What the New Tax Cuts and Jobs Act Means for Retirees

Many of the initial provisions in the GOP tax bill that were aimed specifically at retirement income were removed from the plan before it went to a final vote. But that doesn't mean it's time for retirees to breathe a sigh of relief. The Tax Cuts and Jobs Act of 2017 will still have a significant impact on those in their golden years. For this demographic, there are both pros and cons to the new tax law. Understanding what the changes are and how to make the most of them will be key to navigating the years ahead.

Note: Most of the changes introduced by the law went into effect on Jan. 1, 2018, and will not affect 2017 taxes.

The average retiree itemizes numerous expenses on their taxes, such as medical costs, state income taxes, property taxes, and charitable contributions, said Gerald Wernette, managing director with Rehmann Financial in Farmington Hills, Michigan. These deductions have long allowed taxpayers to reduce taxable income. The new tax law however, eliminated or restricted many itemizations. The Tax Cuts and Jobs Act also doubled the standard deduction for all taxpayers. Wernette, whose practice is nearly 50 percent retiree clients, says the result is: "A lot of retirees will no longer get any benefit for itemized deductions."

Many financial experts are advising clients to plan itemized expenses carefully, bunching two years of charitable contributions and property taxes into one calendar year, if their budget allows. In other words, pay your 2018 property taxes in February 2018 and pay your 2019 property taxes in December 2018. Do the same shifting with charitable contributions -- make contributions for the coming year, at the end of the current year. This approach ideally results in increasing itemized deductions beyond the standard deduction threshold. "It takes a little bit of careful planning and a little bit of flexibility in terms of when you pay charitable contributions and property taxes," says Wernette.

The 7.5 percent medical deduction threshold remains in place for 2017 and 2018, but without some action on the government's part, that threshold will rise to 10 percent for 2019. Most of the people who claim this deduction are over age 50, says Lingke Wang, co-founder of Ovid Life Settlements. "If the medical deduction threshold rises to 10 percent, that could negatively affect many retirees' tax bills," says Wang. "Seniors at every income level should speak with a financial planner and tax professional to learn about their options moving forward."

The new tax law doubles the exemption allowed for gift, estate, and generation-skipping transfer taxes through 2025, which is a win for extremely wealthy retirees. From 2018 through 2025, the exemption has been increased from $5 million to $10 million. "This may make estate planning easier for some individuals," says Mario Costanz, CEO of Happy Tax. "But since these tax breaks sunset in seven years it may not be helpful in the long term."

Many people take 401(k) loans to cover various life expenses -- buying a house, paying college tuition, and more. When leaving an employer (such as to head off into retirement), the loans must be paid back or the money is taxed. Even those who roll the remaining 401(k) balance into an IRA face being taxed on the loan. Under the new law, however, taxpayers are given a slight reprieve. Individuals now have until the annual tax due-date of the following year (April 17 for most people) to put the borrowed money into an IRA or pay taxes on it. "Now people have extra time to come up with the money and not get hit so hard with that taxable distribution," explains Wernette.

The new tax law not only doubles the standard deductions (to $12,000 for single filers and $24,000 for joint, married taxpayers), it also leaves in place the additional standard deduction for those who are 65 and over or blind. The additional standard deduction is $1,300 each (on top of the standard deduction) for married individuals and $1,600 for those who are single. The net result of the new doubled standard deduction combined with the untouched additional standard deduction is even lower taxable income for those in this demographic. "This reduces taxable income outright and can really help out seniors and retirees living on a fixed income," says Costanz.

The home equity loan interest deduction also got the boot under the new tax law, which will likely impact many retirees, according to financial advisers. "Effective immediately, retirees can no longer deduct the interest from a home equity loan or line of credit," says Jake Serfas, lead financial strategist at Baltimore-based firm OWRS. "This was a very effective tool while it lasted." Now retirees will want to take a second look at their finances, Serfas adds, and make sure they have a plan in place to counteract that change.

Many retirees will see a net tax savings as a result of the doubling of the standard deduction, according to Ben Soccodato, a financial planner at Connecticut-based Barnum Financial Group. As already mentioned, the standard deduction jumps to $12,000 for single filers and to $24,000 joint, married filers. That's money that can be used to open a Roth IRA, contribute to an existing IRA, or be put into an emergency fund to cover future healthcare costs.

Retirees typically have several income sources -- Social Security, traditional IRAs, Roth IRAs, pensions, and investments. Some sources are taxable, some are not. For this reason, they should plan carefully regarding which income they use under the current decreased tax rates versus which incomes sources they will tap in 2026 and beyond when the laws may change again. For instance, people are not required to take money out of a Roth IRA by a certain age, so Wernette suggests saving that income for future higher tax years. But with a traditional IRA, withdrawals must start by age 70½, whether you need the money or not, so consider using that money now when tax rates are lower.

By and large, most retirees should see a 2 percent to 3 percent decrease on their effective tax rate beginning in 2018, says Gage Kemsley, vice president of Rio Rancho, New Mexico-based Oxford Wealth Advisors. But tax rates after 2026 remain unknown. "Because of the uncertainty of taxes in the future, it's strongly suggested that people remove that tax risk by paying the tax on qualified assets now and converting them into tax-free assets for the future," said Kemsley. In addition, it may make sense to switch traditional IRA contributions to Roth IRA contributions. This change protects the income from required minimum distributions, which could be taxed higher after 2026.

Of course, not everyone will benefit from the standard deduction being doubled to $12,000 for single filers and $24,000 for joint, married taxpayers. Retirees who typically have many itemized deductions, will have a higher threshold to meet in order for it to make sense to continue itemizing deductions. "Because the new standard deduction has doubled, it's unlikely that mortgage interest deductions will benefit a retiree, especially for those nearing their mortgage payoff date," explains Kemsley. "Even if a retiree has itemized in the past, the chance of surpassing the ($12,000 or) $24,000 standard deduction is significantly reduced." As a result, if a mortgage is no longer providing a tax benefit, it might make sense to pay the mortgage off sooner rather than later, if possible.

Under the new tax plan, starting in 2018, taxpayers who itemize will be able to deduct their state income taxes, sales taxes and property taxes up to a limit of $10,000. Currently, these taxes are fully deductible, even on multiple homes. This change will be painful for many homeowners (particularly for those in states with higher property taxes or who own multiple homes) and could take a bite out of retirement income. "The new limit may inspire retirees in high tax areas to finally consider downsizing to the condo or townhouse, something they may have been delaying due to sentimental attachment to the big family home," said Soccodato of Barnum Financial Group. "They may also simply decide to relocate to lower cost-of-living, tax-friendlier areas."