Under the new tax laws, individual tax rates are broadly lower and the standard deduction — which directly reduces your taxable income — is nearly double what it was.
A taxpayer who previously fell into the 15 percent tax bracket is now taxed at a 12 percent rate. Retirement investors can and should take advantage. Here’s how.
Reconsider a Roth IRA
A Roth IRA is a retirement account that you fund with after-tax dollars. Those dollars and the investment growth you earn on them can be pulled out in retirement tax-free.
A Roth has always been an attractive option for those who think their tax rate is lower now than it will be in retirement. Under the new tax law, more people are likely to fall into this category.
You can put $5,500 into a Roth IRA in 2018, or $6,500 if you are 50 or older.
Look into Roth conversions
A Roth IRA has income limitations: In 2018, if you earn $135,000 or more as a single filer or $199,000 or more as a joint filer, you can’t contribute.
There are two solutions to that: One is a Roth 401(k), if you are offered that at work. The other is a Roth IRA conversion, which is a way of getting money into a Roth IRA if you are not otherwise eligible, by converting money in a traditional IRA. (A traditional IRA is the opposite of a Roth when it comes to taxes: Contributions are tax-deductible but distributions in retirement are taxed.)
When you convert money from a traditional IRA to a Roth IRA, you will pay taxes on all or part of the converted amount, which is why it often makes sense to convert when tax rates are low.
Diversify among accounts
Praises for the Roth IRA aside, you don’t want to be monogamous with your retirement money. It’s wise to spread your savings among several accounts, said Jim Davis, a certified financial planner and partner at Partnership Financial in Columbus, Ohio. Doing so earns you tax diversification in retirement.
“There’s a huge difference in the retiree’s tax bill if he has a $2 million portfolio that’s all in pretax accounts — 401(k)s, IRAs — vs. a retiree that has a $2 million portfolio that is apportioned across pretax, after-tax and Roth accounts,” Davis said. “The latter will have a much lower tax bill in retirement and his or her heirs will inherit assets with a much more friendly tax status.”
Dividing your money among accounts with different tax treatments means you will be prepared no matter which direction taxes go in the future.
Arielle O’Shea is a writer at NerdWallet. E-mail: firstname.lastname@example.org. Twitter: @arioshea.