Should You Increase Your 401k Savings Due To Tax Reform?

February 22, 2018

Have you noticed a little boost in your paycheck recently? That’s probably because employers have just started updating their employees’ withholding based on the new tax law, which reduced tax brackets across the board. So what should you do with the extra money?

Should you contribute more?

It may seem like the responsible thing would be to contribute it to your 401(k). After all, if you’re like the average American, you may not be saving enough for retirement and this would be a painless way to get closer to that goal. (You can use this calculator to see how much you should be saving.) Here are a few questions you may want to ask yourself first:

Is the tax bill really saving you money?

While rates have come down, some deductions have also been reduced or eliminated, including the state and local tax deduction. If you pay high state, local or property taxes, you may actually see your taxes go up. You don’t want to find that out at tax time next year and have to borrow from your 401(k) to pay the IRS. You can use a calculator like this to estimate your tax liability under the new law and compare it to what you owed previously.

Do you have adequate emergency savings?

Even if you are saving money, your 401(k) may not be the best place for those savings. Financial planners typically recommend having enough emergency savings to cover at least 3-6 months’ worth of necessary expenses. Otherwise, you may be forced to raid that 401(k) (with possible taxes and penalties) or borrow at high-interest rates in the event of an emergency.

If you can’t bear the thought of neglecting your retirement savings for even a short period of time, consider contributing to a Roth IRA. You can withdraw the sum of your contributions at any time and for any reason without tax or penalty so it can double as your emergency fund. (If you withdraw earnings before age 59 ½, they are subject to possible taxes and penalties but the contributions come out first.)

Just be sure to keep the Roth IRA money someplace safe like a savings account or money market fund until you have enough emergency savings somewhere else. At that point, you can invest the Roth IRA money more aggressively to grow tax-free for retirement.

Do you have high-interest debt?

It probably doesn’t make sense to contribute more to your 401(k) if you have a credit card balance at 19% interest. Those 401(k) contributions would have to earn 19% after-taxes just to break even. That’s something I certainly wouldn’t count on, especially with many financial experts forecasting future returns in the low to middle single digits due to historically low interest rates and high stock valuations. For that reason, my rule of thumb is to pay off any debt with interest rates above 4-6% before investing extra money (unless you haven’t maxed your employer’s match).

Are you planning to buy a home?

If so, consider stashing the extra money in savings. You’ll need cash for the down payment, closing costs, and any furnishings and renovations you want to add. This is on top of your emergency funds, which will be even more important when you can’t call a landlord anymore for home repairs.

If you’re saving money from the tax bill, have adequate emergency savings, no high-interest debt, and aren’t looking to buy a home anytime soon, your 401(k) can get be a great place for those extra savings. Go ahead and adjust your contributions before you start getting used to the bigger paychecks. After all, many said the tax law favors the rich so the quicker you can get there, the better!

 

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7 Steps You Can Take To Adapt To The New Tax Law

January 08, 2018

Tax laws have just changed, and that is likely to affect you. Whether your see a net benefit in your paycheck (which I hope you do) or end up paying more is a function of personal factors like your mix of income sources, your overall income, what you currently deduct, how many children you have and where you live. Here are some steps you can take now to adapt to the new law:

Step One: Run a tax projection

How will the new tax legislation affect you? Will your taxes go up or down? The only way to know for sure is to run a tax projection – an estimate of what your tax return will look like for 2018. Several sites have tax projection calculators up now which incorporate proposed major changes, including CalcXML, CNN, and MarketWatch.

If you’ve got a complex situation and you think you may owe more or need to make estimated tax payments, consider asking your accountant to run a “pro-forma” tax projection early in 2018 to gauge your tax liability for the remainder of the year.

Step Two: Update your tax withholding

You may need to withhold more or less going forward. Unfortunately, it’s going to take some time for payroll departments – and the IRS – to put out new forms and rules. If you think you may owe less in taxes, keep your withholding allowances the same for now until the withholding guidelines are updated. You may not need to make any changes to see more in your paycheck once your payroll department has implemented the new standards.

