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Tax Law Fallout Yields These Five Fiduciary Facts For Retirement Savings

Tax Law Fallout Yields These Five Fiduciary Facts For Retirement Savings
April 23
01:11 2019

Just as accounting firms and the CPAs that inhabit them can finally breathe a sigh of relief, a sudden realization has overtaken their tried-and-true maxims. The calculus for retirement saving has shifted dramatically. This can bear heavily on the retirement plan fiduciary. Why? Because it may no longer in some people’s best interest to save for retirement in the manner they’ve grown accustomed to.

How eerie might this be for tax planners? We’re talking fingernails-on-the-chalkboard disturbing. It’s the kind of reality that causes accountants to question their very foundation. Worse, it’s a push-me/pull-ya strangeness of epic yin and yang proportions.

Is there a single best solution? To discover this answer, we must explore deep into to this new world of facts emerging from the 2017 Tax Cuts and Jobs Act (a.k.a., the “new tax law”). With the final dust comfortably settling on this year’s tax season, we can know begin to put together the pieces of this new reality that may have plan sponsors and their service providers rethinking their long-held strategies.

Reality #1: Retirement Saving Tax Deductibility Now More Important Than Ever
Here’s the old standby we’ve all known to love: “Saving for retirement is good because you get to lower your taxes.” This is still true. The new tax law continues this time-honored tradition of encouraging people to become self-reliant. “Retirement plan contributions allow clients to reduce their taxable income because they allow clients to save for retirement on a tax-deferred basis,” says Marguerita Cheng, Chief Executive Officer at Blue Ocean Global Wealth in Gaithersburg, Maryland. “The new tax laws eliminate the personal deduction.”

Alas, the new tax laws also come with several new twists and turns. Some of these actually incentivize saving on a tax-deferred basis more than ever before. “For individuals, tax-deferred retirement saving becomes increasingly more important to reduce taxable income, since the new tax law has increased the standard deduction to $12,200 per individual, $24,400 for married filing jointly,” says Patrick Di Fazio, Director of Wealth Management Consulting at 1st Global and Matt Zokai, Senior Advisor of Retirement Services at 1st Global. “The higher standard deduction eliminates the need for many tax payers to itemize ‘below the line’ deductions.”

In other words, increasingly, the only way for most people to reduce their taxes (beyond what the new law already reduces them by) requires the make a retirement plan contribution. Not only is the standard deduction much higher, but some past deductions are no longer available. “As a result of the Tax Cuts and Jobs Act, individuals no longer have the ability to deduct many items that were previously allowed,” says F. Michael Zovistoski, Managing Director at UHY Advisors NY, Inc. in Albany, New York. “These items include: state income and real and personal property taxes in excess of $10,000, interest costs relating to home equity lines of credit, alimony paid on divorce decrees entered into after December 31, 2018, and all miscellaneous itemized deductions, such as employee business expenses, investment expenses, and tax preparation fees, among others. Many taxpayers in the past may have taken advantage of certain tax strategies to bunch cost in a selected year to maximize the deductions and in turn, minimize tax. With the inability to take these deductions, taxpayers will be looking for other methods to legally minimize taxation.”

Like the best in breed American Kennel Club winners, taxpayers have been trained to covet their deductions. Notwithstanding that lower tax rates make deductions less necessary; they nonetheless desire them. Today, they find slim pickings. “So many taxpayers are now searching for ways to reduce current tax or at least defer taxes to the future,” says Zovistoski.

The narrowing of deduction opportunities isn’t all that bad. In many ways, it’s opened the eyes of those who need their eyes opened in terms of saving for retirement. “Many Americans are coming to the realization that they may not have saved enough for their eventual retirement,” says Zovistoski. “Contributions to a retirement plan fit both of these needs. The contribution limits for 2019 increased to encourage taxpayers to save for retirement. (IRA, 401(k), 403(b), 408(p)(2) and 457 plan limits all increased $500 from 2018 to 2019).”

We may be seeing a new wave swelling as the new tax law appears to be inspiring a new economic opportunity. “The new tax law has left fewer ways to reduce taxation,” says Mark Wilson, President of MILE Wealth Management in Irvine, California. “Maximizing retirement plan contributions is one of the few options left. Setting up a plan for a side-gig is often a missed opportunity.”

Reality #2: This “QBI” Thing Is Both Good And Bad
In their struggle to come up with the perfect law, Congress created this new tax fact. They called it “qualified business income.” This figure is used to calculate an owner’s retirement plan deduction. “The full 20% deduction of qualified business income (QBI) is only available to business owners with total taxable income less than the $315,000 threshold for joint filers,” says Di Fazio. “When taxable income exceeds the threshold, the 20% deduction may be reduced based on a wage of capital limitation.”

On the face of it, QBI appears to be a good thing. “The new tax law actually favors small businesses that are ‘pass through,’” says Ben H. Feldmeyer, Private Wealth Advisor at Feldmeyer Financial Group in Dayton, Ohio. “This is everything that’s not a ‘C’ Corporation.  So sole proprietor, S-Corp, LLC, partnership, etc.  all get a 20% reduction in business income – unless they fall into a specifically named category, then the benefit is limited. – it’s too complicated to explain in this note.  There are some good flow charts available to explain how it works.

