The Tax Cuts and Jobs Act (TCJA) of 2017 is now a done deal and people saving for retirement and people who are already retired (that's everybody, really) should consider how the new law will affect their after-tax income and financial plans. Here are some essentials to think about.
Is it Time to Relocate?
Taxpayers who itemize deductions for state and local taxes, often referred to as SALT, might consider moving to a tax-friendly state, one with low property taxes and no or low state income tax rates.
State and local income and real estate taxes will be capped starting in 2018 at $10,000 per year. Given that, "living in New York or California just became that much more expensive for retirees, making states such as Florida, Texas, Nevada, and the like more attractive," said Tim Steffen, director of advance planning for Baird Private Wealth Management. (Residents of those states, as well as South Dakota, Alaska, Washington, and Wyoming, pay no state individual income taxes.)
You can use this Wolters Kluwer website to review state income tax rates. Of note, seven states have no income tax and two tax only interest and dividend income, according to Wolters Kluwer.
You can also use this Tax Foundation website to review the effective property tax rates on owner-occupied housing; it represents the average amount of residential property tax actually paid, expressed as a percentage of home value. Of note, it shows low or no personal income tax states such as Texas and New Hampshire having relatively high effective property tax rates.
Your best move? Consider the overall tax burden of the state to which you contemplate moving as well as the after-tax effect of relocating. You don't want to pay more in sales tax, for instance, than you would in state and local income taxes and not be able to itemize the deduction. Visit this Tax Foundation website to get a sense of state sales tax rates.
Plus, you should factor in the increase in the standard deduction to $24,000 and how that changes your tax bill before moving.
Another tactic to consider if you currently itemize state and local taxes now, but might not in future years, is this: "Consider paying state or local income or real estate taxes by Dec. 31 if it appears such payments may not be deductible in 2018," said John Kilroy, a managing member of iValue Financial Planning. "Also making these payments in 2017 may be deducted at a higher marginal rate than if paid and deducted in 2018."
Fund a Donor-Advised Fund
Under TCJA, the rules for charitable contributions limit the deduction for cash donations to public charities (and private operating foundations) at 60% of the taxpayer's AGI, up from 50%.
"Notably, this increase will not only make it easier for those who make substantial charitable contributions to claim a full deduction, but for those who previously made substantial gifts, it may help to 'release' existing carryforward deductions under the new higher limit," Michael Kitces, publisher of the Nerd's Eye View, wrote in a recent report about the TCJA.
Steffen said retirees, who typically see their income drop significantly from what it was during their working years, have a planning opportunity.
"Since your tax rate is higher while you're working -- and even more so now that future tax rates will be falling -- maybe it makes sense to accelerate things such as charitable contributions into the years before you retire," he said. "By doing that through a donor-advised fund, you can get the tax deduction today when income is at its highest, but then distribute the money to charities later during your retirement years."
Whether taxpayers fund the donor-advised fund this year or in 2018 and beyond, however, depends on one's facts and circumstances. "If they are retiring now or next year, then getting the deduction in 2017 probably makes more sense, as 2017 income is likely higher than 2018," Steffen said. "With the marginal tax rates generally falling in 2018, the marginal tax benefit of a charitable gift -- and really all deductions -- is slightly less next year than it is this year. So yes, there is a bigger benefit to making the larger donation in 2017 versus 2018."
Elimination of the Recharacterization of Roth Conversions
You can still convert your traditional IRA into a Roth IRA. But the TCJA repeals the rules permitting recharacterizations of Roth conversions, effective starting in 2018.
Recharacterizing is, in essence, converting some or all of Roth IRA you just converted back into a traditional IRA. The tactic, which typically had to be completed by Oct. 15 in the year after the conversion, allowed taxpayers to take advantage of swings in the market value of securities.
"This is huge," said Jeffery Levine, the CEO and director of financial planning for Blueprint Wealth Alliance. "It single handedly eliminates about a half-dozen Roth conversion planning strategies."
Kitces further noted that TCJA makes systematic partial Roth conversions messier, though not impossible.
So, should you consider recharacterizing your Roth IRA now before year end if it makes sense? "Yes," said Levine. "One hundred percent, my thoughts. I have seen some articles from people suggesting that 2017 conversions may still be recharacterized next year -- but that is not my reading of the law, as well as many other experts I know. If there is any doubt, which at best there is, and a recharacterization is desired, it pays to do it now before the end of the year."
Medical Expense Deduction Expanded, Temporarily
According to Kitces' report, the medical expense deduction was not repealed or limited -- it was actually temporarily expanded under the final TCJA. "The 10%-of-AGI threshold for medical expense deductions is reduced to just 7.5% of AGI, both retroactively for the now-ending 2017 tax year, and the upcoming 2018 tax year," wrote Kitces.
In addition, Kites wrote that the medical expense threshold is adjusted to 7.5%-of-AGI for AMT purposes in 2017 and 2018 as well, ensuring that even AMT'ed taxpayers receive the benefit. After 2018, the medical expense deduction reverts to the 10%-of-AGI threshold.
"Medical expenses are a major expense for some retirees," said Levine. "They (taxpayers who can benefit from this itemized deduction) may get a much needed, albeit brief, respite for this year and next with the 10% AGI hurdle for deductibility temporarily dropping to 7.5%."
To be sure, taxpayers will still have to get above the standard deduction and the 7.5% AGI threshold to benefit from the medical expense deduction. "But for those with really significant expenses -- home care, nursing home, and the like -- that will still happen," said Levine.
Value of Mortgage Deduction
Because of the expanded standard deduction, Kitces said very few retirees will itemize deductions now. "Especially given their tendency to move to states such as Florida (that have) low property tax bills and no state income tax deduction," he said. "That's important because broad use of the standard deduction eliminates the value of the mortgage deduction in retirement, and reduces the value of small charitable deductions that don't clear the hurdle."
According to the most recent IRS data, for the 2013 tax year, 30.1% of households chose to itemize their deductions (44 million returns). It's anticipated that only a very small percentage of households will itemize deductions at all in the future, according to Kitces' report.
Also of note, the TCJA eliminates the deductibility for any home equity indebtedness, and without any grandfathering for existing home equity indebtedness, according to Kitces. "After 2017, interest on home equity indebtedness simply will no longer be deductible, period," he wrote.
That means, according to Kitces, that it's not worth retiring with a mortgage or home equity indebtedness, if ever it was. "I've never been a huge fan of retiring with a mortgage just to invest in stocks with leverage, because of the risk that it entails," said Kitces. "But for all those who keep mortgages in retirement 'just for the deduction,' it will be a useless strategy for most because they won't even get a deduction."
Frankly, Kitces said, it was never a good strategy to keep a mortgage just for the deduction, because the deduction is never worth as much as the cost of the interest itself. "But it's really a moot point when you don't even itemize anymore," he said. Read "Why Is It Risky To Buy Stocks On Margin But Prudent To Buy Them 'On Mortgage'?" and "Why Keeping A Mortgage And A Portfolio May Not Be Worth The Risk."
Taxes Might Get Simpler
According to Levine, the larger standard deduction under the TCJA means that many more will not itemize deductions. This, said Levine, "goes towards the goal of simplification many retirees have for/during retirement."
Got questions about money, retirement and/or investments? Email Robert.Powell@TheStreet.com
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