Written by Christine Benz, Morningstar’s Director of Finance | 10.26.2017
Inflation is currently so modest that the Federal Reserve has wrestled with what steps it could take to drive it higher. But the cost of living has picked up enough to affect retirement savings contribution and income limits, as well as Social Security payments, for 2018.
Here’s a roundup of what’s set to change on the retirement investing and Social Security fronts next year, as well as implications for investors’ plans.
401 (k), 403 (b), 457 Plans
401 (k) contributions have taken a rare starring role in the discussion over tax reform, with politicians debating the pros and cons of limiting pretax contributions in an effort to bring new revenues in the door. In the meantime, 401 (k) participants will be able to boost the contributions in 2018, up to $18,500 from $18,000 in 2017. As in 2017, investors older than 50 will be able to contribute an additional $6,000 in 2018, for a total of $24,500.
Total contributions to 401 (k)s and other defined-contribution plans are also getting a boost next year, up to $55,000 for 2018 ($61,000 including catch-up contributions for those older than 50), from $54,000 in 2017. That’s a boon to high-income workers who participate in workplace retirement plans and have the wherewithal to make after-tax 401 (k) contributions. (The limit includes employee pretax or Roth contributions; employer matching contributions, including forfeitures; and aftertax contributions.) This article takes a closer look at aftertax 401 (k) contributions.
If you’re in a position to make the maximum allowable contribution to a 401 (k) or other employer-sponsored plan next year, make sure you’re taking full advantage of any matching contributions on offer from your employer. SOme employers match contributions on a pre-pay-period basis, meaning that high-income earners who hit their own contribution limits early in the year can miss out on matches later on. (Some plans include a “true-up” provision to ensure that heavy savers receive the full employer match regardless of contribution timing, but some do not.) This article takes a closer look at employer matching.
As you set your contribution level for 2018, take a closer look at your decision to make Roth or traditional contributions. Sixty percent of employers now allow Roth contributions, but most employees who have the choice between Roth or traditional favor traditional. Roth contributions aren’t right for everyone, but they can make sense for early career workers who expect their incomes to ramp up over time, as well as mid- and late-career workers seeking tax diversification in their portfolios. Because Roth contributions are aftertax, the accounts have a higher effective contribution rate than traditional 401 (k)s.
IRA contribution limits are staying the same in 2018: $5,500 for investors younger than 50 and $6,500 for those 50 and older. However, the income thresholds used to determine eligibility for IRA contributions are going up a bit in 2018.
To make a fully deductible traditional IRA contribution, a single taxpayer who can also contribute to a workplace retirement plan would need to have a modified adjusted gross income of less than $63,000. (Singles with incomes between $63,000 and $73,000 can take a partial deduction on their contributions.) For married couples filing jointly and the spouse making the contribution is covered by a workplace retirement plan, they can make a fully deductible IRA contribution only if their income is less than $101,000. (The deduction for contributions are phased out–or are reduced–for married filers with income between $101,000 and $121,000.) For an IRA contributor who’s not covered by a workplace retirement plan but is married to someone who is covered by such plan, contributions are fully deductible only if modified adjusted gross income is less than $189,000; the deductibility of contributions phases out at incomes between $189,000 and $199,000.
While Roth accounts receive the lion’s share of attention, traditional deductible IRA contributions can make sense in certain situations. One of the most attractive candidates for traditional IRA contributions is the older worker who can deduct his or her contribution and hasn’t yet amassed significant retirement savings. Such individuals are apt to owe tax at a lower rate in retirement than they do while they’re working.
Anyone can make a traditional IRA contribution, but if they exceed the income threshold outlined above, the contribution won’t be tax-deductible.
As with traditional IRAs, contribution limits to Roth IRAs are staying the same in 2018 as they were in 2017: $5,500 for investors younger than 50 and $6,500 for investors who are ago 50-plus. The income threshold for Roth IRA eligibility are nudging up, however. Single filers with modified adjusted gross incomes of less than $120,000 can make a full Roth contribution in 2018; contributions for single filers are reduced at incomes between $120,000 and $135,000. For married couples filing jointly, a full Roth contribution is available at modified adjusted incomes less than $189,000; contributions phase out between $189,000 and $199,000, and are not allowed at incomes higher than that.
