The most obvious difference in the tax code makeover, if the measure is passed as currently written, is the reduction in tax brackets – from seven down to four at rates of 12 percent, 25 percent, 35 percent and 39.6 percent.. The effects on those strategizing their retirement could be profound, depending on their bracket and investment approaches. At minimum, many will need to review their situations carefully.
“Those proposed changes – and any others that may come with this administration – could have a big effect on annual tax returns and retirement investment plans,” says Richard W. Paul (www.rwpaul.com), president of Richard W. Paul & Associates, a financial advisory firm in Michigan, and author of The Baby Boomers’ Retirement Survival Guide. “So, of course, people are curious about how they should prepare.”
Paul lists four areas where the possible tax changes could be significantly impacted:
- 401(k). One common question with the proposed tax plan is whether contributing to a 401(k) will become less valuable from a tax perspective. “If President Trump succeeds in restructuring the current tax bracket system, it’s something to look at if you think you will end up moving into a lower tax bracket,” Paul says. “But remember, your bracket may be lower in retirement than it is now or will be even with Trump’s changes. Also, your 401(k) earnings grow faster because they’re tax-deferred. And if your employer offers some kind of match, you don’t want to miss out on that money.”
- Itemized deductions. The proposed cap on itemized deductions could impact higher-income earners by neutralizing any reduction in marginal tax rates. According to Howard Gleckman of the Tax Policy Center, singles and couples who make $1 million or more could take a hit with the $200,000 cap. “One really significant proposal that would benefit some higher-income earners would be the elimination of the alternative minimum tax,” Paul says. “Those who live in higher-tax states, or who have stock options or other alternative minimum tax preference items, would no longer have to pay the non-graduated alternative minimum tax rates on their income.”
- The Roth option. Paul says the Roth 401(k) is a good option when one believes their assets will appreciate substantially. “That’s because those gains are exempted from additional tax,” Paul says. However, a traditional non-Roth may be advantageous if one doesn’t anticipate big gains, or if planning their income to maintain lower marginal tax rates. “You need to take a realistic look at the tax bracket you’ll be in when you retire,” Paul adds.
- Capital gains. Trump’s proposals would not change the current rate structure for long-term capital gains; however, short-term capital gains, Paul says, which are taxed at ordinary marginal income tax rates, would be reduced to reflect the new marginal rate structure.
“At this point, it’s difficult to know if or when Trump’s tax proposal will become a reality,” Paul says. “Still, there’s a chance his proposals could become policy, so plan to meet with your tax