tax planning

Are You Taking Advantage of the Current ‘Tax Holiday’?

The tax picture is scheduled to change in the not-too-distant future, so now is a good time to make some moves to capitalize.

The Tax Cuts and Jobs Act of 2017 (TCJA) made significant reductions in individual income estate taxes, benefiting many Americans. But with a new administration and new tax proposals from President Biden’s office, some may be worried about possible changes to their tax rates.

What many people are overlooking is that the TCJA has a sunset provision at the end of 2025. At that time, tax rates will revert to the higher rates of 2017 – or perhaps even higher, considering our mounting national debt. While some may be concerned with future tax hikes, many are missing the current opportunity for strategic tax planning, regardless of present or future political dynamics. With the TCJA still in place, we essentially have a “tax holiday” until the start of 2026. With taxes on sale, we can take advantage of rates that may never be this low again.

Some people are concerned that the current administration will soon increase taxes, in addition to the 2026 increase. Realistically, however, politicians have little incentive to promote tax hikes now when current legislation already has a tax increase scheduled. Why be the bad guy who raised taxes when it’s already written into existing legislation?

To see the tax holiday in practice, consider a married couple currently earning $250,000 a year. Currently, they’re in the 24% tax bracket. Prior to the TCJA, that same $250,000 income fell in the 33% tax bracket. The current 24% bracket includes a wide range of incomes and avoids the “tax wall” – jumping from the 24% bracket to 33% – until reaching almost $330,000 in income.

For a couple earning $250,000, that means they have about $80,000 of annual wiggle room to increase their income and still be taxed at a 24% rate. This provides options for future tax reduction and tax-free growth. One way to achieve this is through Roth conversions. Though subject to income tax in the year(s) of conversion, Roth IRAs are never taxed again. This couple could convert $80,000 per year through 2025 and pay the 24% in income tax now, avoiding the scheduled guaranteed tax increase to at least 33% in 2026 and beyond.

These are three ways to take advantage of our current tax holiday:

Soften the blow of capital gains taxes

With long-term capital gains taxes perhaps doubling for those making over $1 million if President Biden’s proposal is enacted, it might be prudent to sell off some high gainers you’ve had in the stock market. Because the market is experiencing all-time highs, it may make sense to sell and pay taxes on the capital gains now if you make more than $1 million per year. Additionally, this provides an opportunity to better manage risk through portfolio diversification and allocation. Considering the huge gains in certain stocks and sectors of the market, some portfolios have become very unbalanced in recent years.

Convert to a Roth IRA

Considering the current administration’s tax proposals, it’s worthwhile to consider a Roth conversion during the tax holiday period. Conversions are taxable in the year they are done, but for many, it’s better to do it now while tax rates are relatively low. The long-term benefits of a Roth make it worth taking a tax hit now; the money grows tax-free and is not taxable when withdrawn properly after age 59½.

Furthermore, a Roth conversion now is good for your beneficiaries later. When the SECURE Act was signed into law by President Trump in 2019, a major change happened that requires retirement accounts to be fully distributed (and taxed) to non-spouse beneficiaries within 10 years. Though beneficiaries must deplete the Roth IRA within 10 years, they can let it grow tax-free for the full duration, then withdraw it all at once without tax consequence. There is no required minimum distribution (RMD) on Roth IRAs. If the funds aren’t needed, that money can continue to sit and grow tax-free, regardless of how high tax rates climb in the future.

Consider life insurance strategies

Besides Roth IRAs, another tax-free investment is life insurance. Various legislators are proposing a reduction in the  estate tax exemption, reducing it from $11.7 million to potentially as low as $3.5 million for a single person (double the values for married couples). This will increase substantially the number of people paying estate taxes. Life insurance provides an influx of cash that can help your beneficiaries pay the estate taxes. Plus, with the addition of an Irrevocable Life Insurance Trust (ILIT), these life insurance proceeds can potentially be removed from the estate completely for purposes of calculating the estate tax.

Of course, an important consideration for married couples is protecting the surviving spouse. If one spouse passes away, the other will experience a reduction in Social Security income and potentially pension income. The death benefit from a life insurance policy provides a lump sum of money that the surviving spouse can use to replenish lost income sources and pay any necessary taxes.

Additionally, life insurance can protect against long-term care costs, an increasingly common thief of wealth among the elderly. Most people needing long-term care spend down their assets at a significant clip to fund their care. Upon death, the surviving spouse may not have enough left to support a comfortable lifestyle. With a life insurance policy that incorporates long-term care, the cost of care is deducted from the policy’s death benefit and extends beyond the death benefit if needed. Unlike traditional “use-it-or-lose-it” long-term care policies, if you don’t require long-term care on these policies, the death benefit stays intact and passes tax-free to your beneficiaries.

The time is now to take advantage of your tax holiday. The moves you make between now and 2026 will forever impact your tax situation and that of your beneficiaries. Tax-wise, there’s never been a better time to control your financial future.

Dan Dunkin contributed to this article.

About the Author

Kurt Fillmore, Investment Adviser

Founder and President, Wealth Trac Financial

Kurt Fillmore is founder and president of Wealth Trac Financial, an independent financial services firm based in Bingham Farms, Michigan, specializing in customized wealth management and retirement planning. He is an Investment Adviser Representative and licensed insurance professional.

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 was not compensated in any way.

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