Tax Reform and Your Retirement Income: 4 Key Changes

The Tax Cuts and Jobs Act of 2017 could impact your retirement income in the years ahead. Here's what to know—and key actions to take now.

a couple meeting with their advisor

If you're currently retired—or if you plan to stop working in the next few years—now's a good time to determine how the Tax Cuts and Jobs Act of 2017 ("TCJA") might affect your retirement income. While some changes may be beneficial, others may not be. And in some cases, it may depend on your approach. 

"Wealth planning is very intricate," says Ayham Bahnassi, Wealth Planner at Wells Fargo Private Bank. "A slight modification in one aspect of your wealth plan may have unintended consequences elsewhere. You have to look at everything."

The four provisions outlined here could increase—or reduce—your after-tax income. Be sure to discuss them with your tax and wealth advisors.

1. Revised tax rates and deductions
The new law established lower income tax rates and raised the standard deduction amount. The top marginal rate was lowered from 39.6 percent to 37 percent. The 2018 Federal income tax brackets are "less compressed" than the previous year's income tax bracket, Bahnassi says. "That means lower tax rates are being applied against a much wider range of income than before," he says. With a higher standard deduction, many taxpayers may skip itemizing, too.

Potential impact on retirement income: Taxpayers in the highest tax bracket should see a 2.6 percent tax savings right off the top on a portion of their income. In addition, some may find themselves slipping into a lower tax bracket, which could result in even more savings.

"[Less compressed Federal income tax brackets] means lower tax rates are being applied against a much wider range of income than before." — Ayham Bahnassi, Wealth Planner, Wells Fargo Private Bank

2. No more reversals of Roth IRA conversions
Before the enactment of TCJA, taxpayers could convert all or a portion of a traditional individual retirement account (IRA) to a Roth IRA but maintain the ability to reverse or "recharacterize" such conversion if such reversal was done before the due date of the income tax return with an extension. Sometimes a taxpayer may have wanted to reverse a Roth conversion because the conversion resulted in being placed at a higher income tax bracket than previously anticipated. 

However, under the new law, those reversals can no longer happen if the Roth conversion occurred after 2017. Because of that, Bahnassi says taxpayers who want to do a Roth IRA conversion should wait until later in the year when they can better predict their tax liability and investment returns.  

Potential impact on retirement income: Less flexibility could make it trickier to plan for retirement. Taxpayers and their advisors should closely consider the timing before undertaking a Roth conversion.

3. A cap on state and local tax credits
There's now a $10,000 cap on state and local tax deduction. Previously, this deduction allowed certain taxpayers who were not subject to the alternative minimum tax (AMT) to offset their federal income tax liability. Now, people living in high-tax states may feel the pinch.

"The new tax law makes it more expensive for high earners to live in high-tax states," Bahnassi says—meaning those taxes could take up a bigger chunk of your overall income. Some taxpayers, Bahnassi says, may relocate to a state with lower taxes to reduce their overall income tax liabilities.

Potential impact on retirement income: If you already are spending part of your year in a low-tax state, you may want to determine if it makes sense to shift your residency there to help lower your overall tax bill and increase your potential net retirement income. 

4. A 20 percent deduction for pass-through entities 
A 20 percent deduction on qualified business income (QBI) from pass-through businesses made headlines for people who conduct their business through a pass-through entity such as an LLC or S corporation. But Real Estate Investment Trust (REIT) investors could also reap benefits from this change.

REIT dividends are generally taxed as ordinary income. While certain pass-through entities have to fulfill specific employee wages and capital depreciation requirements to be eligible for the full 20 percent QBI deduction, "REITs automatically qualify for the 20 percent QBI deduction," Bahnassi says.

With the 20 percent deduction, someone in the highest tax bracket could see their tax rate on REIT dividend income drop from 37 percent to 29.6 percent. Given that, Bahnassi says, investors may wish to consider holding their REIT investments in taxable accounts versus tax-deferred accounts to preserve this favorable tax treatment on REIT dividends. 

Potential impact on retirement income: Investors may have an opportunity to increase their net income from REITs since they automatically qualify for the 20 percent QBI deduction. For some taxpayers, it may be more advantageous to hold such investments in a taxable account. Of course, investors should consult with their advisors to determine the appropriate mix of assets across their entire portfolio.

One final note: Most of these changes are set to expire in 2026, but Bahnassi warns that elections that shift power in Washington, D.C., could prompt changes before then.

"I recommend meeting with your advisors at least once a year," he says. "Even if there aren't changes in the tax law, there could be changes in your own personal circumstances that require re-assessing your tax-planning strategies."

Mark Tosczak has spent 25 years wrangling words for newspapers, magazines, businesses, nonprofits, and other organizations. He focuses on health care, science, and business.

Image by iStock

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Whether you’re nearing retirement or have already reached retirement, Wells Fargo Conversations offers a diverse blend of content to help provide options for your life’s second act.

Wells Fargo & Company and its affiliates do not provide legal advice. Wells Fargo Advisors does not provide tax or legal advice. Please consult your tax and legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your taxes are prepared.

This information is provided for educational and illustrative purposes only.

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