Last Thursday the IRS released its 2018 tax updates. If you are anything like me, you like to reduce your taxes by as much as possible. If you are not like that, you should be!
Here are the 4 biggest 2018 tax updates that you should be aware of.
1) Retirement Planning
My personal favorite part of the announcements is updates to the 2018 retirement contribution limits.
The limit for the 401(k), 403(b), 457 and government’s Thrift Savings plan increased $500, from $18,000 to $18,500
Putting away an extra $500 will now save you $125 in taxes if you are in the 25% tax bracket.
That said, the contribution limit for the IRA and Roth IRA remains unchanged, at $5,500.
Additionally, the catch up contribution limit for individuals aged 50 and older was not adjusted. It remains at $6,000 for 401(k) (and similar) plans and at $1,000 for IRA plans.
For more information, see the IRS announcement.
2) Standard Deduction
Good news here as well.
The Standard Deduction was increased for the 2018 tax year.
- Individual: Increased to $6,500 from $6,350
- Married, filed jointly: Increased to $13,000 from $12,700
- Head of household: Increased to $9,550 from $9,350
3) Personal Exemption
The personal exemption was adjusted for the 2018 tax year, increasing to $4,150 per individual. This is an increase of $100 versus 2017.
The phase out of the personal exemption begins with income at $266,700 ($320,000 for married couples filing jointly) and phases out completely at $389,200 ($442,500 for married couples filing jointly).
4) Tax Brackets
The annual adjustments to tax brackets may have the biggest impact on your yearly tax bill. The bracket you fall under defines the amount of tax you will pay, from 0% to 39.6%. These income levels are important to pay attention to when evaluating what your tax liability will be.
Paying attention to these will help you determine what you need to do to reduce your annual taxes. (Pro tip: try to reduce taxes as much as possible.)
For 2018 the tax percentages remain the same. However, the taxable income for each range has been adjusted:
2018 Tax Updates
Keep in mind, these are for the 2018 tax year. You will file your 2017 taxes at the 2017 levels.
But it’s important to start planning for next year. Use these updates to project your 2018 tax obligation.
My general advice is to take advantage of as many of these options as possible to reduce your tax burden. The easiest way to do this is to contribute the maximum amount to a 401(k) type of retirement plan.
Contributing the maximum amount to a 401(k) will reduce your taxable income by $18,500 in 2018.
Combined with a standard deduction of $6,500 and personal exemption of $4,150, an individual is able to reduce their taxable income by $29,150.
Considering this example, an individual could have a gross income of $67,850 in 2018 and reduce their taxable liability to $38,700, dropping them into the 15% tax bracket.
Their 2018 tax obligation would be $5,328.75, putting their effective tax rate at 7.9% ($5,328.75 divided by $67,850).
If this individual contributed zero to a retirement plan, their tax obligation for 2018 would be $9,953.75. In this scenario, the individual pays $4,625 more in taxes and pays an effective tax rate of 14.7%. That is almost double the amount of taxes paid than the scenario where the individual maxed their 401(k).
Do what you can to (legally) reduce your taxes and put that extra money to work for you. My suggestion would be to invest the savings in low-cost index funds.
Of course, the U.S. Congress is currently debating tax reform which could dramatically change all of this.
That said, Congress has proven ineffective at passing legislation thus far, so the best advice is to plan for the tax updates provided by the IRS.
If the tax landscape does change, we will address how that affects you.
For now, happy tax planning!