Tax Reform and Tax-Advantaged Savings Accounts

The Tax Reform has been etched in stone and the dust has, for the most part, settled.  I wanted to teach/describe to the reader/ to readers that there are still advantages to the tax-advantaged accounts in 2018, even if we are in slightly lower rates, with a few other minor things to think about.  Therefore, this article will go into detail on the pre-tax 401(k), Traditional IRA and the Health Savings Account, in relation to the Tax Reform and how it can still open up more cash to invest.  I will have a few tid bits at the end, to think about, as well.

accounting calculator and files

Tax advantaged Account & Impact from tax reform

1.) Pre-Tax 401(k): Let’s start off with the largest area that can serve you on a pre-tax basis.  We will begin with the 22% tax bracket, as my previous kicking Uncle Sam’s ass articles had the 25% bracket as an example (22% is now the equivalent bracket).  Congratulations!  The government has INCREASED what you can contribute by $500, or $18,500 in 2018.  This represents a 2.77% increase to what you can contribute pre-tax.  I am still planning on maxing out this bad boy.  Why?  Well, in 2017, the $18,000 pre-tax at 25% federal rate was a savings of $4,500.  This year, $18,500 at a 22% federal tax bracket equates to $4,070 in savings.  Therefore, the increase in 401(k) contributions slightly offsets the 3% decline in federal rates.  However, still does not equate the tax savings one experienced in 2017.  This obviously is not addressing any state tax savings, which still stands.

2.) Health Savings Account (HSA): My favorite of them all!  Self-Only HSAs stand at $3,450, up from $3,400 last year (Family is $6,900).  Similarly, last year’s $3,400 at a 25% federal tax rate would have saved you $850 in federal tax and this year, the $3,450 can net you $759 in federal tax savings.  A drop, yes, but similar to above – slightly is offset by the increase in what you can contribute.  Cumulative with #2 above, we are at a $4,829 federal tax savings; not including the FICA and state tax savings one receives from the HSA.

3.) Traditional IRA: If you fall under the maximum phase out limits, your maximum (under 50) contribution is $5,500, again, for the year.  This was a little disheartening, as this represents the 6th year in a row that $5,500 is the maximum, especially with a reduction of the tax rate.  I would have thought, for sure, this would have increased to $6,000.  However, if you are still lucky to invest in the traditional or pre-tax IRA, this can save you $1,210 in federal tax at 22%.  The cumulative amount saved with #1 and #2 above equate to $6,039 in federal tax savings.

In comparison, last year (at last year limits) would have netted you $6,725.  This is DEFINITELY a steep drop in federal tax savings in 2018, when compared to 2017, if you plan on fully maxing out these tax-advantaged accounts.

Bonus Tax reform Tid Bits to Ponder

I will bullet out a list of other tax beneficial items to think about, as it relates to the 2018 year and Tax Reform:

  • With a reduction of tax rates and an increase in deposit savings account interest rates – the “margin” is getting slightly smaller; as now – your taxable interest is taxed at these lower federal rates, i.e. 22% vs. 25%.  This is something to keep in mind and also to be on the lookout for savings account interest rates to be over 1.50%, and luckily, mine is at 1.55%!
  • The phase out limits for the Traditional IRA did increase for single and married filing jointly.  In 2017, they were $72,000 and $119,000 for single & married filing jointly individuals.  In 2018, they increased to $73,000 and $121,000 or a 1.4% and 1.7% increase for those filing single or married filing jointly.  This isn’t too steep of an increase, but if your pay did not go up from prior year (not as likely) and you weren’t able to contribute as much – you may be in luck this year.
  • For those of you who did not have children, were married and did NOT itemize or itemize a significant amount, a nice treat came your way.  If the reform didn’t occur, 2018 would have brought you two exemptions at $9,300 total and $13,000 in standard deductions, for a total of $22,300.  Now, the government’s is making it straight to the point at $24,000 or an increase of $1,700 for you.  I will say, for those of you that benefit from this, congratulations.  There are many that do not, however.
  • The dividend tax rates stay the same, albeit, but shifted to the new bracket mentality.  What does this mean?  You pay 0% tax on qualified dividends if you are essentially in the 10%/20% tax brackets.  You will pay 15% tax if you are in the 22%/24%/32% brackets, or up to $425,800.  Anything above that, you are paying 20% (not including the 3.8% net investment income tax).

