Q. I read that President Trump’s plan is only going to allow two personal exemptions ($4,100 each). A family of four would only be allowed to deduct $8,200 instead of the $16,400 allowable today. Do you know if 401(k) contributions would still be deductible under the Trump plan?
A. The Trump tax plan involves a major rewriting of the tax code, but it does not include personal exemptions at all.
The plan would eliminate the personal exemption all together and increase the standard deduction for joint filers to $30,000 (up from $12,600) and to $15,000 for single filers, said Laurie Wolfe, a certified public accountant with Lassus Wherley in New Providence.
“For those able to itemize above these amounts, the plan caps total itemized deductions to $200,000 for joint filers and $100,000 for single filers,” Wolfe said.
Wolfe said some other potential changes worth noting in the individual taxation area are a reduction in the number of tax brackets from 7 to 3, the elimination of the Alternative Minimum Tax and getting rid of the Medicare tax on investment income that helps to fund Obamacare.
There is nothing in Trump’s plan that indicates a change in the way retirement contributions are treated, but the lowering of overall tax rates does affect the value of the deduction — or pre-tax treatment in paychecks, Wolfe said.
She offered this example: If you are in the 25 percent bracket now, your $18,000 401(k) contribution, net of federal taxes, is $13,500. This is the amount your pay will decrease in order to get $18,000 into the plan. If your tax rate decreases to 12 percent, your pay will decrease by $15,840 ($18,000 X (1-.12)).
In this example, we are not considering the overall tax reduction in your individual case, just the impact on the retirement contribution, Wolfe said.
“People in their retirement years, or those over 59 ½ — the minimum age to withdraw penalty-free — would potentially take that money out at a greatly reduced rate,” Wolfe said. “Those retiring 10 years and beyond face uncertainty with respect to what the tax rates in effect will be at that time.”
Wolfe said if you contribute to a Roth IRA or have a Roth feature in your 401(k), you pay taxes now on the amount you put into the Roth. Your tax cost to contribute will be lower with the lower rates.
So if these changes happen, you may want to review whether you’re saving to traditional or Roth plans to make sure you get the biggest tax benefits overall and over time.
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