During his campaign, President Trump promised a significant overhaul to the federal tax code. If he comes through on his promises, the seven federal tax brackets would be streamlined to just three: 12, 25, and 33 percent.
Under such a plan, taxpayers who make between $48,000 and $83,000 would see roughly a $1,000 reduction in income taxes per year. High earners—America’s 1 percent—would enjoy an average reduction of $214,000. But not everyone will pay less.
For instance, removing the head of household filing status, as Trump proposes, would force single parents to pay more in taxes. So, it’s important to assess how these tax policies could affect what you pay. Because you could end up with more or less money in your hand each year.
With all that said, a new tax plan like the one White House leadership wants will impact your retirement as well, especially if you change tax brackets. Here’s what you need to know:
The possibility of lower taxes equals more options for retirement
As mentioned, Trump’s tax plan will save many folks money each filing season. Overall, taxes would decrease by $2,940 per filer on average. That extra money can be spent on retirement investments, like life insurance, stocks, mutual funds, or real estate, rather than a new TV or car.
If a new tax plan is implemented, and your taxes are reduced, start planning for what to do with the extra cash you save. You want to make the right investments for your retirement, which involves taking a look at how the entire tax plan affects where you should put your money.
Pre-tax investments may become less attractive
One of the advantages of a pre-tax investment, like a traditional IRA or 401K, is that it reduces your present tax burden. You can let that investment grow and then pay taxes on it when you retire.
But if you have less tax to pay, then it becomes less beneficial to save money on those taxes today. It may actually be smarter to pay the taxes now and then invest the money (especially if you believe taxes will go up in the future).
Consider this scenario:
- In Trump’s proposed plan, a married couple with $100,000 in taxable income would pay $12,000 in taxes (a 12 percent rate).
- Previously, a married couple having $100,000 in taxable income would have paid $25,000 in taxes (a 25 percent rate).
Clearly, it makes less sense to toss money into a traditional IRA or 401K to decrease your taxes. What you’re able to save is reduced because you’re already paying less in taxes (at least in this case).
Also, since pre-tax investments would become less attractive for most, after-tax investments, like a Roth IRA or annuity, would become more attractive. For most people, it might be wise to pay taxes on income now since rates are lower, and invest in something like a Roth IRA account to ensure money can be withdrawn tax-free in retirement.
Cutting Medicare surtax would benefit the wealthy
The Affordable Care Act helped fund Medicare partially with a surtax on investment income of 3.8 percent for those in the highest tax bracket. Trump and the GOP plan to eliminate this surtax, which would give high-income investors significantly more return on their investments.
The capital gains tax rate for them would decrease from 23.8 percent to 20 percent.
Opponents say this surtax would reduce federal revenues by $117 billion over a decade and accelerate Medicare insolvency, all the while putting an incredible amount of money back in the pockets of the wealthy. This could result in Congress raising Medicare’s eligibility age from 65 to 67 or higher. It also could lead to a reduction in benefits from Medicare, which is seen as a bedrock of health care coverage.
You should pay serious attention to what goes on with the Medicare surtax and even the Medicare employer tax (which could change).
Other factors to consider
Although President Trump has promised to protect Social Security, no concrete plans have been put forward. Some research institutions estimate Social Security will be insolvent by 2035, and there may be changes in the tax code that will impact the program. Pay serious attention to this, especially if you’re going to depend on that income in retirement.
Additionally, Medicare isn’t the only medical issue you need to consider. The Trump administration has talked a lot making Health Savings Accounts (HSAs) more accessible for Americans. Plans include increasing contribution limits, establishing easier ways to pass HSAs on to beneficiaries, and making the accounts more portable.
HSAs, which are tax-deductible, will definitely become a more useful option if the Medicare surtax is repealed and the Cadillac plan is canceled. That plan, starting in 2020, would impose a 40% excise tax on high-cost employer-sponsored plans.
Wait to see what happens—then make the right move
Tax policies change with every administration, so it’s always best to observe what’s being changed and how it affects what you’re doing for your retirement.
Analyze your personal situation and do your research. See what investment vehicles suit you best—and make those investments. Watch out for changes in the tax plan that will affect Social Security and health care in retirement—and prepare accordingly. Doing all this will put you in a better spot for retirement.