The Tax Cuts and Job Act that went into effect on January 1, 2018, created lower tax rates, a higher standard deduction, and a larger child tax credit for individuals and married couples.
Although the new tax code eliminates or caps a number of previously-allowed deductions, many deductions remain and others have been expanded.
When you understand the new rules it can help you make smart decisions going forward.
Here are three strategies that can help to optimize your tax breaks in 2018.
Take Advantage Of Lower Tax Rates To Grow Your Retirement Savings
Without a doubt, the lower tax rates make this the perfect time to invest in a Roth 401(k) or a Roth IRA.
Because the income you contribute to a Roth has already been taxed, qualified distributions you receive in retirement are tax-free.
Locking in today’s low tax rates makes sense because the new rates will expire at the end of 2025 and revert back to the previous, higher levels – or sooner if lawmakers decide to increase taxes under a new administration.
Even if you’re certain you’ll be in a lower tax bracket when you retire, having a mix of Roth and traditional tax-deferred retirement accounts can help you save on taxes owed in your golden years.
For 2018, people under age 50 can contribute up to $18,500 to a Roth or as much as $24,500 if you’re 50 and older.
You may also want to consider a Roth conversion which allows you to move money from a traditional IRA into a Roth IRA.
This enables you to pay today’s lower tax rate on the conversion making those funds tax-free income when you retire.
Keep in mind that, under the new rules, you’re not allowed to re-characterize the conversion back to a traditional IRA if you change your mind.
Consider The Tax Benefits Of Health Savings Accounts (HSAs)
Health Savings Accounts (HSAs) provide three tax benefits: tax-deductible contributions, tax-free earnings and tax-free withdrawals when paying for qualified healthcare expenses.
Contributions to an HSA can lower your gross income because they’re not considered wages.
This can help put you in an even lower tax bracket under the new tax code.
Considering the average person can expect to spend approximately $200,000 or more on medical expenses in retirement, with an HSA you won’t need to pull those funds from your IRA or 401(k) or pay taxes owed on the withdrawal.
To be eligible to save in an HSA, you need to be enrolled in a high-deductible health insurance plan.
For 2018, the annual contribution limit $3,450 for singles under age 55 and $6,850 for those with qualifying family plans.
If you’re 55 or older, you can contribute an additional $1,000 annually.
Another advantage to consider – there’s no “use it or lose it” restriction on an HSA and you can let it roll over from year to year.
Use 529 Plans For Elementary And Secondary School Tuition
Section 529 plans were originally allowed only for college tuition but the new tax code extends the advantages for private elementary and secondary schools.
Starting in 2018, families with younger children in private schools can now use up to $10,000 of 529 funds, per child, per year, for kindergarten through 12th grade tuition costs.
Although contributions are not deductible, earnings in a 529 plan can grow federal tax-free and will not be taxed when the funds are withdrawn for qualified education expenses.
However, when it comes to tax-free withdrawals for K-12 expenses, not all states have automatically conformed to the new federal tax law.
Before you consider a 529 withdrawal for K-12 tuition, check your state’s tax laws or consult with a tax adviser.
Remember – The Lower Tax Rates Have An Expiration Date
For individuals and married couples, the lower tax rates are scheduled to sunset at the end of 2025.
This means tax rates will rise again beginning in 2026 unless Congress takes steps to make the lower rates permanent.
Or, as mentioned above, there’s also the possibility that taxes will be raised if a new administration takes over the White House.
That’s why it’s important to meet with your tax professional to develop a tax strategy before the current “sale on taxes” expires.
