How will the new tax law affect how you save?
And while some of the changes do, in fact, favor business interests, the good news is that the Tax Cuts and Jobs Act largely avoids meddling with retirement planning and savings vehicles.
The new law shouldn’t significantly impact how you save for retirement, as the legislative changes have been largely good news for taxpayers. But you can now take advantage of lower federal income tax brackets to increase your contributions and maximize your savings.
Hardship withdrawals from your 401(k) or 403(b) plan
Internal Revenue Service (IRS) guidance provides for safe harbor events that would be considered to be an “immediate heavy and financial need,” allowing a participant in a 401(k) or a 403(b) plan to request a hardship withdrawal. One type of hardship event is to cover expenses for the repair of damage to an employee’s primary residence that would be eligible for a casualty deduction under the Internal Revenue Code.
What’s different: The Tax Cut and Jobs Act changed the criteria for a casualty deduction for losses incurred starting in 2018 to be available only for losses attributable to a federally declared disaster. This change limits plan participants seeking a hardship withdrawal to repair damage – like a tree falling on their home – to casualty losses that are part of a federally declared disaster if the plan operates under the IRS’ safe harbor guidelines.
Roth IRA conversions
Contributions to Roth IRAs are taxed up front, while earnings on those contributions are tax-free (if the withdrawal meets the IRS "qualified distribution" requirements of course). And unlike traditional IRAs, Roth IRAs don’t force the account owner to take required minimum distributions (which otherwise would start at age 70 ½). In the past, you could convert a traditional IRA into a Roth IRA. You paid the taxes on the amount converted and then, enjoyed tax-free growth. But, say the growth of your Roth IRA assets didn’t meet expectations. Or you lost your job. Or you incurred big medical expenses. Then you could do a Roth IRA “recharacterization,” or essentially convert the conversion back to a traditional IRA. Sound complicated? Yes. But it proved to be a fairly popular vehicle in the world of retirement savings.
What’s different: Congress may have believed that some taxpayers were gaming the system and using recharacterization as an investment strategy, so they closed the window on it effective in the 2018 tax year. In other words, no more Roth IRA recharacterizations. You can still convert your traditional IRA to a Roth IRA, but once you do, you can’t convert it back again. With this change, consider being strategic in your approach to conversion, if it's something you're interested in.
529 plan distributions
One of the most popular savings vehicles around, the 529 plan allows families to set aside money and pay for college tuition on a tax-free basis.
What’s different: Effective for distributions starting in 2018, the new tax law expands 529 plans to distribute up to $10,000 per year per student for tuition expenses at public, private or religious K-12 schools. Moreover, an individual who wants to help fund your child’s education – say a grandparent or great aunt, for instance – can contribute $15,000 (married couples can give up to $30,000) as a tax-free gift.
ABLE account transfers
These accounts provide tax-advantaged savings for people with special needs or who are living with a disability, without affecting eligibility for programs like Medicaid and Social Security Income.
What’s different: Starting in 2018, you can now transfer funds within a 529 account to an ABLE account, without incurring any tax or penalty. The new tax law creates another tax-favored option for accumulation, funding education and covering disability expenses by allowing you to roll funds into an ABLE account if one of your children qualifies. Keep in mind that the ABLE account owner would need to be the designated beneficiary of the 529 account or a member of that designated beneficiary's family.
While the new tax law’s long-term impact isn’t clear, it’s important to continue to save for the future and stay informed along the way.