If you’re retired or nearing retirement, and think taxes are boring, think again: Though it may not be apparent yet, the new tax law could deal a blow to your finances. Understanding what’s around the bend can help you plan for the future.
Currently we are straddling two different sets of tax rules. To appreciate what’s at stake, you need to think beyond the tax return that’s due April 17; that form covers 2017, before the new law took effect. Far more worrisome are the new rules, which kicked in at the start of 2018. Unless Congress does something to alter the situation, they will dictate your finances until the provisions sunset at the end of 2025.
During those eight years, people who are now 50 or older are likely to go through several major life transitions. Here’s how the new law, popularly (and ironically) known as the Tax Cuts and Jobs Act, could affect each of them.
1 Where you live. Being able to deduct property taxes has long been a crucial factor in figuring out how much one could afford to spend on a home. The new law changes the calculation – most notably by setting a $10,000 cap on the total deduction for real estate taxes; state and local income taxes; and sales tax.
With this limit on what’s called the SALT deduction (an acronym for state and local tax) in place, far fewer people will be able to itemize, or list, each deduction to which they are entitled. Instead, they will opt for the standard deduction, which has roughly doubled this year, to $12,000 for individuals and $24,000 for married couples filing jointly.
To see whether you will be worse off, turn to Schedule A of your most recent federal income tax return if you itemized and follow these steps: 1) Total the amounts on line 5 (state and local income taxes, and sales tax) and line 6 (real estate taxes); and 2) Subtract $10,000 (the new cap) from the amount in No. 1. If the answer is more than the 2018 standard deduction, the changes put you at a disadvantage.
Without these deductions, can you afford to stay in your current home? In high-tax states, especially, many people have new financial reasons to downsize – or relocate.
2 Declining health. If, based on the calculation above, you determine you’re worse off, get ready for the domino effect of the new law: Other deductions that you’ve been accustomed to taking will also go by the wayside – assuming they don’t bring your total itemized deductions to more than the new standard one. How much is each of these lost deductions worth? Its approximate value to you, in pocket, is the amount of the erstwhile deduction, multiplied by the tax rate that applies to you in a given year.
Which brings us to unreimbursed medical expenses. For 2017 and 2018, they are deductible when they exceed 7.5 percent of adjusted gross income. Starting in 2019, these expenses are deductible if they exceed 10 percent of adjusted gross income (7.5 percent if at least one spouse is older than 65). But, as a practical matter, any deduction, including this one, is worthless unless you itemize. Good health is fleeting. Medical expenses increase as we get older. So losing this tax break hurts our nation’s aging population.
3 The search for new purpose and meaning. As they transition to retirement or get pushed out of the workforce sooner than expected, many baby boomers are looking to reinvent themselves. Chances are their earning power has been diminished. Volunteer work can provide another way to find fulfillment and remain part of a community.
Under the new tax law, however, giving back is potentially more expensive. Why? Because if you’re no longer itemizing, you can’t deduct unreimbursed expenses associated with volunteer work.
As in the past, you aren’t allowed to deduct the value of your time or services, but you can deduct transportation costs, including the use of your automobile (either the actual expenses or 14 cents per mile). Even travel might be deductible, but the rules are strict: The main purpose of your trip must be to volunteer (rather than vacation). For more information, see IRS Publication 526, Charitable Contributions, which downloads as a PDF.
These rules haven’t changed, but fewer volunteers will be able to rely on them. This could discourage some volunteers, and ultimately hurt those who benefit from their generosity.
Though indirect effects of the new law may seem subtle, the impact can be profound. As our income declines, money gets tighter. Those of us who saved money in retirement accounts will start to take withdrawals to meet current expenses. When we do that from traditional IRAs or 401(k)s (as opposed to Roths, which are funded with after-tax dollars), the money is taxed at ordinary income rates. So are Social Security benefits. In an environment in which fewer deductions are available to offset income during retirement, more of those funds will go to taxes and less will be available for personal use.
Still think taxes are boring? What could be more interesting than your own financial well-being? In future posts I’ll describe specific strategies that, depending on your circumstances, may help temper these harsh effects. Stay tuned.
Deborah L. Jacobs, a lawyer and journalist, is the author of Estate Planning Smarts: A Practical, User-Friendly, Action-Oriented Guide. A free update to the book, reflecting the recent tax overhaul, is available for download on the book’s website. Follow Deborah on Twitter at @djworking and join her on Facebook here. You can subscribe to future blog posts by using the sign-up box on the homepage of her author’s website.
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