With another tax season in the books, many Americans are now thinking about how the financial decisions they make in 2018 will affect them on Tax Day next year and well into the future.
One area in which taxes have long been a central focus is retirement planning. The hallmark of the workplace 401(k), one of the most popular vehicles for saving for retirement, is the tax advantage it can offer. Traditional 401(k)s are funded with pre-tax dollars, so saving in them means that in addition to putting away money for retirement you are also lowering your pre-tax income, which may help lower your tax bill. In 2018, the maximum 401(k) contribution amount has increased to $18,500, up from $18,000 in the previous few years. On top of that, savers aged 50 and over can sock away another $6,000 as a catch-up contribution.
For those who prefer to save for retirement with after-tax dollars, some companies offer their employees the choice to contribute to a Roth 401(k) instead. Because you are contributing after-tax dollars with the Roth option, you won’t have to pay taxes on your withdrawals in retirement, including any investment growth, after you meet a few requirements. This option often makes sense for young workers who anticipate retiring in a higher tax bracket than the one in which they began their career.
Individual Retirement Accounts (IRAs) offer another avenue for saving for retirement beyond investing in a 401(k), and contributions to a traditional IRA may also be used to reduce your taxable income when filing your taxes, depending on your salary. The 2018 contribution limit for an IRA is $5,500, or $6,500 if you’re 50 or older. Similar to 401(k)s, IRAs also are available in a Roth version, meaning the account is funded with after-tax money but distributions are tax-free in retirement, after requirements are met.
2018 Changes From The IRS
So what’s new for 2018? For one, the IRS has announced some changes to the rules around IRAs. First, the income ranges that determine eligibility to make deductible contributions to traditional IRAs and to contribute to Roth IRAs have increased. These ranges vary depending on whether the taxpayer is single or married as well as whether they have access to a retirement plan at work.
The IRS has also increased the income limit for the Retirement Savings Contributions Credit, commonly known as the Saver’s Credit, which offers eligible low- and moderate-income workers a credit for saving for retirement – up to $2,000 for individuals or $4,000 for married couples filing jointly.
2018 Changes Under The New Tax Law
While there was a lot of speculation about what might be different when saving for retirement under the Tax Cuts and Jobs Act, 401(k)s and IRAs ultimately came away mostly unscathed. However, what has changed directly impacts tax planning around IRAs.
In short, if you convert a traditional IRA to a Roth IRA—an action that results in having to pay taxes now but allows for tax-free income in retirement—you no longer have the option to convert it back. Like choosing a Roth 401(k), a Roth conversion for your IRA might make sense if your current tax rate is lower than your anticipated tax rate in retirement or if you have a significant drop in income.