Everyone has heard about how the new tax law is less complex and saves people money. The new law will reduce taxes for a large number of people and make it simple for some people to file their taxes. The main reason for this is that tax brackets were lowered and the standard deduction has gone up from around $12,000 to around $24,000 for a married couple. But how does the new tax bill effect retirees and those on Social Security?
I need to say that the following is general information only. Taxes can be complicated see your own tax advisor to optimize a tax strategy for your own situation. Keep in mind that all of these changes including the estate tax exemption I talk about later expire in 2025.
For some retirees taking Social Security there may be some additional complexity along with opportunities. Some of the old strategies may need to be updated. Because of the higher standard deduction in general fewer retirees will pay taxes. As always, if you only have Social Security benefits and no other income you will pay no taxes.
Just as it has been in the past the taxes you pay depends on how much other income you have during the year because every dollar you earn above $12,000 adds $1.50 to your taxable income because Social Security benefits begin to become taxable. The difference is that with the higher deduction of $24,000 per couple you can generally have more other income like IRA distributions before you pay taxes on your Social Security. But after a certain point this may create a situation where the taxes on each dollar of additional income become larger more quickly than you might anticipate.
If you are over age 70 ½ you must take a distribution each year from any IRA’s you may have. These Required Minimum Distributions (RMD’s) are taxed as ordinary income. For most retirees these RMD’s are the bulk of their taxable income.
The new tax law has created an opportunity because of the new higher standard deduction. If you are required to take money from your IRA via the RMD it may now make more sense for you to use the existing QCD or Qualified Charitable Distribution option when you take you distributions. The QCD allows you to use your RMD to make gifts to qualified charitable organizations. Those amounts will count as part of your RMD but will not be taxable income to you.
Now because of the higher standard deduction you probably won’t itemize any charitable contributions you make (because it won’t lower your taxes). Before the higher standard deduction many times it was a wash between itemizing charitable deductions and doing the QCD from an IRA. But now in most cases it may make more sense to use the QCD for charitable deductions. The QCD must be done directly from your IRA to the charity. You cannot take an IRA distribution to yourself and then give the money to the charity.
Another area of the new tax law that is of interest is the new estate tax exemption. It is true that most people don’t have to worry about this but those who do including those with lots of assets like farmers need to pay attention. Many people saw that the estate tax exemption goes from about $5.5 million in 2017 to $11.2 million in 2018 and gave a sigh of relief. This meant that if properly structured the amount a couple could shield from estate taxes went from $11 million to $22.4 million.
The problem is that as I mentioned above the provisions of the new tax bill all sunset in 2025. So unless Congress extends the estate tax exemption it goes back to $5.5 million per person plus cost of living increases. So if you are one of those that relaxed because you think are out of the woods you may want to reconsider. This may be an opportunity to use the larger lifetime exemption you have now to move assets out of your name and avoid possible future estate taxes. This would benefit any couple with over $11 million in assets or any individual with over $5.5 million in assets just in case the current exemption actually does expire in 2025.
Bill Oldfather is a fee-only financial planner and investment advisor. Oldfather Financial Services is an SEC Registered Investment Advisor based in Kearney NE. Email to bill@oldfatherfinancial.com