At the end of the year, everyone is busy with holiday celebrations, travel, and for some a very busy working season (retailers, accountants, financial advisors). But before we close out the year, let’s not overlook the opportunities that can help with our final tax bill for 2018. Here are some reminders on how to utilize tax advantaged accounts, deductions, and contributions before the drop-dead date of Dec 31st to reduce your 2018 taxes as much as possible.
Required Minimum Distributions (RMD)
PENALTY ALERT! Please make sure to take your RMD from qualified accounts if you are 70.5 or older OR have an inherited IRA! For any RMDs not taken, there is a 50% penalty.
You can aggregate all IRAs you may have and take the RMD from just one. However, you still have to take separate RMDs for any other retirement plans (ex:401k).
Qualified Charitable Deduction (QCD)
If you normally deduct any charitable contributions, that may not help your taxes as much in 2018 as in the past. With the new tax law, only about one third of people who previously itemized will be doing so since the standard deduction for married couples is now $24,000 ($12,000 for Single filers).
QCD to the rescue! To get the biggest bang for your buck, have your RMD sent directly to your charity of choice. This keeps the RMD out of your taxable income (up to $100,000), which is even better than a tax deduction! (You must be 70 ½ to take advantage of QCD, so this won’t work for inherited IRAs of younger folks.)
If you have already taken your RMD for the year, this option is no longer available for 2018. The IRS deems the first amounts withdrawn to satisfy the RMD. There is no way to retroactively go back to earlier distributions from the year and re-categorize them as QCDs. But now you know for next year!
One other caveat: QCDs are only available from IRAs (including SEP, SIMPLE, Inherited). They are not available from 401k/403b. If this is something you are interested in doing and have already left your employer, consider rolling your 401k to an IRA in order to take advantage of the QCD.
Maximize Retirement Contributions
Whether you have a 401k, 403b, or 457, the contribution to these plans is tax deductible. If you haven’t maxed this out yet, you may still be able to change your withholdings for the last 2 paychecks of the year so that more is withheld.
Business Owners – Small Business Retirement Plans
For business owners, you can potentially contribute 100% of December’s pay to your Solo 401k or SIMPLE IRA as the employee (assuming you are set up with W-2 income) if not already maxed out. On top of this, if you haven’t already contributed the employer match portion (or profit sharing), you have until year end to do so. The total contributions allowed to Solo 401k, 401k, 403b, 457 are $55,000. This would include your employee and employer match, but not the catch-up. Catch-up would be in addition to the $55,000.
If you would like to contribute to a 401k or Solo 401k for the year but don’t have an account yet established, you have until Dec 31st to do so.
Flexible Spending Accounts
Make sure that money in these accounts doesn’t go wasted (for medical or dependent care). Normally, all funds must be spent by Dec 31st. However, some employers offer a grace period of 2 ½ months after the first of the year (Mar 15th) to use the funds OR they may allow you to carryover $500 to the following year. So start thinking about any glasses you need, dental work, prescription refills, etc. that will spend down this account. Here is a list of FSA approved over-the-counter items:
Separate Inherited IRAs
You may have heard of ‘stretching’ an IRA. This refers to the beneficiary (usually non-spousal) of an IRA stretching the RMD over their own life expectancy rather than the account owners (which was probably shorter).
What normally happens?
RMDs are calculated based on life expectancy of an actuarial table. An RMD for a 70 year old is much higher than that of a 30 year old because the actuarial tables say there are not as many years left to deplete the account for the 70 year old. If, for example, a child age 25 inherits an IRA, the RMD can be ‘stretched’ over his/her life span, thus making the RMDs much smaller, allowing the money to stay in the account and grow if the child doesn’t need the money.
What happens when more than one person inherits an IRA?
The RMD calculation will be based on the older person’s lifespan. This forces the younger person’s inherited account to potentially be depleted sooner than it would be if based on their younger age.
Is there a better way?
The way to get around this is to split the account by Dec 31st of the year following the original owner’s death. If the deceased passed in 2017 with multiple beneficiaries, you want to make sure the account is split by Dec 31, 2018 so that each beneficiary can ‘stretch’ it over their own lifetime rather than having to use just the older person’s life expectancy. This would be most beneficial when the beneficiaries are very different ages (ex: spouse of deceased and their child).
What if I inherit a 401k?
The above ‘stretch’ for non-spousal beneficiaries is not offered for all 401k custodians. Many times, the custodian will make you withdraw all funds within 5 years, causing tax advantaged money to cease being tax advantaged AND maybe significantly increasing the taxable income of the beneficiary for those 5 years.
Solution: Roll to an IRA by Dec 31st of the year following the death of the original owner.
Health Savings Accounts (HSA)
These accounts are becoming more available and popular as part of the medical insurance offerings. They have a huge benefit in the sense that they are TRIPLE tax advantaged!
Many are using these as IRAs, especially for those whose income is too high to qualify for an IRA or Roth IRA contribution. Contribute the money, but instead of using it for the medical expenses, let it grow for future medical (or any) expenses. Pay for current out-of-pocket expenses with regular cash flow. This is a great option for high earners as it allows for the IRA-like savings and provides a tax deduction.
Maximum contributions 2018: $6,900 for family plans; $3,450 for individual plans.
*distributions must be used for qualified medical expenses to be tax free at any age. There is a 20% penalty to use the funds on non-qualified medical expenses prior to age 65. After age 65, there is no penalty, but distributions are ordinary income.
Achieving a Better Life Experience Act (ABLE) Accounts
These are accounts created for families who would like to plan for the future of a disabled child. These accounts allow saving into a tax advantaged plan for their loved one without compromising federal aid programs (ex: Medicaid).
- Contributions to ABLE accounts are on an after-tax basis
- Earnings are tax free as long as funds are used for qualified disability expenses
- For those disabled or blind prior to age 26
- First $100,000 is not treated as an asset of the beneficiary. This is an important distinction because typically any personal asset over $2,000 disqualifies them from federal assistance (Medicaid, SSI, and housing)
Convert pre-tax savings (IRA or 401k) into a Roth IRA or Roth 401k. This allows any future earnings to be tax free**. This is one that may actually increase your tax bill for this year, but decrease overall taxes down the road. This is for those who believe taxes will be higher upon retirement or have many years until retirement.
- Watch out for:
- the new tax law took no longer allows ‘recharacterization’ so make sure this is right for you.
- This could push you into a higher tax bracket
**(if wait until after age 59.5 & have had the account for 5 years)
Seek guidance from your financial advisor with any questions or assistance in implementing these ideas. We are here to help!
Written by Teresa Talton, CFP® Professional with Allgen Financial Advisors, Inc.
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