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Here's What the House Tax Bill Proposal Could Mean for You and Saving for Retirement

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It’s November, and once again votes are being counted. Only this time, it is the votes of the people we elected in 2016 that are making news. The House of Representatives is voting on what President Donald Trump calls the “Cut, Cut, Cut Act.” (Its official name is the Tax Cuts and Jobs Act.)

Let’s take a look at what the House bill proposes to cut and how those cuts might affect you and your efforts to save for retirement. (Note: The House of Representatives hopes to vote on the bill before the Thanksgiving recess, and negotiations are still going on. The Senate also is writing its own bill. Assuming both are passed, the two bills will go through a reconciliation process before being presented to the President for signature. (That means the details discussed here may still change. Check daily news sources for updates.)

401(k) and IRA Retirement Savings Plans

The best news here is that the tax reform bill leaves contribution limits and deductibility for 401(k) and IRA plans intact. That means savers can stash up to  $18,000 for 2017 and $18,500 for 2018 in their 401(k) plans ($24,000 [2017], $24,500 [2018] if you’re 50 or older) and as much as $5,500 in their IRAs ($6,500 for people age 50 and over). That makes this a good time to open and fund a self-directed IRA in time for the 2017 tax year, and to continue contributing on into the future.

The proposal also would make it easier for people to re-start saving through a 401(k) after they have taken a hardship withdrawal, by eliminating the current six-month waiting period that now applies.

The news about re-characterizing conversions to a Roth IRA is less promising. The proposal would take away that opportunity. People often choose to re-characterize Roth contributions to a Traditional IRA if they are not eligible for a Roth, or if a Roth conversion bumps them into a higher tax bracket they can choose to recharacterize the conversion and undo the transaction. It’s important to keep in mind, these are just proposals, and they may or may not pass.

Tax Brackets: Implications for Low, Middle, and High Earners

Speaking of tax brackets, the proposal would pare down the current six brackets (10%, 25%, 28%, 33%, 35%, and 39.6%) to just four: 12%, 25%, 35% and 39.6%. The people most affected by this change are taxpayers now in the 33% bracket. Because the 35% bracket has a lower income threshold, a number of people will be bumped into a higher bracket, and therefore, owe more taxes.

The new 12% tax rate covers a broad range: up to $45,000 for individuals and $90,000 for joint filers. For people who had been in the lowest (10%) tax bracket, this will be a tax increase; for people previously in the 15% bracket, it will be a welcome tax decrease. Low-income taxpayers who are also parents will, however, benefit from a $600 increase in the child-care tax credit to $1,600. Keep in mind that incomes that are taxed are based on an individual’s Adjusted Gross Income (AGI), and not gross income. There are increases in the standard deductions that will affect taxation. 

The Pew Research Center defines a four-person household earning between $45,000 and $145,000 as “middle class". Using that as a guide, those households will likely fall into the 25% tax bracket, and could well see a tax cut of approximately $700 a year, according to experts at the Urban-Brookings Tax Policy Center.

Middle-class households also will benefit from a standard deduction set to double to $12,000 for a single taxpayer; $24,000 for joint filers. (This also may influence who chooses to itemize. See below.)

People at the top of the salary ladder fare the best: The tax rate would drop to 35% for people earning up to $500,000 (singles filers) or $1 million (joint filers). This equates to a 4.6% reduction in their tax rate. People earning more than that would still be taxed at 39.6%. Other benefits attained by wealthy individuals include changes in the estate tax. It would be applied only to inheritances valued at more than $11.2 million, and would be phased out completely in six years.  In terms of retirement saving, contributions to Traditional IRAs up to the annual limit may continue to reduce your taxable income.

Alternative Minimum Tax Eliminated

Finally, wealthy individuals are most likely to benefit from the proposed elimination of the alternative minimum tax or AMT. The AMT, passed as an effort to ensure everyone pays his or her fair share of taxes, most often applies to the top 20% of earners—those who earn at least $149,000—and is most often paid by people in the top 1% of earners, or those who earn more than $732,000. Today, approximately five million middle-to-high earners pay this tax.

Fewer Opportunities for Itemized Deductions

As part of the simplification of the tax system, the Tax Cuts and Jobs Act eliminates a number of tax breaks, including student loan interest, spousal support, medical expenses, and deductions for casualty losses, moving expenses, and the cost of having your taxes prepared.

While the mortgage interest deduction survived, the House bill imposes new restrictions. In the future, buyers will be able to deduct interest on loans up to $500,000, and only on mortgages for their primary residence. In addition, home equity loans and lines of credit no longer qualify for the deduction.

One deduction—for charitable giving—was expanded. Under the bill, donors will be able to deduct cash contributions valued at up to 60% of the adjusted gross income, a 10% increase over the current deduction.

Finally, one consequence of the higher standard deduction ($12,000 for individuals, $24,000 for families), fewer taxpayers are likely to itemize their deductions at all.

Deductibility of State and Local Taxes Limited

Under the House proposal, taxpayers will no longer be able to write off all of the local and state income, property, and sales taxes they pay where they live. The bill would limit these deductions to $10,000. For people who live in states with no income tax, this will not be an issue. However, it will affect taxpayers in states with high income taxes and/or property taxes.

“Pass-Through” Small Businesses May Benefit

If you own a small business, such as a partnership, sole proprietorship, or S-corporation, you may benefit from a lower 25% tax rate. Previously, income from these entities was taxed at the relevant personal income tax rate. However, most small businesses do not earn enough to have been taxed at the highest 39.6% rate, therefore the benefit may be limited, according to experts at the Urban-Brookings Tax Policy Center.

Save, Save, Save with a Self-Directed IRA

You don’t have to wait to find out how Congress decides to reform the tax system. We already know that incentives to save for retirement aren’t changing. Why not cut to the chase and contribute to your IRA or other tax-advantaged retirement savings account today?  Don’t have an account? Open one today; it takes less than 10 minutes online.

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