It may be December, but it’s always tax season for us. (Yes, really.) That’s because taxes tend to be our clients’ biggest expense – so we want to leverage every strategy that will minimize it, regardless of the time of year.
Here are some measures to consider – and potentially act on – before we close out 2018:
You may want to take a new approach to charitable giving due to this year’s tax law. Many people will no longer be itemizing their actual expenses because of limitations on deductions. Having said that, the IRS increased the standard deduction to $24,000 (for married couples filing jointly) to offset these limitations. What’s the bottom line? If your personal deductions don’t exceed $24,000, your charitable deductions may not offset your taxes for 2018. In lieu of this, you may want to do what’s called charitable-deduction bunching. Here’s how it works: Let’s say you typically donate $5,000 per year to your favorite charity. You could instead donate $10,000 to them in 2018 (or 2019) rather than spreading it out between both years. That would enable you to get past the $24,000 standard amount and reduce your taxes. It’s a complex area so, if you’d like more details, be sure to talk with your CPA and your Bluerock team.
The 2018 contribution limit for tax-deferred accounts is $18,500 for 401(k), 403(b) and most 457 plans for employees under age 50; for those who are age 50 or older, it’s $24,500. To ensure you’re taking full advantage of this deduction, please check your pay stubs.
If you don’t qualify to make outright Roth contributions, you can convert your IRA funds (or a portion of them) to your Roth account. They haven’t been taxed yet because IRAs are tax-deferred accounts. If you “convert” those funds to your Roth, they must be taxed as income; however, you won’t be penalized for an early withdrawal because the funds still will be in a retirement account. Every dollar converted will be added to your AGI and your tax expense for the year.
Why do this? There are three reasons:
- Funds in your Roth account grow tax-free and will never be taxed again.
- If the account is more than five years old, your beneficiaries won’t be taxed on the funds.
- You won’t be obligated to take required minimum distributions from your Roth Account.
These types of Roth conversions aren’t for everyone. There are other factors to consider besides having different income buckets (tax-free, deferred, ordinary) during retirement. If this option sounds appealing and you’d like more information, please don’t hesitate to contact us.
Required Minimum Distribution
Your RMD (or required minimum distribution) is the amount the IRS requires you take out of your tax-deferred retirement account each year. This requirement starts at age 70½ and is considered taxable income. If you don’t make the annual withdrawal, you may have to pay a penalty equal to 50% of the required amount.
Qualified Charitable Distributions
Qualified charitable distributions (QCD) are charitable donations made through your RMD. The donation must leave your retirement account and go straight to the 501(c)(3) organization. The amount sent to the charitable organization counts toward satisfying your RMD; however, it’s excluded from your taxable income.
Qualified Business Income Deduction
If you’re a business owner, there’s a new deduction called the QBID (qualified business income deduction). In a nutshell, it can allow business owners to exclude taxes on 20% of their income. (Yes, you read that correctly.)
As you can imagine, this part of our tax code is very complex. There are rules based on the type of business you own, how much income you make, and even how much you pay in W2 wages. Just know that this is new in 2018 and you may want to defer/accelerate your income to take advantage of this. Your CPA should guide you in this area.
In the New Year
Lastly, here are a few things to keep in mind for 2019:
- The 401(k)/retirement plan limits have finally changed! You can defer up to $19,000 in a 401k plan (up from $18,500). For folks 50 or over, the catch-up contribution remains at $6,000.
- We recommend spreading out your contribution throughout the year. Some like to max it out as early as possible, but if you do, you may not get the full employer match. Additionally, dollar-cost averaging never hurts either!
- The traditional IRA and Roth IRA limits have changed to $6,000 (up from $5,500). The catch-up contribution remains at $1,000 for individuals age 50 or over.
- As we’ve mentioned in previous newsletters, the new tax rates this year (and through 2025) are lower. After 2025, the tax rates “sunset” (or go back up to what they were in 2017). That means many people who are doing traditional 401(k)s (take a tax-break now and pay it back in the future) could be better off doing a Roth 401(k) (no tax-break now, but pay no taxes in the future). In fact, in some cases, there’s almost a 10% rate reduction. Like all things in life, each person’s situation is different. To determine if this makes sense, you must consider: your current tax bracket, your potential tax bracket in the future, and current compositions of Roth vs. traditional 401(k) balances. This is something we spend a lot of time analyzing, so we would be happy to help you make the right decision.
As we’ve said in this past, wealth management isn’t one size fits all. There are many factors to consider, so please contact us if you’d like to discuss these year-end tax strategies or ideas for 2019.