The beginning of the Trump presidency is right around the corner—and, for many high-income clients, this new era is expected to bring about substantially reduced income tax rates. While this reduction in income tax rates will likely come as a welcome change, it also adds a new layer of complexity to retirement income planning.
Many high-income taxpayers max out contributions to pre-tax retirement savings accounts specifically in order to minimize taxable income (meaning that these clients likely aren’t contributing to a 401(k) because of an anticipated need for these funds during retirement). For some of these clients, falling tax rates in 2017 could mean that the tried-and-true system of maxing out pre-tax retirement account contributions will no longer be the smartest strategy. However, before clients opt to take this route, it’s critical that they weigh all the potential options in order to maximize savings potential while minimizing taxes.
The 2017 Retirement Planning Landscape
Currently, most taxpayers are entitled to contribute up to $18,000 in pre-tax dollars per year to their 401(k) plans (older taxpayers are entitled to make catch-up contributions and max out pre-tax contributions at $24,000 in 2017). Many high-income taxpayers who choose to max out their 401(k) contributions will likely reach the maximum rate mid-year, assuming that they are deferring a portion of their salary each month.
While it is impossible to know the exact form that the new tax proposals will eventually take, if the Trump administration is successful in lowering the current highest income tax rate from 39.6% to 33% in 2017, many of these high-income clients could be better served by allocating a higher portion of their total contribution limit to a Roth savings account instead of maxing out pre-tax retirement accounts. This is especially true because, even if tax rates for high earners are lowered in 2017, it is difficult to predict how long these lower tax rates will remain in effect.
Because of this, many high-income taxpayers might benefit from contributing more funds to a Roth account in 2017 (and in the following years of the Trump presidency, if income tax rates are anticipated to remain low) in order to maximize this tax-free income source during later years, when income tax rates might increase.
Potential Complicating Factors
If the new administration’s tax plans are enacted as proposed, it is likely that higher-earning clients will enjoy at least a few years of reduced income tax rates—meaning that they could benefit from contributing to Roth accounts and paying the tax during these lower-tax years instead of upon withdrawal in later years.
However, clients who would benefit from an employer’s matching contribution to a pre-tax retirement account should likely continue to take advantage of that employer match.
Clients should check the terms of their particular plan to determine specific requirements that must be satisfied in order to earn the employer match (i.e., some plans require that a portion of each paycheck is directed into the 401(k) in order to qualify for the matching contribution).