It's always good to build your retirement accounts. Now those
contributions also can help many taxpayers avoid new taxes.
The new levies are aimed at high-income taxpayers. A top tax
rate of 39.6% applies to individuals with taxable income over
$400,000 ($450,000 for married couples filing joint returns).
Here's what the new levies do:
Everyone in the 39.6% tax bracket also owes 20% on long-term
cap gains and dividend income. Others pay a max of 15%.
The new tax law cuts the value of personal exemptions and
certain itemized deductions.
Those provisions kick in for taxpayers with adjusted gross
) over $250,000 for singles, over $300,000 on joint returns.
There's also a 3.8% Medicare surtax. It is applied to your
net investment income, with limits.
You're vulnerable if your modified AGI tops $200,000 ($250,000
for couples). This MAGI usually is the same as your AGI.
Reducing your AGI also will reduce your taxable income, making
the overall bite less painful.
One way to reduce your AGI is to maximize pretax contributions
to retirement plans such as 401(k)s and 403(b)s. You can defer up
to $17,500 of earnings this year, or up to $23,000 if you're at
least age 50.
Most people can take advantage of this strategy because few
workers max their retirement plan contributions. In 401(k) plans
run by Fidelity, for example, only 9.4% of plan members who
contribute to their accounts reached the upper limit.
And 7.9% of all plan members -- whether or not they contribute
-- did so. Among workers 55 or older, 16.0% of contributors maxed
their 401(k) deferrals, while 13.2% of all participants hit the
Plans For Entrepreneurs
Professionals and entrepreneurs may find even more tax
shelter. Solo 401(k)s and simplified employee pensions (SEPs)
permit deductions up to $51,000 this year.
At the other end of the scale, deductible IRA contributions
also can trim AGI. The max for 2013 is $5,500, $6,500 if you're
50 or older.
Deducting your contributions is difficult if you participate
in an employer's retirement plan. You face income-based cutoffs,
with relatively low thresholds.
But there is room for more IRA deductions. According to the
latest IRS data, from 2008, only 50% of traditional IRA
contributors made maximum contributions.
Sixty percent is more typical now, says Sarah Holden, senior
director of retirement and investor research at the Investment
Company Institute. So many investors likely can put more into
their IRAs, perhaps reducing their AGI.
What if you are already maximizing 401(k) and deductible IRA
contributions? Another strategy involves a Roth IRA
Say a hypothetical Ed Park is married. The Parks expect
taxable income this year of $180,000.
The 28% tax bracket goes up to $223,050 of taxable income for
couples. So Park can afford to convert up to $43,050 of his IRA
to a Roth without putting himself into a higher tax bracket and
also exposing himself to the new, additional taxes on
The Parks would owe roughly $12,054 tax on the conversion. But
they will still be in the 28% bracket.
And after five years and reaching age 59-1/2, their Roth
withdrawals will be tax-free. Also, they'll cut future taxable
IRA distributions, which might be at higher rates.