Roth IRA contributions are sensible for investors who expect to pay tax at a higher rate in the future–for example, early career go-getters who believe their incomes–and in turn their tax rates–will rise in the future. Roth IRA contributions can also be an attractive way to pursue “tax diversification,” offering tax-free withdrawals and relief from RMDs for retirement savers whose accounts are dominated by traditional tax-deferred assets.
For would-be Roth IRA contributors who earn too much make a direct Roth contribution (and therefore cannot make a deductible traditional IRA contribution, either), it’s worth noting that the backdoor Roth IRA is alive and well as we head into 2018. That means that such investors can contribute to traditional nondeductible IRA, then convert those assets to Roth. (Income limits don’t apply to nondeductible IRA contributions or conversions.) This maneuver isn’t advisable for investors with substantial traditional IRA assets already, however, as discussed here.
Health Savings Accounts
HSA contributions are getting a slight boost in 2018, up to $3,450 for singles covered by a high-deductible healthcare plan (from $3,400 in 2017) and $6,900 for those with family coverage (from $6,750 in 2017). Savers older than 55 can contribute an additional $1,000 to an HSA, whether they have self-only or family coverage.
In addition, the minimum deductible for a plan to be considered a high-deductible healthcare plan is increasing to $1,350 for self-only coverage and it’s $2,700 for family coverage. The maximum allowable out-of-pocket costs associated with these plans is also increasing next year, to $6,650 for self-only coverage and $13,300 for family coverage.
For many individuals getting by on a shoestring, the rapid adoption of high-deductible healthcare plans–and related out-of-pocket expenses–is an unwelcome development. But for wealthier consumers with the wherewithal to fund out-of-pocket healthcare costs from taxable accounts, HSAs are a terrific addition to their retirement-savings tool kits, as discussed here. The accounts offer the best tax treatment of any account type: pretax contributions, tax-free growth, and tax-free withdrawals for qualified healthcare expenses. This article discusses using an HSA as an ancillary savings vehicle, and this one discusses tips for getting the most out of your HSA.
The headline is that Social Security recipients will pcik up a 2% cost-of-living increase in 2018. Yet as Morningstar contributor Mark Miller discusses here, many Social Security recipients won’t actually see an increase in their checks. If they’re having their Medicare Part B premiums deducted directly from their Social Security benefits and are subject to Social Security’s “hold harmless” provision, the increase in Medicare premiums will partially offset their increase in Social Security benefits. On the flip side, Social Security recipents who are not subject to the hold harmless provision–a group that has been hurt in recent years by increasing Medicare premiums–will benefit from declining premiums in 2018, according to Miller.
In addition, the amount of income that Social Security recipients who are not yet of full retirement age can earn without triggering a reduction in their benefits is increasing next year. For 2018, early filers who have earned income from work will see a $1 benefit reduction for every $2 in earned income above $17,040 threshold. (There’s no reduction in benefits for workers who are of full retirement age, and even those who are subject to benefits reduction due to exceeding the earned-income threshold will get their money back in the form of a higher payout once they reach full-retirement age.)
High-income accumulators, meanwhile, will see the amount of income that;s subject to the Social Security tax increase in 2018. Next year, income of up to $128,700 will be subject to the 6.2% Social Security tax, up from $127,200 this year.
Even though Social Security recipients are receiving their highest COLA since 2012, for many retirees, much of that increase will be offset by Medicare premium increases. That underscores the importance for retirees to stay vigilant on the inflation front. This article takes a closer look at adding inflation protection to your portfolio.
Sawston Wealth Management, LLC, is a Registered Investment Adviser with the State of Washington. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.
The above material was prepared by Morningstar. Morningstar is not affiliated with the named advisor.