The Healthcare Tax Break You May Be Missing

Healthcare planning and retirement planning are as inseparable as catfish and whiskers. Get this, an average 65-year old man will need $131,000 in retirement to cover just premiums and prescriptions – the average woman, $147,000. These are expenses that could blow up one’s retirement plan. Learn here how a Health Savings Account may be just the solution while offering generous tax advantages.

Health Savings Accounts (HSAs) are extremely flexible as they offer triple tax advantages: 1) Contributions are tax-deductible or taken out pre-tax of your paycheck; 2) They grow tax-free; 3) Withdrawals for qualified medical expenses are also tax-free. So, they are like a traditional IRA and a Roth IRA combined in one investment account. Plus, after age 65 you can take withdrawals for non-health expenses if you just pay normal income tax on the amount. As a result, there’s no risk in saving more than you’ll need for healthcare and having it go to waste.

Do you qualify?

People who obtain health insurance through a High Deductible plan qualify for an HSA. For singles, a plan with a minimum deductible of $1,350 and a maximum total annual out-of-pocket expense of $6,650 qualifies. For families, the deductible minimum is $2,700 and the max out-of-pocket expense is $13,300. If your health insurance plan meets that criteria, you may establish and contribute to an HSA. If you change employers or health plans to a non-high deductible plan, you can still use your HSA, you just can’t contribute to it at that point.

Those who have very good health insurance options through their employers, like the University of Kentucky, won’t have access to an HSA. Self-employed individuals, small business owners, members of law firms or contract lobbying firms and non-profit associations, however, often use High Deductible plans because the premiums are more reasonable than their other health insurance options. Those individuals should consider establishing an HSA.

Contributing to an HSA

In 2018 the contribution limit for individuals is $3,450 and $6,850 for families. And, unlike a Flexible Savings Account, you don’t have to spend what you contribute each year. In fact, an HSA is really an investment account for health care – you contribute a certain amount each year, invest it appropriately for when you expect to need the money for qualified health expenses and watch it grow – tax free – until you need it. For instance, if 45-year old Monica contributes $298 per month, or $3,585 a year, to an HSA until she turns 65, earns an average of 7% per year on her investments, she will have accumulated that $147,000 the average woman will need for healthcare premiums and prescriptions in her retirement. That’s just an example, any amount will help toward future expenses.

Should you establish an HSA?

First, before establishing an HSA, investigate the options the plan offers for investments. Does it offer the opportunity to invest in a variety of stock and bond mutual funds? If so, great, proceed saving. If the plan simply parks your hard-earned dollars in a money market account earning .1%, it’s then just a good opportunity to save for a large medical expense you expect to incur in the next 2-3 years. It is not, however, a good option for saving for medical expenses in retirement.

Second, while extremely flexible, an HSA should be viewed only as a supplement to your 401(k) and your traditional IRA and Roth, especially if your employer matches your contributions to their sponsored retirement plan. After those, an HSA is an excellent way to save and invest for what we must assume will be pricey healthcare expenses later in life. Even if you don’t save the amount Monica is, having a fund with “extra” healthcare dollars in it can really pay off when you need it.

 

Making Charitable Contributions Under the New Tax Law

When the federal tax law changed late last year, part of the concern raised by many was the potential impact of the law on charitable contributions. Specifically, would people still be inclined to give even if they are unable to deduct them from their income taxes? Do people give because they believe in the cause or because they simply want the tax deduction? For charitable organizations, colleges and universities and other groups, these are serious questions that could materially impact their mission. So, let’s walk through the potential deterrent to contributing and offer a solution for those over the age of 70 ½.

When completing your return, you have the choice of taking what’s called the standard deduction or itemizing deductions. Obviously, you deduct the larger amount. Under the new tax law that takes affect in 2018, the standard deduction for a married couple filing jointly doubles to $24,000. Plus, the law caps the deductions for state income and property taxes at $10,000. As a result, the only way to “receive credit” for your charitable contributions now is for them to total more than $14,000 in order for your total itemized deductions to exceed the new standard deduction of $24,000. Quick, raise your hand if you’re still reading this.

Yep, this is pretty awful stuff. So, here is a crisp explanation of how to receive a tax benefit from your charitable contributions if you are over the age of 70 ½:

As you probably know, we all must start taking what are called Required Minimum Distributions (RMDs) from Individual Retirement Accounts (IRAs) in the tax year in which we turn 70 ½. Those RMDs are subject to income tax. However, one can make Qualified Charitable Contributions (QCDs) by transferring up to $100,000 per year from an IRA directly to a qualified charity. This tax-savvy strategy offers the combined benefit of satisfying your annual RMD while lowering your taxable income, resulting in a lower tax bill to you.

