Taxes

401(k) contribution limits can change every year. We’ve got the latest limits released by the IRS for 2018, as well as prior years.

401(k) plans are the primary retirement savings vehicle for the middle class. This is particularly true as more employers automatically enroll new employees in the plans. And for those who have the ability to maximize their contribution each year, the new calendar year offers an additional opportunity.

In 2016 and 2017, the maximum contribution limits were the same. For retirement accounts–which include 401(k) accounts, 403(b) accounts, most 457 plans, and Thrift Savings Plans–these stayed at $18,000. In case you were holding out for an increase, I have good news: for 2018, these contribution limits will go up to $18,500.

Of course, savers and investors aged 50 or older can take advantage of an additional catch-up contribution. This effectively increases the limit for those approaching traditional retirement age. In 2018, these taxpayers can contribute an additional $6,000 above the regular maximum of $18,500. As a result, if you are 50 or older, you can contribute a maximum of $24,500 into these tax-advantaged accounts in 2018.

Resource: Maxed out your 401(k) or looking for better investment options? Check out an IRA at WealthFront.

Total Contribution Limits and Examples

The total contribution limit, including employer contributions, has also changed. It is now at $55,000, up from last year’s $54,000.

The benefits of a 401(k) plan are, by design, directed primarily at people who most need an incentive to save for retirement. This may help contain the tax benefits within the middle class. The government does this by applying a maximum level of compensation to which matching benefits apply.

In 2017, only the first $270,000 in an employee’s compensation over the course of 2017 may be applied to the company’s matching formula. That goes up to $275,000 in 2018. That’s a sufficiently high maximum. It should cover more than just the middle class.

To illustrate,say a company matches an employee’s contributions at a rate of 50% up to a limit of 5% of the salary. An employee with a $100,000 salary contributes $15,000 to her 401(k). She will receive, at most, a $5,000 matching contribution (5% of the full $100,000 salary).

An employee at the same company earns $400,000 in compensation. She defers $15,000, so the matching contribution will be $13,750 (5% of the $275,000 maximum compensation, not $20,000).

The IRS has additional rules that require a company to balance benefits between employees earning $120,000 or more and all other employees.

Finding Account Fees

Beginning in 2013, new regulations required 401(k) plan administers to explicitly state in quarterly statements how much investors are paying in fees. Previously, this information was not easy to discover. You could (and should) look at the various prospectuses in search of management expenses fees or expense ratios, expressed as a percentage of assets. But there were at least two obstacles:

• The expense ratios force you to do your own calculations to determine how much money you’re spending in fees.
• Not all fees are included in expense ratios. Some funds, like annuity-based mutual funds, don’t have expense ratios but certainly have fees.

Now finding those fees is easier. The regulations that started in 2013 are still in place today.

Maximizing Your Contributions

To maximize your 401(k) contribution in 2018, spread the $18,500 across the number of paychecks you plan to receive throughout the year. That’s a contribution of about $1,541 each month for those age 49 or younger. The calculation for those over 50 who want to max the contribution is about $2,041 per month.

If your employer records your contributions as a percentage of your paycheck, remember to change them to account for raises and bonuses. If you are expecting your company to match your contributions at some level, and you reach your 401(k) contribution limit before your last paycheck, you may miss out on free money.

The following table illustrates the change in 401(k) contribution limits over the past several years.

Take Control of Your 401k

Track and Analyze your Investments for Free: The easiest way to track and analyze all your investments, regardless of where they are located, is with Personal Capital’s free financial dashboard. By far the best financial tool we’ve ever used, Personal Capital enables you to connect all of your 401(k), 403(b), IRAs, and other investment accounts in one place. Once connected, you can see the performance of all of your investments and evaluate your asset allocation.

You can also see the fees you are paying through Personal Capital’s Retirement Fee Analyzer. I was stunned to learn that the fees in just my 401(k) could cost me over $200,000, requiring me to put off retirement for three years! They also offer a free Retirement Planner. This robust tool will help you plan for retirement and show you if you are on track to retire on your terms.

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The IRS has released the 2018 tax rates. Here they are by income and tax filing status. We also cover exemption amounts and standard deduction.

Ah, fall has arrived. You know, the time of year when the leaves change colors, the days get shorter . . . and the IRS releases next year’s tax brackets.

This year is no different. Last week, Uncle Sam let us know how much we can expect to pay in taxes next year, based on our income.

It’s important to remember that these numbers are not the ones you’ll be using to prepare your taxes this coming spring. (If you need a refresher, those numbers can be found on the 2017 bracket page.)

