How to plan for your retirement when tax laws are constantly changing
A lively friend of mine once said: “Everything is in motion; it moves more and more every day! That’s what many think of the back-and-forth statements about the proposed tax changes. In Congress, provisions to raise revenue (think “taxes”) to fund physical and human infrastructure bills seem to be attracting more attention than the infrastructure proposals themselves. Tax proposals even appear on the evening wear of a certain politician.
But how can you plan for your retirement when there is not only the threat of tax changes, but the proposed changes keep changing?
In planning for retirement, this is a serious problem because you have to make decisions today that will affect your plan for years to come.
Some questions you may already be asking yourself:
– Should I continue to fund my IRA or, due to upcoming tax increases, do I have to convert to Roth?
– They are past the age at which the minimum required distributions must start at 72, but is there currently a tax reason to withdraw some of my tax-deferred money?
– And my 401 (k)? Should I stick to pre-tax contributions or pay taxes now to get tax-free income in the future?
– And what happens when I am gone, how should I structure the retirement accounts that I bequeath to the heirs?
The traffic light of the tax proposal
One way to deal with the proposed tax law changes is to ask yourself “are the proposals currently affecting my retirement path?” Consider the idea of a traffic light. Red means “stop”, green means “go” and yellow means “attention”.
For tax laws already passed, you have the green light. For example, SECURE is the current law, and because the law has largely removed IRA Stretch as a planning tool, you should review your plans for Legacy IRAs. You’re ready to plan for Roth conversions and look for alternatives to lengthen payments after you leave.
Likewise, current law states that the federal inheritance tax exemption will halve (from $ 11.7 million currently to about $ 6 million) starting in 2026. application of the law may be delayed, but the law itself is the rule of the land. Unless you plan to die before 2026, you have the green light to assume the exemption will apply to much smaller estates. And that can mean more taxes for you and your heirs. No reason to hold back the planning of ways to minimize the increase in transfer taxes.
With laws that have little (if any) chance of being passed in today’s political environment, stop worrying about these proposals. They are stopped dead for now. A likely example is Senator Warren’s wealth tax. This could dramatically increase your taxes if you are well-off or wealthy. But will he do it? Even a healthy contingent of Democrats is opposed to the idea. A watered-down version of this tax emerged last week, but even it’s unlikely to turn into law.
On the other hand, there is a bill in Congress approved by representatives of agricultural states that would cut the federal estate tax rate in half by 40%. In a Democrat-dominated Congress and administration, this tax cut proposal is more for the show, and if not a non-starter. Why take either of these suggestions into account in your retirement planning if they get nowhere? Leave the brakes on tax proposals that are not likely to occur in the near future.
The yellow on the brake light of the tax proposal – or “proceed with caution” – are issues that warrant your concern. The tax proposals we’ve seen over the past few weeks have fluctuated, but a common theme is that taxes are likely to go up for some people. There are proposals to increase income taxes, inheritance and gift taxes, and even payroll taxes. These taxes are used to finance the deficit and pay for necessary infrastructure improvements.
Additionally, the proposals, while varied in their approaches, clearly target higher income and high net worth families. Overall, these proposed tax increases have enough support to merit careful consideration. Although they are not yet a law, they are probably imminent.
How you might fit these impending tax changes into your retirement planning depends on your personal situation. Here are some examples:
– If you have a pending sale for your business and that sale will help fund your retirement, it is worth considering closing the deal before the capital gains tax increases. It’s not a law yet, but the threat is palpable for next year – or sooner.
– If you do not expect your income to decrease significantly in the years to come, this may translate into a tax increase and encourage you to consider converting some of your IRAs to Roth IRAs now. In the future, you may need to choose whether some or all of your 401 (k) contributions go to an after-tax Roth account. The idea is to pay tax on the seed (at low rates) rather than on the harvest (when the rates are higher). The downside to these strategies is small – you are only negatively affected if your taxes go down.
– Develop your thinking to consider the tax situation of your whole family. If you expect to have qualified retirement accounts to pass on to your heirs upon your death, the tax status of your beneficiaries is an additional concern. At the time of your death, your heirs may be adults with their own tax concerns. This suggests that you focus even more on paying tax now to avoid tax in the future. In addition to Roth conversions and Roth 401 (k) accounts, consider withdrawing some of your IRAs now to pay for life insurance premiums. The proceeds of the policy can then be paid tax-free to your beneficiaries.
– Conversely, if you are planning a large tax deduction with a flexible schedule, it may be worth waiting to see where Congress goes with the current tax proposals, especially if your plan includes a major charitable contribution soon. The higher the tax bracket, the larger the deduction. So you may be considering paying the premium this year while you are still working. We are entering the fourth quarter, but you still have time. Consider waiting a few weeks before paying the contribution to find out where Congress is going with taxes. This tax deduction could be more attractive in 2022 than today.
– If you think you’ll have enough wealth to be subject to 40% federal estate tax, now is the time to consider estate freeze and gift strategies. Unnecessary wealth can be heavily taxed on death, and the inheritance tax exemption will soon be reduced. In addition, many members of Congress intend to put an end to some popular estate tax planning techniques. The wealthiest taxpayers use exotic strategies like grantor trusts and FREEs to dramatically reduce their tax exposure. Shutting down these concepts is a priority for many tax writers. Time is running out and estate planning lawyers are overwhelmed with clients who want to use these techniques while they still exist.
On your journey to retirement, taxes can speed up or slow down your progress. We are aware of the tax changes that have occurred in recent years, and we have the green light to implement them. We also know that Congress is carefully considering the proposed tax changes. While any of these proposals are likely to affect your personal tax situation, consider doing – with caution – incorporating these changes into your plans. They aren’t law yet, but those bumps in the road need your attention now.