Three tax savings strategies for a secure retirement to try right now

Individuals who rushed to prepay property taxes after the passage of the Tax Cuts and Jobs Act may have saved some money in 2018 — but that’s pennies compared to the long-term tax savings taxpayers should take advantage of before the TCJA’s individual tax provisions are expected to expire in 2026, according to Robert Fishbein, vice president and corporate counsel at Prudential Financial.

Also expected to expire in 2026? According to trustees for Social Security, that’s when Medicare’s main trust fund will run out of money. With the increasing likelihood that Social Security and Medicare benefits may be reduced in the future, it’s more important than ever to use every technique available to maximize your retirement savings.

Three outside-the-box strategies could make an enormous difference in your retirement readiness. The sooner you start, the more you may save.

Fund an HSA for retirement health care

Estimates suggest even a healthy 65-year-old couple will need at least $275,000 to cover retirement health care costs. A Health Savings Account, or HSA, provides a way to save that money without paying a dime in taxes. An HSA account is available to individuals enrolled in a high deductible health insurance plan.

First, these individuals can fund their HSA through a tax-deductible contribution or pre-tax payroll deduction. Second, any interest and investment gains are tax-free. Finally, the funds can be withdrawn tax-free to pay for qualified medical expenses— a triple tax advantage over a traditional savings account.

The best part? There is no requirement to use HSA funds in the year of contribution, which means funds can grow on a tax-favored basis for future health care expense needs.

For 2018, family contribution limits are $6,900, or $7,900 if you are 55 or older, and those amounts are indexed for inflation in future years. If you start contributing the maximum even as late as age 55, and earn 3 percent per year, you could have more than $90,000 to pay for your retirement health care by age 65. If you start contributing the maximum as early as age 40, you could have saved almost $270,000. These funds will continue to grow tax-free in retirement until you need them.

If you don’t use HSA funds in full before you die, excess funds are subject to income tax, but will be otherwise available for your heirs.

Consider a Roth IRA conversion

The typical dogma says that converting an IRA or traditional 401(k) to a Roth IRA does not make sense if you expect your tax rate in retirement to be lower than at the time of conversion. However, lesser known benefits of a Roth IRA may make it worthwhile to have at least part of your retirement assets in Roth IRA form.

Start with no required minimum distributions. With a Roth you aren’t forced to draw down your funds once you attain age 70½ and can continue to benefit from the tax-free growth, thereby maximizing the after-tax funds eventually available for you or your heirs.

Another significant benefit of a Roth IRA or Roth 401(k) is tax diversification. For example, you may choose to take taxable distributions up to a certain amount and then tax-free distributions to avoid a higher income tax bracket.

If you are a high-income taxpayer, Roth IRA distributions are not considered income when determining thresholds for increased Medicare premium charges or the 3.8 percent income tax surcharge on investment gain. If your income is more modest, Roth IRA distributions are not considered income when determining whether you are subject to income tax on Social Security benefits.

If anything, a conversion is more attractive now since you have an opportunity to convert and pay income tax with marginal rates that are generally lower than under prior law. Since individual tax law changes are temporary and tax rates will revert to the former higher amounts starting in 2026, you have an eight-year window to benefit from lower rates.

Make “backdoor” Roth IRA contributions

The tax law prescribes income limits so high-income individuals may not make a direct contribution to a Roth IRA. However, there are no income limits on converting traditional IRA funds to a Roth IRA.

Any person under age 70.5 who has earned income by year-end can make an IRA contribution. While income limits may prevent you from making a pre-tax contribution, you can make this contribution even if you have fully funded a 401(k) or another employer plan.

Once you have made your contribution to a traditional IRA, simply convert that amount to your Roth IRA. As long as this is your only traditional IRA and you have made an after-tax contribution, then an immediate conversion will have converted a tax-deferred asset into a potentially tax-free asset. If you have multiple IRAs, the IRAs are aggregated to determine how much is taxable upon conversion.

While we spend much time on our investment strategies to help gain an extra percentage or two of investment yield, these tax planning strategies can be a more reliable way of maximizing your after-tax retirement income and wealth for your family — no matter how Social Security and Medicare turn out.

Prudential Financial, its affiliates, and their financial professionals do not render tax or legal advice. Please consult with your tax and legal advisors regarding your personal circumstances.

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