At this time of year, as financial advisors review the previous 12 months with clients, they also look ahead to tax changes that may affect plans.
For 2022, advisors are revising plans to account for higher tax brackets and an increased standard deduction, among other changes.
Here are some specifics regarding the tax changes that advisors identify as important to their clients.
With inflation rearing its head, income limits in all tax brackets will be adjusted in 2022, for taxes filed in 2023.
There will be seven federal income tax rates, ranging from 10% to 37%, starting next year. The top marginal tax rate of 37% applies to those with taxable income higher than $539,900 for single filers and $647,850 for married couples filing jointly.
These higher brackets are designed to offer relief to Americans who find themselves spending more as inflation has pushed up the cost of living. While that may sound like Congress and the IRS are showing sympathy for taxpayers, it’s actually part of an automatic tax-bracket adjustment relative to inflation.
In addition to the adjustment, the standard deductions for filers will rise next year. For single taxpayers, the 2022 deduction is $12,950, an increase of $400. For married couples filing jointly, that’s up $800 to $25,900.
“The high inflation rate everyone experienced over the past year really hurt budgets and tightened cash flow, but the tax changes going into 2022 should help a lot of people in the middle class,” says Ron Tallou, founder and owner of Tallou Financial Services in Troy, Michigan.
Michael Fischer, director and wealth advisor at Round Table Wealth Management in Westfield, New Jersey, says he expects a tax reform bill to pass Congress at some point in 2022.
“But we also had a similar expectation for 2021 after the runoff election in Georgia in January,” he adds.
If the legislation does pass, Fischer expects higher marginal rates for high earners and possibly a reinstitution of the 39.6% bracket that was in place until 2017.
“We’d also expect corporate rates to increase slightly from the current 21% to possibly 26.5% or 28%, which have both been suggested,” Fischer says.
“My biggest tax concern is not knowing what will happen with the Build Back Better bill, especially as it pertains to Roth conversions,” says Tricia Rosen, principal at Access Financial Planning in Andover, Massachusetts.
Build Back Better is legislation proposed by President Joe Biden. It includes funds for infrastructure, social services programs and other initiatives, such as climate change.
A proposal in Congress would end the practice of backdoor Roth individual retirement account conversions — when an account owner converts a traditional IRA to a Roth and pays the required taxes — and impose new rules on all Roth conversions.
“Roth conversions are such an integral part of many people’s retirement strategies, so it could potentially have a significant impact,” she adds.
Congress would likely only end Roth conversions for very high earners, those with incomes of $400,000 or more as individuals or $450,000 as a couple, by 2032. As many financial advisors work with “mass affluent” clients, a halt to Roth conversions isn’t likely to disrupt many plans.
Steve Wittenberg, director of legacy planning at SEI in Oaks, Pennsylvania, has been following the proposed tax changes to provide information to his firm’s clients.
“Even with these changes, Roth conversions continue to be very attractive,” he says.
Cindi Turoski, managing partner at Bonadio Wealth Advisors in Albany, New York, says her firm is encouraging clients who do backdoor Roth conversions for this year to act before Dec. 31, rather than wait until April 15. Converting earlier may give account owners more time to pay any taxes, which aren’t due until Tax Day the subsequent year. In other words, taxes for a Roth conversion in December 2021 wouldn’t be due until April 2023.
She is also urging clients with after-tax money in a 401(k) plan that also offers a Roth account to convert that balance to the Roth account by year’s end. That way, she says, “future earnings on that money can grow tax-free.”
In 2022, the IRS will allow retirement savers to contribute an additional $1,000 per year to a qualified account such as a 401(k), 403(b) or 457. That means employees can contribute a maximum of $20,500 next year. The increases are intended to accommodate for a rise in inflation in 2021.
The catch-up contribution limit for those 50 and older remains $6,500. That means workers over 50 can defer income tax on as much as $27,000 in their employer-sponsored qualified plans.
In addition, Turoski says, “the limit on total employer and employee contributions to these plans increased from $58,000 to $61,000, so more can go into these plans.”
David Anderson, co-owner and managing partner of Moneywise in Bakersfield, California, emphasizes the need for retirement savers to keep up with these changes.
“One of the most important things an investor can do, looking ahead, is to make sure their contributions to their retirement accounts are increasing with the times,” he says, adding that “it is up to the investor to make those changes in their account.”
“One major change we’ve been focused on is the increase in estate exemption for inflation,” Wittenberg says.
He is referring to an area of the tax code that affects high-net-worth Americans, which is being raised to $12.06 million from $11.7 million per individual for 2022. A married couple can now shield a total of $24.12 million from federal estate taxes or gift taxes.
Lisa Featherngill, national director of wealth planning at Comerica Bank’s Dallas office, notes that the exemption increase means “almost $300,000 of additional assets that a person can give away either during life or at death without incurring a 40% transfer tax.”
Wittenberg also points out the increase in the annual gift tax exclusion, which will be $16,000 per person in 2022, after four years of holding at $15,000. He predicts these changes will spark new gifting initiatives.
“While the estate exemption is increased for inflation in 2022, the current law will sunset in 2025, which means that it’s time to utilize the exemption now before it is cut in half,” he says.
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How 2022 Tax Code Changes May Affect Financial Advisors’ Clients originally appeared on usnews.com
Correction 12/17/21: A previous version of this story misspelled Cindi Turoski’s name.