If you think you may owe more, consider reducing your withholding allowances. Remember, it’s better to overpay and get a refund than underpay and get penalized. When updated for the new law, use the IRS withholding calculator to estimate how many withholding allowances you should claim for the remainder of the year. Contact your payroll department to change your elections (Form W4) if needed.

Step Three: Losing employer-subsidized commuter benefits? Increase your own contribution to your commuter account

The GOP tax plan eliminates the tax incentive for private employers that subsidize their employees’ transportation, parking and bicycle commuting expenses. If you’re using this benefit and your company has been paying for all or some of it, make sure you increase your contribution to your commuter account. Your contributions will still be pre-tax. The max is $255 per month.

Step Four: Consider the impact on buying or selling a home

The deduction limit for mortgage interest drops to $750,000 of debt on your primary residence. If you have a larger mortgage and are planning to stay in your home, no worries. It remains $1 million for homes purchased before Dec. 15 of 2017.

However, if you are buying a new home, a jumbo mortgage is not as financially attractive. Thinking about a vacation property or second home? Your mortgage interest will not be deductible over the limit of $750,000, including your primary residence.

If you are selling your primary residence, you can still exclude up to $500,000 for joint filers or $250,000 for single filers of capital gains if you have lived in the residence for two of the past five years. Moving for work? You may no longer deduct your moving expenses.

Step Five: Review the Roth/pre-tax decision

Generally, the lower your income tax rate and the further away you are from needing your savings in retirement, the more sense it makes to contribute to a Roth 401(k) and/or a Roth IRA.  However, if you’re losing itemized deductions with the new $10,000 cap on deducting state and local taxes (SALT), run some numbers to see if a pre-tax 401(k) contribution can help lower your tax rate. Conversely, if you don’t itemize and the standard deduction exceeds what you could take in previous years, it may make more sense to change from pre-tax to Roth. Compare your two options with this calculator once the new rates are incorporated.

Step Six: Rethink home equity loans

The deduction of interest on home equity loans has been suspended through 2025 unless the loan is used to substantially improve your home. This can make home equity loans more expensive. You may want to think twice before taking out a home equity loan and perhaps give higher priority to paying off existing ones.

Step Seven: Rescue your 401(k) loan if you leave your job

Up until now, if you left – or lost – your job while you had a 401(k) loan outstanding, any unpaid loan balance would be taxable and penalized at an additional 10 percent. Under the new law, it appears that you have until the April filing deadline to basically contribute the unpaid balance to an IRA and call it a rollover.

For example, if you had a $2,000 loan balance outstanding when you left your job in June, you would have until the following April to contribute $2,000 to an IRA rollover in order to avoid the income taxes and additional 10 percent penalty. That’s a good deal if you can find the money

Keep reading. There’s more in the tax bill that will have implications for individual taxpayers. If your income is complex or you have questions about your personal situation, please consult a professional tax advisor.

This post was originally published on Forbes.

The Skinny On The Latest Tax Reform Package – Should You Worry?

November 03, 2017

You’re likely to see lots of headlines in the coming weeks about the tax reform package that Congress will be hashing out, which many are calling the biggest tax overhaul in 30 years. Time will tell if that’s true and should a new tax law be passed, chances are it will look much different from what has been put forth so far.

I personally tend not to worry too much about this stuff until it’s actually law, but I know not everyone works like that, so here are the highlights of what’s being proposed and whether or not you should worry about it.

Mortgage interest deduction

What’s being proposed: A limit on the amount of interest you can deduct.

Should you worry? The limit applies to interest paid on NEW mortgages bigger than $500,000, so if you currently have a mortgage that’s larger than $500k, you’re good. If you were to take out a mortgage in the future that is higher than $500k, you’ll still be able to deduct interest, the amount would just be capped at the interest on the first $500k.

FYI, the current law caps the deduction at $1 million worth of mortgage debt.

Student loan interest deduction

What’s being proposed: Eliminating the deduction altogether.

