as pushing back the age when an individual must make a minimum distribution. Okay, this might sound somewhat confusing, but by understanding the basics of IRA and 401(k) accounts, it’ll all make more sense. For an IRA, you have two options – traditional and Roth. With a traditional IRA, you’ll get an immediate tax deduction on all qualified contributions. But when withdrawing at retirement age, those contributions become subject to income tax. Whether you choose a traditional IRA or a Roth IRA, these accounts aren’t deductible. However, once you reach age 59.5, you can make withdrawals tax-free in most instances. Before the new tax reform laws, retirees had to withdraw money from a traditional IRA and a 401(k) account once they reached 70.5 years of age. Required Minimum Distributions (RMDs), as they’re known, are taxable. With the passing of the SECURE Act, retirees don’t have to take RMDs until they reach age 72 . Although that’s only a six-month difference, it invests your money longer, which is good.

Undoing Roth Conversions

Under the Tax Cuts and Jobs Act, the most significant change is that account recharacterizations no longer exist. Created in 1997 by the government, Roth IRAs gave people the ability to move money from a traditional IRA to a Roth IRA. To do so, they had to pay income tax on the amount converted. Before the tax reform changes, many individuals would do a conversion at the beginning of the year, giving them an extra 12 months of tax-free gains. During that time, people could recharacterize or undo the conversion should they end up in a higher tax bracket or if the market didn’t do as well as expected. Today, recharacterizations aren’t allowed under the Tax Cuts and Jobs Act. So, choosing the time to convert is super important. Since the age for RMDs is now 72, that could provide retirees with a small window to convert a traditional IRA to a Roth IRA while they’re still in a lower tax bracket.

Inherited IRA Changes

The SECURE Act brings another significant change. While this tax reform won’t have any impact on retirees, it will affect beneficiaries of a retirement account. Before this tax reform, non-spousal heirs could spread inherited IRA withdrawals over their life known as a “stretch IRA.” They could also take out a lump sum of cash right away, which would likely result in a hefty tax bill. With the SECURE Act in place, non-spousal beneficiaries don’t have that amount of time to stretch out payments. Instead, they have to take all of the money from an inherited IRA within 10 years. That means those needing to liquidate a large account would get hit with a substantial tax bill. This creates a problem for retirees who want to leave a sizable inheritance. To eliminate a tax burden on beneficiaries of an inherited IRA, you could secure a life insurance policy to cover the liability. Another option is converting to a Roth IRA account.

Keep Perspective

You don’t want to allow these new tax reforms to dictate your investment decisions. Instead, the goal is to maximize the savings you have in your retirement accounts by using tax advantages. Remember, the government doesn’t promise that at some point, changes to both IRA and 401(k) accounts won’t reduce tax benefits. Therefore, you might consider diversifying various financial products, including insurance. Something else, for the next five years, the Tax Cuts and Jobs Act lowers tax brackets. So, this might be a good time to move your retirement savings to a Roth IRA.

Don’t Feel Overwhelmed

Yes, there’s a lot involved with putting money aside for retirement. But rather than feel consumed by everything involved, sit down with a professional financial planner. That way, you’ll make decisions that benefit you, as well as your beneficiaries, both short term, and long term.