By Barry Williams, CPA, JD
As you finalize your 2018 tax plans and begin to look forward, you need to understand the impact of tax reform – the Tax Cuts and Jobs Act of 2017 (TCJA) – and how it changes tax planning. This is not an easy task: there are more than 100 changed or new tax provisions to wade through. There is no one-size-fits-all approach for all taxpayers, so IRS Publication 5307 should be reviewed to see how the changes will impact your 2018 tax returns and how they fit into your personal tax planning for future years.
One aspect of the TCJA that taxpayers need to recognize is that many of the tax benefits, including tax reform’s reduced tax rates, will not last forever. The new tax rates and many other provisions are scheduled to expire in 2025. You have a seven-year window to take action that can lower your overall lifetime tax liability, not just the current or upcoming year's tax liability. The key here is to include retirement savings planning in your short-term and long-term planning related to the changes in the tax law.
When individual taxpayers consider retirement planning, two broad options are available: employer-provided retirement plans – 401(k)s, 403(b)s, 457(b)s, and the federal Thrift Savings Plan – and individual retirement accounts (IRAs). Traditional planning reduces current tax through contributions to employer-sponsored plans and IRAs with pretax dollars, but the Roth IRA provides an option for taxpayers to reverse the traditional order and use after-tax dollars to provide the contributions. With the Roth IRA, the tax benefit is deferred until retirement years, when a qualified distribution from a Roth will be tax-free; a qualified distribution from an employer-sponsored plan or traditional IRA would be taxable. How do you determine which is better? Laurie A. Siebert, CPA, CFP, offers information on making the decision of sheltering income now or in retirement in her 2017 Pennsylvania CPA Journal article, “Roth IRAs Revisited.”
Taking a Roth approach can be a feature in an employee’s qualified retirement plan: an employee may be able to designate a portion or all of his or her elective deferral as Roth contributions rather than traditional pretax elective contributions. This option can bring together the best of the 401(k), 403(b), 457(b), and the federal Thrift Savings Plan with the Roth IRA. There are no income eligibility rules (see below), the contribution limits for 2018 are $18,500 or $24,500 for those who are age 50 or over, and the withdrawals will be tax-free. Any matching contributions that your employer makes to the plan are still required to be included in traditional pretax holdings. A designated Roth account at work may be a consideration for those with limited resources or who are in lower tax brackets (such as taxpayers at the beginning of their careers).
The TCJA’s reduction in tax rates will have an impact upon the tax planning decision of whether you should choose a Roth IRA option because your tax rate is a major factor in making this decision. If you have decided that a Roth IRA is for you, there are some limitations that you need to understand. For 2018, the maximum contribution to a Roth IRA is $5,500; if you are age 50 or over, it is $6,500. You may make a 2018 contribution anytime up to the tax filing deadline of April 15. There are some limitations to consider on the contribution to a Roth IRA that relate to your modified adjusted gross income (AGI). For 2018, the Roth IRA contribution limit will be reduced or eliminated in the following situations:
- For those married filing jointly or as a qualifying widow or widower who have modified AGI of at least $189,000, your contribution will be limited. You cannot make a Roth IRA contribution if your modified AGI is $199,000 or more.
- Taxpayers who are single, head of household, or married filing separately (and who didn’t live with your spouse at any time in 2018), your contribution will be limited if your modified AGI is at least $120,000. You cannot make a Roth IRA contribution if your modified AGI is $135,000 or more.
- If married filing separately, but lived with your spouse at any time during the year, your contribution is limited if your modified AGI is less than $10,000. You cannot make a Roth IRA contribution if your modified AGI is $10,000 or more.
If you have concluded that you want a Roth option included in your long-term tax planning but you are not permitted to make a contribution to a Roth IRA, there is another option available. As discussed above, your employer may allow employees to designate all or part of their employer-provided retirement plan contributions to be treated as an after-tax Roth contribution.
As you move forward with your tax planning, make certain you understand all the pros and cons associated with each opportunity and how they impact your own situation in the short term and long term. This discussion of just one planning option provides an overview of basic concepts and options that may or may not fit into your strategy. A CPA can provide further guidance, and the PICPA can assist you in locating a CPA to help you successfully achieve your goals.
Barry Williams, CPA, JD, is dean of the McGowan School of Business at King’s College in Wilkes-Barre, Pa. He serves as a member of PICPA’s CPA Image Enhancement and Relations with Schools and Colleges committees.