Retirement planning challenges under tax reform

During retirement, clients may be counting on certain deductions to reduce their taxable income, but under the latest tax proposal some of the biggest deductions are on the chopping block. Advisers will have to address what might happen, before you know exactly what the final law will be.

For example, as clients get older they tend to have larger medical deductions. These deductions are scheduled to be eliminated and replaced with a larger standard deduction, but that may not come close to the amount they will be spending on medical bills.

That can mean higher taxes on retirement income like required minimum distributions from IRAs.

PLAN NOW

Now, in this transition period between tax proposals and actual new tax law, advisers should be having planning conversations with clients based on what can be done now to keep taxes low in retirement. The higher the tax bill, the less there will be for retirement and the less likely it is that the money will last as long.

Keeping taxes lower in retirement will be critical to clients. Losing big tax deductions, even in lieu of a larger standard deduction, may cause taxes to increase in retirement for many clients.

Under current law, required minimum distribution income is somewhat sheltered by itemized deductions such as medical expenses, real estate taxes and state and local income taxes. In addition, investment-income related deductions such as financial adviser, tax planning and preparation fees which are currently deductible subject to the 2% adjusted gross income limit for those who itemize, would be axed under the current proposals.

DISASTER RELIEF

For clients who were affected by the recent hurricanes, the casualty loss deduction would be lost too. That could be a big deduction.

On Sept. 29, the Disaster Tax Relief and Airport and Airway Extension Act of 2017 was signed into law. It provides tax relief on several fronts, including enhanced deductions for casualty losses attributable to the hurricanes. The law eliminates the current 10% of AGI threshold and allows deductions to be claimed for losses exceeding $500. This deduction is scheduled to be eliminated, and possibly retroactively, which would negate this benefit as if it never happened.

One solution here, is to take advantage of a special provision in the current law that can allow the casualty loss deduction for those in federal disaster areas to be claimed in the prior year (in 2016, for 2017 hurricane losses). An amended return would be filed and this can lock in that deduction for 2016.

ROTH CONVERSIONS

Address Roth IRA conversions now. That means paying some taxes now, but never again, and there are no lifetime RMDs for Roth IRA owners. This can help keep taxes lower in retirement because any Roth distributions in retirement will generally be income tax free, so clients won’t have to worry about losing tax deductions that could have lowered the tax on their IRA RMDs.

Although a 2017 Roth conversion will trigger a tax now, at least some of that tax can be offset with deductions which may not be available in future years (assuming, hopefully, that the new proposals won’t be retroactive). A 2017 Roth IRA conversion is risk free, since that is one of the few tax moves that can be undone up to Oct. 15, 2018.

If not converting, evaluate whether it pays to take more taxable income from the traditional IRA in 2017, in excess of the required amount and offset that with deductions that are still available.

(More: Trump reconsiders plan to eliminate deduction for state, local taxes.)

In that same vein, look at deductions that can be bunched into 2017 to lock those in. For instance, medical expenses (for elective surgery, dental work, eyeglasses and other larger medical bills, including typically large entrance fees for life care facilities) and prepaying state and local taxes. If money is scarce, give less to charity this year, since that deduction is expected to remain untouched and available next year.

Retirees may be shocked to learn that some of the biggest offsets to taxable retirement income could go away. At a minimum, advisers should have these conversations with clients now, even before the final tax law details are known.

Ed Slott, a certified public accountant, created the IRA Leadership Program and Ed Slott’s Elite IRA Advisor Group. He can be reached at irahelp.com.