The Tax Cuts and Jobs Act of 2017 (TCJA) made significant changes to the way you and I pay taxes. It also makes more subtle changes that affect your IRA. Here are five ideas to consider as you think about your IRA under the new tax regime.
1. Pay investment advisory fees with your traditional IRA. Although TCJA eliminates the tax deduction for investment expenses, you can still get a tax benefit for your advisory fees if you instruct your custodian to pay them directly from your IRA. In essence, this allows you to pay your investment fees using previously deducted dollars and the fees come out of your IRA tax-free.
2. Say goodbye to Roth IRA recharacterizations. Before TCJA, investors who converted traditional IRAs to Roth IRAs were able reverse the conversion any time prior to October 15 of the year following the conversion.
Recharacterization gave investors a free option. If the investment in the Roth didn’t perform well enough to justify the taxes from the conversion, the investor could simply recharacterize it and the unfavorable tax situation disappeared. Under the new law, that option goes away. Now, once the conversion is completed, it is irrevocable.
3. Watch out for the kiddie tax. Previously, if a dependent child had unearned income (including distributions from inherited IRAs) in excess of $2,100, that excess income was taxed at the parents’ highest rate. Under the new tax law, a dependent child’s unearned income is taxed using the same tax brackets as trusts.
The tax brackets for trusts escalate faster than the tax brackets faced by real people. For example, a trust reaches its highest marginal rate (37 percent) with annual income of only $12,500. In contrast, a married couple filing jointly would need adjusted gross income of $600,000 to reach the 37 percent tax rate.
Unearned income includes interest and dividends as well as the required distributions from IRAs. Therefore, if your child is expected to inherit an IRA—especially a large IRA—you should carefully consider converting it to a Roth, thereby sidestepping the kiddie tax.
4. More help for kids. TCJA doubles the lifetime exemption for the estate tax to $11.2 million for an individual or $22.4 million for a married couple. It also increases the lifetime gift allowance to $11.2 million and the annual gift tax exclusion to $15,000 per recipient. As a result, parents and grandparents have a much greater ability to help younger generations prepare for retirement by transferring money to fund Roth accounts for children and grandchildren. Of course, there are a number of other considerations with a decision like that, but the new exemption levels give a lot more flexibility.
5. Don’t forget your favorite charities. The new tax law eliminates or reduces most itemized deductions and doubles the standard deduction that tax payers can take. As a result, many people will lose any tax benefit from making charitable contributions. However, owners of traditional IRAs over the age of 70 ½ can still receive a significant tax benefit for their charitable contributions by making what is called a qualified charitable distribution (QCD) directly from their IRA. Because the money in your IRA has never been taxed and the QCD comes out of your IRA tax-free, you get the same net tax benefit as if you had donated taxable income and taken a deduction for it.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to.