Instead, these 2018 brackets are for the taxes you can expect to pay on any income that you earn in 2018. This means that you’ll use these numbers for the taxes that you prepare in the spring of 2019. Let’s take a look and see what’s new.

Updated Tax Rates

The new brackets below outline the taxes that you can expect to pay from January through December of 2018, which you’ll then file in spring 2019. You can use them to adjust your withholdings and plan your finances next year (especially if you’re a contract employee or freelancer and need to pay quarterly taxes).

• Resource – View the different ways you can file your tax return with H&R Block

2018 Marginal Rates

As you can expect, bracket limits have been bumped for the year. The limits haven’t risen all that much, though, so your impact won’t be too significant.

Here’s a look at the chart:

2018 Tax Brackets

Here are the tax brackets in more detail.

Married Filing Jointly and Surviving Spouses

Heads of Households

Unmarried Individuals (other than Surviving Spouses and Heads of Households:

Married Individuals Filing Separately:

The most important thing to remember about these numbers is that they could still change if tax reform actually happens. If it doesn’t, however, you can count on the numbers above for 2018.

Standard Deduction

Another slight increase comes in the form of the standard deduction. But again, this isn’t a significant bump.

For 2018, single taxpayers and those who are married but filing separately can take a standard deduction of $6,500 (an increase from last year’s $6,350). Heads of household can take $9,550 (up from $9,350) and married couples filing jointly can take $13,000 (up from $12,700).

If you’re blind or older than 65, you can take an additional standard deduction of $1,300. If you’re unmarried, this additional deduction is $1,600.

This means that you can decrease the amount of income on which you pay taxes by this standard deduction. So, if you made $50,000 last year and are single, the standard deduction will decrease your taxable income down to $43,500.

Personal Exemption

After two years at $4,050, the personal exemption has increased to $4,150 for 2018. And just like the standard deduction above, the personal exemption means that you can earn even more money without owing income taxes on it.

However, the personal exemptions phase out beginning with a certain level of income. This means that if you make too much money, you won’t be able to take the full personal exemption on your earned income. This threshold begins at $266,700 for single filers, $160,000 for married filing separately, $320,000 for married filing jointly, and $293,550 for heads of household.

How to Calculate Your Taxes

While most of us simply plug our W-2 into TurboTax and let the computer do the thinking for us, it’s still important to at least know how tax brackets work.

For the sake of our example, let’s assume that you’re a single filer with an earned income of $110,650, and you don’t have any dependents. Take your income and subtract both your standard deduction and personal exemption, and you’re left with $100,000 in taxable income.

Now, apply your marginal tax rates.

Based on your first $9,525 of income, you’ll own 10% (for a total of $952.50 in taxes). For income dollars $9,526 through $38,700, you’ll owe 15% (for another $4,376.25). Then, for income dollars $38,701 through $93,700, you’ll pay 25% in taxes (adding up to another $13,750). This means that for your first $93,700 in income, you’ll pay a total of $19,078.75 in income taxes.

Now take the income left over ($6,300) and apply the next marginal tax rate of 28%. This will add another $1,764 to your tax bill. That means that for the year, you will pay a total of $20,842.75 in taxes on your total $110,650 earned.

For that level of income, your marginal tax rate ranged from 10% to 28%; however, your effective tax rate comes out to only 20.84% of your taxable income ($100,000). If you count it against your entire earned income ($110,650), though, you’re paying only 18.84% in taxes for the year.

You should also note that investment income can sometimes be taxed separately from, and at a lower interest rate than, earned income.

It’s interesting to look at these newly-released brackets, knowing that there’s a chance for tax reform. This would, of course, change everything shown here. If this happens, we will be sure to update you right away!

Next Steps

• Get your tax returns filed quickly, easily and inexpensively with TurboTax.

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Whether you’re an investment guru with billions to your name or a small business owner who has seen years of hard work finally result in success, you definitely don’t want to see even more of your money eaten away by estate taxes. To combat this, you may be looking to spread the wealth now. This could include gifting your children with the down payment on their new home, buying your mom a new car, or simply writing your nephew a generous check at Christmastime.

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Making large disbursements such as these can be a simple and effective way to reduce your future taxable estate, benefiting your heirs considerably. Here’s why you should consider the annual gift exclusion and how your generosity can be utilized in the most tax-efficient way possible.

What is the annual gift exclusion and how does it work?

