Changes in tax laws can have unintended consequences and force people to do what they are supposed to do.
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Congress ended tax cuts.How it helps high-income earners
The Wall Street Journal reported KongResuenDecided to cut taxes.How it helps high-income earners.
This is a “gift” article from the WSJ that you can read for free without subscribing. Here are some excerpts, but we encourage you to read the full article.
Background of tax changes
Many retirement savers are outraged by the law, which is due to take effect in January, and it’s easy to see why.
The provision, enacted at the end of 2022, denies a major tax credit to workers over the age of 50 who earned $145,000 or more in the previous year. Traditional 401(k) and similar plans will no longer be able to incorporate “catch-up” contributions. The plan allows for prepayment of incoming dollars, but imposes income tax on future withdrawals. A catch-up contribution to help boost savings for late-career workers now adds $7,500 to the $22,500 annual limit for many savers.
Instead, these savers can only deposit their catch-up into their Roth 401(k) accounts. As such, future withdrawals may be tax-free, but not tax-deductible. Many of these savers are in their prime years, so depositing after-tax dollars in a loss account when taxes are high can reduce or even eliminate the benefit of subsequent tax-free payments. I have.
There is something surprising about that. Denver-based financial adviser Betty Wang said savers affected shouldn’t be upset. “I tell them, ‘Congress is doing you good by forcing you to save into the loss account. In the long run, you’ll probably get ahead.'” ”
Congress did not enact the recent changes to help high-income earners. For legislators, the main attraction of the Ross account is that it can provide tax revenue upfront, within a 10-year budget window, while tax-deductible IRAs and 401(k)s lose tax revenue. This is one of the reasons recent legislative changes have favored loss accounts, and one of the reasons why it would be complicated for Congress to limit loss accounts so drastically.
The WSJ points out the benefits of Ross
- Roth 401(k) provides Roth access. Many savers cannot contribute to the Roth IRA because their income is too high. Alternatively, “backdoor” Roth donations are complex and partially taxable and cannot be donated. In addition, current Roth IRA contributions are limited to $6,500 annually, plus an additional $1,000 for savers age 50 and older. Savers with Roth 401(k) can usually put in more money.
- Roth’s benefits are cascading. Tax-free loss withdrawals don’t count as income, so they don’t make taxpayers more susceptible to the means-tested Medicare surcharge, known as IRMAA, or the 3.8% net investment income tax.
- Roth’s donation starts a five-year clock. To withdraw tax-free Roth earnings without penalty, savers must be at least 59 1/2 or better and often have held the account for five years. Even a small amount in your loss account can start the five-year clock.
- Roth accounts may be better than taxable investment accounts. The reason for this is that income payments (dividends, interest, etc.) in investment accounts are taxable, while Roth accounts are tax exempt. If someone sells the assets in their investment account during their lifetime, the net gain is taxable, unlike the loss case. Roth IRA and 401(k) owners can also withdraw their contributions tax-free without penalty even five years in advance, but the 401(k) also requires employers to authorize these payments. there is.
- Roth accounts are better for heirs. Many non-spousal heirs of IRAs and 401(k)s whose owner died after 2019 are required to empty their accounts within 10 years of the owner’s death. However, traditional her IRA or 401(k) heirs are often required to make taxable withdrawals every 10 years. Heirs to Roth accounts can wait until the end to withdraw.
mish comment
The wealthy aren’t the only ones who can benefit from a Roth IRA.
But what you put in there is very important. The WSJ did not discuss this important point.
Suppose you have a stock and bond strategy involving some speculative stocks. Within that group, speculative assets are the most suitable for losses.
If your $50,000 investment hits a home run to $5,000,000, you only pay upfront tax on that $50,000. That way, when you’re 59 and a half, you’ll have $5 million tax-free. The same amount of IRA is taxed as regular income when you withdraw money.
If you have both a taxable account and a regular IRA, also think about where you risk it. This decision is further complicated by the fact that we do not know what the future of capital gains law will be, or what the income tax rate will be. However, in a regular IRA, home runs are deferred, but the full amount is taxed as income rather than long-term capital gains.
The purpose of this discussion is not to encourage speculation. Rather, I suggest that if you have speculative assets, consider putting them in the Roth if possible.
Nor is it just a wild speculation asset. If you’re an active trader of something, say energy, and you’re doing it well, the cumulative gains of successful timing are probably much better than the losses.
Given the five-year clock, it’s best to provide Roth with at least minimal funding by age 54.
Finally, timing matters. When converting from a regular IRA to a Roth IRA, it is best to do so during a significant decline. So there is a lot to think about here.
NOT INVESTMENT OR TAX ADVICE
This is not investment advice or tax advice.
Instead, consider the WSJ article and my comments on that article as a starting point for discussions with your tax advisor.
America’s Fiscal Time Bomb in Pictures and Fitch’s Downgrade of US Debt
I can’t say what the future holds. But coupled with congressional spending on steroids, Bidennomics’ current line is inflationary, at least for now.
For discussion, see America’s Fiscal Time Bomb in Pictures and Fitch’s Downgrade of US Debt.