Four Smart Ways to Close Out a Bewildering Tax Year
The countdown to the end of the year always comes with gobs of generic tax advice. Maximize 401(k) contributions. Deplete flexible savings accounts. Lock in stock losses to offset capital gains.
OK, fine. But there’s more to think about this year than usual. There are a handful of substantial tax changes on the horizon, and with congressional Democrats introducing half a dozen different flavors of cuts, hikes, credits and deductions, it’s easy to lose track.
So here's a rundown of the most important changes poised to take effect five weeks from now, and how to take advantage of them or at least minimize the pain they could cause.
Most of the changes to retirement tax breaks enjoyed by the wealthy in earlier iterations of Democrats' proposals have been scrapped or delayed. But there's one significant change that will bar high earners from using a special retirement account known as a Roth IRA. Roth savers don’t get a deduction for money they deposit but can make tax-free withdrawals later on.
The accounts were devised to help middle class people sock money away, so they have restrictions on who can use them and how much can be put in. But a loophole known as a "mega-backdoor" conversion has allowed top earners to circumvent the rules for years. The method involves using a 401(k) account that permits after-tax contributions and then converting some or all of that money into a Roth.
Pre-tax contributions to 401(k)s are capped at $19,500 this year (or $26,000 for those 50 and older), but the limit for total contributions is $58,000 (or $64,500 for those 50 and older) — meaning those looking to funnel money into a Roth have an extra $38,500 to play with.
The version of the tax and spending bill passed earlier this month by the House of Representatives would put an end to those 401(k) after-tax swaps starting next year. Taxpayers usually have until April to make IRA contributions for the previous tax year, but accountants say the Internal Revenue Service may not look so favorably on those who still try to execute a mega-backdoor Roth next year. Consider yourself warned.