There has been a lot of talk surrounding President Trump’s newest tax cuts, which were officially signed into law on December 22nd of 2017 as part of the Tax Cuts and Jobs Act. While not everyone is in agreement about how this legislation will affect job growth, the deficit, and the economy at large, there are a few important takeaways that cannot be overlooked.
Specifically, there are changes that will have a significant impact on everyday American taxpayers.
But before we look at some of these effects, let’s take a look at the Tax Cuts and Jobs Act to see exactly what it does and how it changes the tax code.
What is the Tax Cuts and Jobs Act?
In short, the Tax Cuts and Jobs Act is a Congressional legislative act that makes certain amendments to the Internal Revenue Code. While the bill has dozens of minor changes that only affect a select few, there are several important amendments that have widespread tax implications for the larger population. Specifically, the Tax Cuts and Jobs Act makes the following important changes:
The corporate tax rate is permanently lowered from 37% to 21%.
The act repeals the Obamacare tax on individuals without health insurance.
The standard deduction is doubled for single, married, and joint filers.
The act eliminates personal exemptions and most itemized exemptions.
Personal income tax rates are lowered for 5 of the 7 tax brackets (see below)
Previous Income Tax Rate
New Income Tax Rate
Income Range for Those Filing As:
Income Range for Those Filing As:
While corporate tax cuts are permanent, the lowered tax rates on individuals have an expiration date: 2025. This means that once this period has finished, your income tax rates will likely go up again, possibly even higher than before. So, what should you do to get the most out of this temporary tax break?
How to Take Advantage of the Trump Tax Cuts
While not everyone will benefit from the Tax Cuts and Jobs Act, single filers making between $38,700-$157,000 and joint filers making between $77,400-$315,000 stand to gain the most. Individuals in these tax brackets will pay between 3-4% less in federal income tax each year, from now through 2025. After this period ends, analysts predict that issues like the national debt, shrinking middle class, and social security and medicare funding challenges will likely lead to higher national income tax over the next 10-20 years.
What does this mean for your wealth going forward? First and foremost, it means that you have a relatively small window to seize a great opportunity. You could potentially save thousands of dollars if you play your cards right, so let’s take a look at how best to use these tax cuts.
Converting from a Traditional IRA to a Roth IRA
When it comes to saving for retirement, timing is key. This is especially true when it concerns how and when you pay taxes on your savings. With a traditional IRA, you set aside funds, and these contributions to your account are tax-deductible for the year in which they are made. However, when you withdraw your savings, you will need to pay taxes on your earnings.
Alternatively, a Roth IRA allows you to withdraw funds during retirement without any tax obligations. So, while you cannot get any tax deductions when you make contributions to a Roth IRA, you do not have to pay any taxes to make withdrawals.
So, why does this matter? It matters because there could be vast differences in the amount of income taxes you need to pay now versus when you are ready to withdraw your savings. Right now, income taxes are low. However, that will probably not be the case in 10-20 years. As a result, you can take advantage of the Trump tax cuts now by switching from a traditional IRA to a Roth IRA before the tax cuts expire in 2025.
Let’s crunch the numbers to get a better idea of how this could work for you. For example, let’s say you are single, and make $150,000 annually. This puts you in the 24% tax bracket (formerly 28%). Regardless of how much you put into your IRA account each year, you could deduct these annual contributions at a rate of 24%. However, once you withdraw those funds, you will likely need to pay 28% (or more) on your savings. With a Roth IRA, you will not be able to save anything in taxes now (while the tax rate is only 24%), but you can save later when the tax rate will likely be much higher (28% or more).
This is an excellent risk mitigation strategy, as it allows you to take advantage of ideal tax circumstances now, so that you can set up the optimal cash flow in retirement. But remember, these tax cuts end in 2025, so the sooner you convert your traditional IRA to a Roth IRA, the more you will save in the end.
Have any questions or want to setup some time to discuss your personal circumstances? Visit our website at Afton Advisors and schedule some time to connect!