Those were just a few tax items I wanted to share with the community.  Even though there is a reduction in the federal tax rate, I still believe and will be maxing out my pre-taxed accounts as much as I am able to.  Until the tax rate gets even lower or they do away with certain type of pre-tax accounts, I will keep the investment churning that direction.  The one thing the tax reform has taught me is that there is nothing that is forbidden from change.  There were even rumblings and rumors that they would limit the pre-tax 401(k) contributions up to $2,000.  That would have been a game changer for me, easily.

I hope that you have benefited from these details above.  I will try to write more on related tax topics that relate to what we are doing on an every day basis.  I hope that we keep investing wisely, take these tax updates into consideration and keep striving for financial freedom.  That’s still the goal and it will take more than tax reform to change that!  Please leave questions and comments, thank you for stopping by and talk soon!

-Lanny

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9 thoughts on “Tax Reform and Tax-Advantaged Savings Accounts

  1. Nice write up Lanny. I for one am looking forward to the impact of the tax legislation. Although I bought a house and would be itemizing my deductions for the first time, there’s a chance it may not make sense given the increase in the standard deduction. I haven’t done my taxes yet but we will see.

    I honestly can’t decide if pre-tax contribution to retirement is better for me vs post tax. Prior to the passage of the legislation, I’m was in the 25% tax bracket. It’s unclear if I will be in a lower tax bracket for last year (ie lower than the 22% equivalent). But, regardless, I contribute what I can to my retirement accounts. I do the Roth option for both the 401k and IRA. No clue if that’s the right answer, but at least I don’t have to worry about the taxes from now on.

    I think as a single male with no kids, I should benefit from the tax cut.

    Looking forward to more write ups on the tax legislation and the interplay between taxes and investment strategy.

    • DP –

      Nice comment. I do believe you will benefit mightily in your situation, currently. I will have to continue writing about topics as the impacts are seen. Excited to be my 2017 taxes, for the last time under the old tax law. Should be bitter sweet!

      Thanks for coming by DP, always.

      -Lanny

  2. This is a nice summary. I hadn’t really thought about tid bit bullet 1, but it is a nice to see interest rates rising and ordinary income tax rates falling. I have been building cash during the market rise rather than reinvesting dividends aggressively. It’s nice to finally starting earning a little on that idle cash. Tom

    • Tom –

      Yep, the interest rates are sure rising on the deposit account. My online bank paying me 1.55% is crazy to me, but soon that will be the norm, I assume. Again, that primarily also means that inflation is creeping up at a faster rate, as well, right? Agh… economics, fun, right?!

      -Lanny

  3. Have been reading a little bit about the tax changes. Should be nice to fall into a lightly lower tax bracket. And with the standard deduction basically doubling, may even be able to put myself into a lower one still. Granted I play my cards right and make sure to take advantage of adding to 401k and other tax advantage accounts As well as being smart with all deductions of course. Thanks for sharing.

    • Daze –

      Thank you for the comment. I agree, finding out about the tax changes and impact to you are fun and def. worth while. I agree – bringing yourself down, as always, into the lowest bracket is the goal. Therefore, as you stated, I will be doing as much pre-tax still, that I can, simply for that fact. Let’s keep each other updates on anything else we find, that we may not know about.

      -Lanny

  4. Although not applicable in my case, at least pre-tax stays better for most situations in the new plan. What I’m most interested in – which is probably being written into the as yet to be released rules – is the taxation (and associated credits) of foreign dividends. That will be the factor which dictates any strategy adjustments to keep my tax rate as low as possible (and/or avoid double taxation on those assets).

  5. I’m going to be in the 12% bracket. If you were in my shoes, would you still go pre-tax on the IRA, or would that tip you over to Roth? I’ve been deliberating on this one a lot.

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