So, while Reality #1 remains, Reality #2 has made a bit of a mess of things. “Reducing one’s tax liability is always important but due to the elimination or reduction in other deductions, other strategies, such as retirement plan contributions, have become more important,” says Matthew P. McKee, Financial Advisor at Samalin Investment Counsel in Chappaqua, New York. “However, this option is complicated by one of the most impactful changes coming from the Tax Cut and Jobs Act – IRC Section 199A, which is better known as the QBI Deduction. 199A created a 20% deduction for pass-through profits for qualifying businesses and impacts the pretax retirement plans for many small business owners. The 199A deduction is based on net income (after retirement plan contributions) so the retirement plan contributions can actually reduce the tax benefit of the 199A deduction. Therefore, you may not get the full tax benefit of the retirement plan tax contribution but still have to pay taxes on the distributions in retirement. More important than which plan to choose is figuring out how this change to the tax code effects your contributions. Unfortunately, it is difficult to suggest one solution that fits all as each circumstance can vary significantly, but there are other options such as Roth accounts or Roth conversions.”

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Reality #3: Low Tax Rates Dramatically Change The Paradigm
How’s this for throwing a monkey wrench into the traditional “always lower taxes” mantra accountants have been signing since time immemorial. “Actually, with lower tax rates, current savings aren’t as beneficial for tax reduction,” says Ilene Davis of Financial Independence Services Cocoa, Florida. “The ultimate goal of a retirement plan should be long term financial security. The tax deduction is icing on the cake.”

The imperative to use tax-deferred savings vehicles for retirement has been ingrained in the heads of workers for more than a generation. “This is the fallacy that most baby boomers have been led to believe for many years,” says Michael Menninger, President at Menninger & Associates, Inc. in Trooper, Pennsylvania. “Interestingly, the new tax laws actually make it more beneficial to not contribute to the deductible portion of retirement plans, as I have found that folks who build up a sizeable amount in their deductible 401k/IRA plans will actually find themselves in a higher marginal tax bracket in retirement than they are today. I teach taxes to CPAs, and they were shocked to hear that comment, but after explaining, they understood and agreed.”

Older employees are now discovering the joys their millennial equivalents had found out long ago. “Since income tax rates are at the lowest point in our lifetimes, it would be a good idea to pay tax now and let the retirement grow and be distributed tax free in a Roth IRA,” says Joshua Sutin, head of Employee Benefits/ERISA practice at Chamberlain Hrdlicka in San Antonio, Texas. “If rates go up, you can go back to pre-tax deferrals. Either way, qualified plans are critical to protect assets, save for future expenses, and are still very tax efficient for income tax purposes notwithstanding low rates. If you qualify for the new IRC § 199A deduction on Qualified Business Income, lowering your taxable income could qualify some professions to not be phased out of the deduction.”

This new reality means a whole new urgency in the types of plans companies offered their workers. “If there is a Roth 401k option, then it allows the participant to contribute significantly larger amounts to their Roth in a given year and/or the retirement plan allows for Roth contributions where they may otherwise be eligible to do so based on their income,” says Menninger. “In the event that the business owner is trying to reduce his income below a threshold that still allows him to deduct 20% of his profits (this applies to certain service companies under the new tax laws), then having this option available to contribute more to the retirement plan can be beneficial. By the way, this is exactly what I am doing.”

Reality #4: Tax Diversification In Retirement Plans
Over the last decade or so there’s been a developing consensus around the concept of “tax diversification” in retirement plans. This involves combining both tax-deferred and after-tax retirement savings into one coherent strategy. Under the old tax laws, adopting this strategy wasn’t universally available. The reality has now changed.

“Small business owners typically get tax breaks under the new tax law,” says Kenn B. Tacchino is a professor of taxation and financial planning at Widener University in Chester, Pennsylvania. “These tax breaks can lower the current tax liability. With rates as low as they currently are, it may be a great time for Roth contributions to a 401k plan. This will allow the small business owner to enjoy tax diversification when they are retired. In other words, by making Roth contributions today, they will be able to better control their tax situation tomorrow.”

Reality #5: A New World Order Demands New World Thinking
Stop for a moment and consider our first four realities. What do they tell you? What don’t they tell you? “The new tax law has both reasons to have and not to have a tax deferred arrangement,” says Chris Cooper, Private Fiduciary at Chris Cooper & Company in Toledo, Ohio. “It impacts the QBI under section 199A to get the 20% reduction in taxable income. So, one has to be careful before putting in pensions, profit sharing, 401k, SEP’s and all.”

The new tax law carries within it many exciting opportunities. Perhaps some have yet to be revealed. (Recall, Ted Benna didn’t discover the true meaning of 1978’s Section 401(k) until 1981.) Now more than ever, plan sponsors should revisit their retirement plan objectives. They need to speak to their expert advisors and determine how best they can take advantage of what the 2017 Tax Cut and Jobs Act has to offer.

“For S-Corp and other pass through entities, those business owners should consult with their CPAs about the tax law changes to compare how great a contribution may make sense,” says Andrew Bellak, CEO of Stakeholders Capital in Amherst, Massachusetts. “That is, the maximum may not make sense even if a person has the capacity to do so.”

Or, rather, maybe the “maximum” needs to be measured in a new and different way.

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary SolutionsHey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA, and several other books on innovative retirement solutions, practical business tips, and the history of the wonderful Western New York region. Follow him on TwitterFacebook, and LinkedIn.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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