Should you worry? If you currently have adjusted gross income over $80k ($160k if you’re married), then you already miss out on this deduction. If you’re just starting out in your career and paying down big loans, yes, this could affect your taxes. Depending on your tax bracket and total interest paid, this could cost you up to $625 in taxes. (keep reading though, this could be made up for with other changes)

Want to figure out more closely what it would cost you? Here’s how:

If you’re single and you make more than roughly $37k per year, then take the amount of student loan interest you actually paid (you can find this by logging into your loan service provider) and multiply it by .25. That’s about the amount you save on taxes with this deduction. Same process if you’re married and make more than about $75k combined.

If you make less than those thresholds, then just multiply your interest by .15 to get your number.

State and local tax deduction

What’s being proposed: A limit on the amount of state and local taxes you can deduct, including property taxes.

Should you worry? If you pay more than $10,000 per year in combined property and state income taxes, you could see your taxable income rise should this provision pass. The good news is that there are some powerful Republicans from states with the highest income tax rates who are likely to fight this on behalf of their over-taxed constituents. The fact that next year is an election year will play to your favor if this is an important deduction to you.

Alimony and moving expense deduction

What’s being proposed: Eliminating the deduction altogether.

Should you worry? If you pay alimony or were counting on a tax deduction to help fund a work-related move, then yes, you should worry. If you receive alimony, this will actually help you because you would no longer have to claim it as income.

Medical expense deduction

What’s being proposed: Eliminating the deduction altogether.

Should you worry? Most working people with decent insurance coverage aren’t able to deduct out of pocket medical expenses anyway, due to the law requiring that expenses must exceed 10% of your adjusted gross income before you can deduct it. Older Americans (who have a lower threshold and likely higher expenses), however, may suffer with this provision.

Is there any good news?

One of the goals of this package is to simplify the tax code, which is why a lot of deductions are going away. To make up for that, there are some positive changes proposed as well.

One thing that could help, especially for people who don’t itemize (and therefore don’t care about the mortgage and other tax deduction loss) is that the standard deduction is slated to practically double to $12,000 for individuals (currently $6,350) and $24,000 for families (currently $12,700). In other words, if you’re worried about losing your student loan interest deduction, the loss could more than be made up for by this larger deduction. The proposal also includes lower tax brackets for most of us, which is also good news.

One thing that wasn’t included, that many people thought was on the chopping block, are changes to the treatment of 401k contributions. Unless something gets slipped back into the final package, we can continue to contribute up to $18,000 in pre-tax money plus an additional $6,000 if you’re 50 or older. Even better news, that limit is getting bumped up to $18,500 for 2018.

“Worrying is like paying interest on a debt that never comes due”

The best thing you can do at this point to help your situation would be to let your congressional representatives know how you feel about these proposals. There will likely be organized efforts around some of these issues, so join in if it’s important to you.

There are obviously lots of other changes proposed in the proposed law that our representatives in Congress are working on, but those are the ones most likely to cause confusion and/or directly affect many of us “everyday” working folks. Time will tell what the final result will be. If I had to wager a guess, I’d say we probably won’t know much before Santa starts making his rounds.

 

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What’s Ahead for the Future of Our Retirement System?

August 14, 2012

Over the next few weeks, I will be providing a summary of some of my favorite sessions I had the pleasure of attending during this year’s 31st Annual ISCEBS Employee Benefits Symposium.  The 3 day event in August was held in San Francisco and brought together hundreds of credentialed benefits and compensation professionals from both the U.S. and Canada. Continue reading “What’s Ahead for the Future of Our Retirement System?”

The Proposed Retirement Security Project: Could Retirement Plan Deductions Get Cut?

May 01, 2012

A recent tax reform proposal may bring the end to the cherished tax shelter of a retirement plan deduction.  During testimony to the U.S. Senate Committee on Finance last September, William Gale discussed a proposal to eliminate the current tax deduction on retirement savings plans and suggested replacing it with a flat-rate refundable credit that would be deposited directly into the saver’s account.  Gale, who is the Director of the Retirement Security Project at the Brookings Institution, wants to see a new incentive structure for contributions to retirement savings accounts by changing the treatment of retirement savings in three ways: Continue reading “The Proposed Retirement Security Project: Could Retirement Plan Deductions Get Cut?”