Financial Planning
June 13, 2022

Capitalize on the Current Tax Laws

Stewart Willis
Co-Founder & Co-Owner Asset Preservation Tax & Retirement

We are still in the midst of the largest tax code overhaul in three decades. The Tax Cuts and Jobs Act (TCJA) became law on December 22, 2017. The law cut individual tax rates, doubled the standard deduction and eliminated personal exemptions from the tax code. But, these modifications will expire in 2025. How can you take advantage of this current tax window? There are four key steps I help my clients to take.

Understand How Tax Brackets Work

Tax brackets are like a liquid measuring cup. The money that flows into the measuring cup first will be taxed at a lower rate. As you fill the measuring cup by earning more money, you will pass different income thresholds, and that money will be taxed at a higher rate. It's important to note that when you cross certain income thresholds, only the income that has surpassed each benchmark will be subject to that higher tax rate. The income earned prior to the benchmark will be taxed at a lower rate. This is known as progressive tax, and traditionally what makes filing taxes by yourself challenging.

Embrace Your Current Tax Bracket

Take advantage of the full bracket you are in. As you earn more money, you are more likely to enter new tax brackets. Know where you are in your tax bracket and how much your taxes will increase if you jump to the next bracket. For example, jumping from a tax rate of 10% to 12% is a relatively small change in your tax situation. However, the next bracket after 12% is 22%, and that's a much larger jump.

Some ways to lower your taxable income to stay within your current tax bracket could be to contribute to tax-deferred retirement accounts like a 401(k) or traditional IRA or put money into a Health Savings Account (HSA), which is available to those who have a high-deductible health insurance plan. We recommend avoiding large jumps in your tax bracket unless yourfinancial advisor says it truly makes sense for you.

Pay Some Taxes Now

Consider making some money moves now that will benefit your financial future when taxes group in 2026. We have four years to move money over to a tax-efficient account through Roth conversions. Roth conversions transfer money from pre-tax qualified accounts like Traditional IRAs and 401(k)s into a Roth IRA. You pay taxes on the money you transfer at the time of the conversion, but your money grows and is taken out tax-free in retirement. So it may be advantageous to consider this strategy while we are in historically low tax brackets. Depending on your age, making this money move now will give you another 20 or 30 years of tax-free growth before you need the money in retirement.

Consider Your Timing

Instead of waiting to make changes to your tax situation in 2025, start making them now. Let's say you are converting a significant amount of money to a Roth IRA and will owe $175,000 for that conversion. You may not be able to pay the entire bill in 2025.But you could break it down into partial conversions of $75,000 this year and $100,000 next year, decreasing the amount of taxes owed at the time of the conversion. You also need to consider how close you are to retirement. Be mindful that making large tax moves this close to retirement may cause those 65and older to incur penalties. The same goes for those on Medicare.

How Long Will This Last?

Will this tax law get extended? Normally, I would believe so. But the United States spent more than $5 trillion throughout the pandemic, and because of that, it is unlikely. Our economy isn’t where it needs to be yet, and we will eventually need to pay back the government. Now is the time to take advantage of this discounted window to set yourself up for financial success in the future. At Asset Tax & Retirement Preservation Services, we help our clients find the right plan for them.

Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.

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