We’ve heard the adage so often that sometimes it barely registers: Nothing in life is certain except death and taxes.
It’s a cliche that may never go away because, as trite as it is, there is truth underlying it. And in the next few years investors, retirees and everyone else may find out just how accurate the tax portion of this overused phrase is.
That’s because right now we are celebrating some of the lowest tax rates we’ve ever had. But the odds are good that our Cinderella’s ball of a tax party is going to come crashing to an unceremonious end.
To understand why, we need to revisit the 2017 tax cuts that in reality were two cuts in one. Both individuals and corporations received an income tax cut, but just one of those cuts was permanent. If you guessed that it was the one for corporations, you are absolutely correct.
The tax cut for individuals came with an expiration date – specifically Dec. 31, 2025. At midnight when we ring in 2026, those 2017 tax cuts will turn into the proverbial pumpkin, at least in the financial sense. Barring intervention from lawmakers, our taxes will revert to what they were prior to the cut.
Anyone who follows the workings of Washington, D.C., understands that at some point something has to give. The federal government has a massive debt – $28 trillion and counting. Whittling down that gargantuan amount of money owed requires either decreasing spending or increasing taxes … and there’s not a lot of evidence that spending is going to drop.
That raises concerns for those who are retired and for those who plan to leave a legacy to their families. Let’s take a look at two of those concerns: a potential rise in income tax rates and proposed changes to the estate tax.
Right now, there is an $11.7 million per person exemption on the estate tax. In other words, you pay nothing on the first $11.7 million that you leave to your heirs, and everything over that is taxed at 40%. So, just as an example, if someone bequeathed $14.7 million to a family member, just $3 million of that amount would be taxed. That’s scheduled to change on Jan. 1, 2026, when the estate tax exemption will drop back down to $5 million (indexed for inflation). The House Democrats’ $3.5 trillion reconciliation bill proposes to lower the exemption to $5 million (indexed for inflation) even sooner, beginning in 2022.
To counteract this possibility at least partly, talk with your financial professional about perhaps gifting assets to your beneficiaries while you are still alive. Each parent can gift each child up to $15,000 annually without any taxes coming into play. So, a couple could gift one child $30,000 each year. Another possibility is to create an irrevocable life insurance trust, which can help minimize estate taxes.
Prior to the 2017 act, the top income-tax rate for individuals was 39.6%. That dropped to 37% when the new rules went into effect, and other rates were lowered as well. When those rates go back up in 2026, retirees and pre-retirees definitely will notice, because many of them have their retirement savings in tax-deferred accounts, such as traditional IRAs or 401(k) accounts. Each time they make a withdrawal, their money will be taxed. With tax rates scheduled to go back up, they will have less money in their pockets.
One potential way to counteract this is to shift at least a portion of your retirement savings into a Roth account. You pay taxes at the time of the conversion, but the money grows tax-free and you don’t pay any taxes when you make withdrawals from the account in retirement. The sweet spot for making a Roth conversion is anytime from ages 59½ to 72, because during those years there are no rules when it comes to withdrawing money. Before 59½ you are charged a withdrawal penalty in addition to taxes. Once you reach 72, you are required to withdraw a certain amount each year from your traditional IRA or face a penalty if you don’t reach that minimum. Your financial adviser can help you explore if a Roth conversion is a good strategy for your situation.
Of course, concerns about taxes in retirement are nothing new, even if the specifics change with time. In the more than two decades that I have been advising clients, I have heard over and over variations of this question: How do I keep my taxes under control?
The answer to that question may not be the same for you as it is for your neighbor. That’s why it’s critical to talk with a financial professional who can look at your total financial picture and guide you in formulating a plan to better protect from taxes the money you spent a lifetime working for.
Ronnie Blair contributed to this article.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
Partner, Safeguard Investment Advisory Group, LLC
Reid Abedeen is the managing partner at Safeguard Investment Advisory Group, LLC. He holds California Life-Only and Accident and Health licenses (#0C78700), has passed the Series 65 exam and is an Investment Adviser Representative registered through the Financial Industry Regulatory Authority.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.