Here’s how it works:

Let’s say you and your spouse are both over 70 ½ and your combined RMDs total $24,000. If you wish to contribute $10,000 to say, the Y and God’s Pantry, it will reduce your taxable income by that same $10,000 and now only $14,000 is subject to income tax. And, even better, you still get to claim the standard deduction of $24,000 (plus an additional $2550 because you’re both over the age of 65) So, assuming you’re in the 24% tax bracket, instead of paying income tax of $5760 on that $24,000 of RMD subject to income tax, you would pay just $3360 of tax on the new total of $14,000 of RMD income – a savings of $2400.

This strategy is the classic win-win. 1) You satisfy part, or all, of your annual Required Minimum Distribution; 2) You reduce your tax liability by the amount of your charitable contribution just like you used to; 3) You get to take advantage of the new doubled standard deduction; and, 4) You get the satisfaction of doing good for an organization you care about.

Moneywatch Advisors manages RMDs and QCDs and many other abbreviations for our clients – call us if we can help you.

 

How the Trump, House Tax Proposal Affects You

Back in late September the Lexington Financial Planner blog wrote about how President Trump’s tax proposal would affect you. Now, the House Ways and Means Committee has revealed their tax bill so let’s take another look. No talking points, no politics, just math. Uh, fun math. No, seriously.

While the income subject to tax may be higher for many of us, at least those of us with those pesky kids, our overall taxes may be changed little because the tax rates are spread out farther among brackets. See below for the proposed new rates based on taxable income:

While it’s impossible to capture every person’s circumstances, let’s take a middle of the road example and apply the new proposal. So, as in September, let’s start with our fictitious couple and how much they pay under current tax law:

Current law:

Chandler and Monica earn a combined $125,000 in salary and each contribute 5% pre-tax to their employer’s retirement plan. For simplicity sake, we’ll ignore other pre-tax deductions like their pre-tax cost of their employer’s health insurance plan, and call their Adjusted Gross Income (AGI) $118,750. (Gross income minus their retirement contributions) Unlike our friends on TV, they have two children.

Under current law Monica and Chandler have a choice between subtracting the standard deduction of $12,700 from their AGI or itemizing deductions. As you can see below, their itemized deductions are more than their standard deduction, so they obviously deduct the larger amount:

• Mortgage interest deduction – $5,578 (Interest paid on their $200,000 house where they still owe $150,000)
• State and Local Income tax deduction – $9,797
• Property tax on their home – $2,000
• Charitable contributions – $1,000
Total: $18,375 (clearly more than the standard deduction of $12,700)

In addition to their itemized deductions, Monica and Chandler are also allowed to deduct $4,050 each as personal exemptions plus dependent exemptions for each of the kids, for a total of $16,200.

Finally, their AGI of $118,750 minus their itemized deductions of $18,375 minus their personal exemptions of $16,200 equals Taxable Income of $84,175 and Tax Liability of $12,521.

New Proposal:

Although mortgage interest and charitable contributions are still allowable as itemized deductions, state and local income tax deductions are not allowed. Property tax up to $10,000, however, can be included as an itemized deduction.

• Mortgage interest deduction – $5,578 (Interest paid on their $200,000 house where they still owe $150,000)
• Property tax on their home – $2,000
• Charitable contributions – $1,000
Total: $8,578 (now less than the new standard deduction of $24,000)

Monica and Chandler are no longer allowed to deduct $4,050 for their 4 personal and dependent exemptions because those have been rolled into the proposed standard deduction.

As a result, Chandler and Monica find their itemized deductions are lower than the proposed new standard deduction – $8,578 is lower than $24,000 – so they use the higher number.

Finally, their AGI of $118,750 minus the standard deduction of $24,000 equals their taxable income of $94,750. Based on the new, compressed tax brackets it appears their tax liability would be $11,988 – a tax savings of $533.

In addition, the tax plan highlights indicate an increase in the Child Tax Credit but it doesn’t contain details about how those credits will apply. The credit for their two children could lower their tax liability further.

Key Takeaways:

• Thankfully, and correctly, the proposal keeps the current deduction levels for retirement plans such as 401(k)’s, 403(b)’s, 457(b)’s ($18,000 for those under 50, $24,000 for those 50 and over) and IRA’s and Roth IRA’s ($5500 for those under 50, $6500 for those 50 and over). That’s very good news and good for those of us without a traditional pension (most of us).
• Although a married couple with two children will likely have lower overall deductions than they do now, the lower tax rates may very well lower their overall tax liability.
• Those without children will likely see their deductions increase, and their overall tax liability decrease.
• For those of us with children under age 17, the child tax credit increases but details are still sketchy about any phaseouts based on income.
• The tax rates on capital gains and investment income from taxable investment accounts remains the same.
• For those high earners and those with stock grants from their employers, the Alternative Minimum Tax is eliminated.
• The mortgage interest deduction only applies to mortgages of $500,000 and less where the current amount is $1M.