Derek and Linda – not their real names, of course – are long-term clients of ours. They’re a great family from Sandwich. They’re a few years older than me, hard-working, self-employed, with three kids. Two are in college, and one more is on her way.
Derek and Linda came into the Falmouth office last week buzzing about the new Unified Tax Reform Framework proposed by the Trump Administration. I explained to them that it’s a work in progress and the way things go with those “Washington Wizards,” it could change significantly before a final bill passes into law.
But if plans hold, the framework may considerably change tax brackets, deductions, and more. Like many of my clients and Cutter Family Finance readers, Derek and Linda have built a sound retirement system with its foundational pillars of investment, income, and advanced tax planning. They want to make sure they’ve planned as efficiently as they can for next year and the years beyond.
Those changes and the framework proposed by the Trump administration won’t change Derek and Linda’s or your year-end planning for 2017, but as my grandmother always taught me, an ounce of prevention is worth a pound of cure.
So, this week let’s talk about some of the proposed changes and see how getting ahead of them can work out to your financial advantage.
First, let’s look at the plan’s proposal to eliminate many itemized deductions except for charitable contributions and mortgage interest. Sounds scary, right? But the standard deduction for married couples filing jointly, such as Derek and Linda, would increase dramatically, from $12,700 to $24,000. Single filers’ deductions jump from $6,300 to $12,000. By my math, that about 50%!
Folks, if you itemize a lot of deductions, you need to work ahead of year-end with your tax planner to time deductions in your favor. Derek and Linda are among the 70% of us who already choose the standard deduction because it’s higher than what we’d qualify for if we itemize, so that’s probably a slam dunk for them.
Since about November of last year, Derek and Linda have seen gains in their equity (or stock) portion of their portfolio. Unfortunately, fixed income (bonds) have not fared so well mostly due to the Fed’s artificially low interest rates. So some tax-loss harvesting would work here.
Selling the portion of their portfolio that has losses can help off-set their gains. In fact, lower capital gains tax rates are a possibility under the new plan. So those losses may be more valuable to Derek and Linda now than if they wait to cash in until next year when the capital gains tax rate might be lower.
Also, don’t forget: If your losses exceed your gains for the year, or if you didn’t have any capital gains for the year, you can use losses to offset up to $3,000 in personal income.
Another opportunity for tax efficiency is through gifting. We are allowed to gift each year which helps to avoid gift taxes. If you stay within the federal 2017 limit of $14,000 for individuals or $28,000 for couples, like Derek and Linda, you can make as many financial gifts to people as you like. Gifts within those limits don’t count against the lifetime exclusion of $5.49 million. The current proposal may eliminate that exclusion limit.
That gift tax exclusion may also be an excellent way for you to steer money tax-free into a 529-compliant college savings plan. Contributions grow tax-free, and the government won’t take taxes out when the money goes to college expenses. What’s more, 30 states offer a full or partial tax deduction or credit for 529 plan contributions. In fact, effective January 1st of 2017 through 2021, contributions to a Massachusetts 529 plan of up to $1,000 per year for an individual, and up to $2,000 per year for a married couple filing jointly are deductible in computing Massachusetts taxable income.
Getting started sooner, rather than later, is always a good idea with college savings plans. You can front-load a 529 education savings plan for a five-year period tax-free – the limit is $70,000 for individuals and $140,000 for couples. That gives more time for your investment to grow, but you’ll have to put off contributing more until the five-year period is up. If the gift tax annual exclusion limit increases, this could change.
Between their careers and their investments, Derek and Linda have to worry about edging close to a higher tax bracket – something that may change if the income tax brackets get condensed, as is being suggested.
401(k) and IRA contributions directly reduce taxable income, so Derek and Linda could max out their 401(k) or traditional IRA contributions – $18,000 or $5,500, respectively. Derek’s in his 50s, so he can even exceed the standard contribution limits up to $6,000 for a 401(k) and up to $1,000 for an IRA. That edges them out of that higher bracket and puts income-earning savings away for later when Derek and Linda will need it.
Here is something we considered for Derek and Linda’s parents, who are in their 70s. As Cutter Family Finance readers know, we all have to start taking withdrawals from our Traditional IRAs once we hit 70 1/2 years.
There’s actually a way those IRA withdrawals can work out to your tax advantage. Reduce your taxable income by contributing some or even all of your IRA’s Required Minimum Distribution (RMD) directly to charity.
This type of gift is called a Qualified Charitable Distribution (QCD). The QCD allows you to give up to $100,000 to a charity without counting the distribution as taxable income. It’s a way to fulfill your RMD requirement while lowering your taxable income at the same time. The QCD is still relatively new – it’s part of a 2015 law, so a lot of folks aren’t taking advantage of it yet. But remember, the contribution has to come to the charity directly from the institution holding the IRA…not from you!
You know, financial lessons have a distinct correlation to life lessons…it is the little things that make the biggest difference.
Folks, it’s important to be vigilant and stay alert because you deserve more.
Have a great week!
Jeff Cutter, CPA, PFS is President at Cutter Financial Group, LLC, with offices is Falmouth, Plymouth, and Mansfield. Cutter Financial Group provides private wealth and investment management advice incorporating low risk, low volatility financial strategies. Jeff can be reached at firstname.lastname@example.org.
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