The recent tax bill known as the Tax Cuts and Jobs Act has not only slashed corporate tax rates and attempted to put more money in the pockets of working Americans, but has also made some big changes to retirement planning.
First off, anything in the tax code that has an index increase to inflation will now increase based on the ‘chained’ consumer price index. This is a big deal. ‘Chained’ CPI assumes that when prices go up, consumers will turn to cheaper substitutes. For example, if beef prices go up, people will eat more chicken. According to Investment News and their 2/29/2018 article titled, “New tax law’s hidden cost”,
“Since 2000, the primary CPI measure has risen by 45.7%, while chained CPI grew only by 39.7%… the federal government estimates the new inflation measure will raise $134 billion in tax revenue through 2027.”
The effect on retirement planning is that Social Security increases will be smaller, increases on what you can contribute to an IRA/401(k) etc will be slower, increases in marginal tax brackets will be smaller, which will result in increased taxes in the future and smaller increases to government benefit programs like Social Security.
When it comes to itemizing your deductions, the tax law also affected the deductibility of Home Equity Loans and Lines of Credit as well as the mortgage deduction. The new law makes your home equity line of credit non deductible, unless it was used for capital improvements on the property. No longer can you use your home equity to buy a car or pay for your kids college and get the interest deduction. Also, the maximum balance on a mortgage you can deduct has been dropped to $750,000. This also means people will have to be careful when doing a cash-out refinance as well because you will most likely have to prove that the money was used towards the home and nothing else for the debt to be deductible.
One large benefit to wealthy families is that the estate tax exemption has been increased to $11.2 million per individual. So a married couple with a trust could potentially pass on $22.4 million of wealth to the next generation with no estate taxation. However, the exemption returns to the previous amount in 2025. Therefore, wealthy families should look at utilizing gifting strategies to take advantage of the current gifting limits and watch for guidance from the IRS. This is a unique opportunity for very wealthy families that should not be ignored and requires good planning.
Finally, there is a previous law on the book called “Paygo”, which stands for ‘pay-as-you-go’. The federal government requires any new legislation affecting government revenue to not increase budget deficits, or cuts need to be made. That means that if the new tax law increases the federal deficit, then mandatory cuts will go into effect for government programs such as Medicare. Based on what I’ve read and the research I have done, I would be very surprised if the recent tax change did not increase the deficit…
These are just some of the major changes that are affecting retirement planning and there are many others that I am discussing with my clients as I review their financial plans. When I update my clients financial plans, I am now reducing what amount Social Security inflation increases, I am increasing medical costs in retirement, I am reducing what my clients can increase their savings by in company retirement plans, and I am no longer suggesting using Home Equity Lines of Credit for anything other than home improvement. It is vitally important that your financial professionals stay on top of all these changes, so if you would like to know about how all the recent changes affect you, then please contact me!