Each and every U.S. citizen is allowed to give anyone of their choosing up to $14,000 a year (as of 2017), without incurring either a gift tax liability or being required to report the gift. This means that if you’d like to spread the wealth to your children, you are able to give them as much as $14,000 each per year without any sort of tax implications. Married couples are allowed to compound this benefit, gifting as much as $28,000 to any individual of their choosing without any gift tax being applied.

Example: Let’s pretend that you and your wife have five kids, but are also very close to your best friend’s two children, as well. You have recently retired and sold your company and would like to give them all the gift of a vacation fund this summer. (What a generous fellow you are! By the way, I need a vacation, too…)

As a couple, you and your wife are allowed to give each of your children and each of your friend’s children as much as $28,000, effectively reducing your taxable estate by $196,000 this year. There is no limit to the number of people to whom you can give these annual gifts, and you can do it each and every year. If you were to write them all a comparable check every year for the next ten years, you could easily reduce your estate by $1.96 million… without it counting toward your lifetime gift exclusion or being taxed as part of your estate.

Related: How to Avoid Estate Taxes on Life Insurance Proceeds

Individuals or married couples who make gifts above the $14,000/$28,000 limits do have a reporting requirement, and must file IRS Form 709 on which they tell the IRS about the excess. This does not mean that either the donor or the donee needs to pay gift taxes on the amount over the annual exclusion limit. It simply means that anything above $14,000/$28,000 will count toward the donor’s lifetime gift exemption.

What is the Lifetime Exemption?

Essentially, every American is allowed to give away as much as $5.49 million of their estate (as of 2017), without it being subject to estate taxes. If you are to pass on an estate to your children that is worth more than $5.5 million, they will likely owe taxes on the excess.

So, where does the annual gift exclusion come into play? Well, if you were to give away bits and pieces of your estate on an annual basis, up to the exclusion limit, you would reduce the value of your estate while essentially giving your money away “early.” This means you can bypass some of these taxes and make the money available to others, like your children, right now… when they may need it most. If you give them more than the $14,000/$28,000 limit each year, though, the IRS will keep track of the surplus given, and it will count against your $5.49 million Lifetime Exemption.

Here are some examples, assuming that you have an estate worth $8 million.

Scenario 1: You have an estate that is still worth $8 million when you die, so your heirs will pay estate taxes on approximately $2.51 million of that.

Scenario 2: You and your spouse have been effectively reducing your estate each year, giving each of your children and siblings a $25,000 check at Christmastime. Over the final two decades of your life, you manage to disburse a total of $4 million (8 people, each getting an annual $25,000 check over 20 years).

This means that estate has been reduced to roughly $4 million by the time you pass, which is below the Lifetime Exemption limit… therefore, your heirs will not be subject to estate taxes on the remainder. You’ve just saved your heirs a ton of money.

Scenario 3: You (not you and your spouse) have given each of your four children a $114,000 check every December. The first $14,000 of each check counts toward your annual gift exclusion. The remaining $100,000 of each, though, needs to be reported on the IRS Form 709 and will be tracked as part of your Lifetime Exemption.

Let’s say that you pass away ten years later; you will have given away $4.56 million, reducing your estate to $3.44 million. However, since you went over your annual exclusion each year, you have already used up a whopping $4 million of your Lifetime Exemption. This means that your children will now be subject to estate taxes on $1.95 million of the remainder ($5.49 million Lifetime Exemption – $4 million already gifted = $1.49 million left of your exemption…. $3.44 million estate – $1.49 million Lifetime Exemption left = $1.95 million overage for which taxes are due).

Other benefits of using the gift exclusion

Aside from reducing your taxable estate and saving your heirs money, the other advantage of using the annual gift exemption is sheer simplicity. Using this method you get the perks of:

• Not giving up control of a large portion of your assets.
• No administrative costs i.e. trust tax returns/legal set up costs.
• Only needing to file a gift tax report if making a gift in excess of the annual limit.
• Control over how much to gift each year.
• Control over who to gift to each year.
• No requirement to a make gift every year.

What are the potential issues with an annual gifting strategy?

One possible drawback is that the person you are making a gift to is incapable of managing their financial affairs. In this case, you may want to use a trust to protect them from themselves or creditors. Also, this strategy does not make sense for anyone with a child with special needs. Gifting them money outright may jeopardize their governmental benefits. In that case, the correct way to give to them would be via a special needs trust.

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Finally, a potential issue is if the donor couple has a shorter-than-expected life expectancy, which would diminish the amount given. However, the couple’s untimely death would be somewhat offset by decreased growth in their investments.

The annual gift is a humble but effective solution to wealth transfer. For those of you with larger estates, it can still be an effective tool in your estate planning toolbox.

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