5 ways to hone retirement plans under new tax regime

The Tax Cuts and Jobs Act passed by Congress late last year represents the most significant changes to the tax code since 1986. The changes are biggest for corporate taxpayers. C corps will see their statutory tax rate decline from 35 percent to 21 percent, and pass-through corporate entities — partnerships, sole proprietorships and S corps — where income is taxed at the individual level, will also see permanent and dramatic reductions in their tax liabilities.

The decreases in individual tax rates, on the other hand, are smaller and less certain, with rates set to revert back to current levels by 2026. As a matter of fact, the tax plan will help out corporations a lot more than average Americans. Middle-class Americans itemizing their deductions may actually get hurt by tax reform.

The rule changes regarding deductible expenses, exemptions, credits and the tax brackets pose new income-tax planning challenges for all Americans. They also have implications for retirement planning — most prominently for wealthy Americans — but for taxpayers of more modest means, as well.

Here are five strategies worth considering to improve your retirement planning in the new tax environment.

1. Move to a low-tax state. The lure of the Sunbelt for retirees got a little stronger with tax reform. The capping of the so-called SALT (state and local taxes) deductions at $10,000 will hit taxpayers in high-tax (and invariably blue) states such as California and New York particularly hard. New York Gov. Andrew Cuomo has threatened to sue the federal government over the roughly $14 billion his Department of Finance says it will cost New Yorkers annually.

While the standard deduction on federal tax returns was nearly doubled to $12,000 for individuals, the average SALT deduction on federal returns for New Yorkers in 2015 was $22,000, according to the Tax Policy Center. In California — which also has high income-tax rates — an all-in property tax rate of 1.25 percent on a $1 million home would already put taxpayers over the $10,000 cap.

2. Convert your traditional IRA to a Roth IRA. Roth IRAs provide the ultimate benefit in retirement — tax-free income. You can't deduct your contributions to a Roth IRA, but the investment returns in the account are tax-free and so are account withdrawals (optional-not required) as long as you make them after age 59½.

People need to diversify their tax risk. A tax-free retirement account is important over the long haul because higher rates in the future may hurt you in retirement.

The lower marginal income-tax rates that take effect this year make the conversion of a traditional IRA to a Roth IRA significantly less expensive. With those rates potentially reverting back to current levels by 2026, paying the taxes now could be far less expensive than in retirement. 

One major consideration: The tax bill did away with the option to undo a conversion by the tax-return date of the following year. If the market has a big downturn, you will owe tax on the full amount at conversion even if the account value drops by 30 percent before year-end. We suggests waiting until after Thanksgiving to make a conversion. Taxpayers could also consider converting smaller amounts over several years to reduce taxable income and potentially their marginal rates.

3. Give to charity in a smart way. The deduction for charitable donations was preserved in the tax bill, but with the standard deduction raised to $24,000 for a married couple, you'll have to give a lot to warrant itemizing deductions.

One strategy is to front-load your anticipated donations over multiple years into one tax year. People can bundle up their anticipated donations for the next five years in a donor-advised fund. Of course, that means it's likely only a one-year tax-saving strategy.

If you're over 70½ years old, make your charitable donations directly from your IRA — whether you itemize deductions or not. The donation counts against your required minimum distribution from the retirement account but is excluded from taxable income. The qualified charitable distribution enables a taxpayer to claim the standard deduction and still get the charitable deduction. If you qualify, it's the only way you should give to charity.

4. Mind your business and estate. The tax bill doubled the estate-tax exemption to $11.2 million per person ($22.4 million per married couple) and kept it indexed for inflation. In 2026 it will revert back to 2017 levels indexed for inflation. For the vast majority of Americans, the increase is meaningless, but for high-net-worth taxpayers — particularly business owners — it raises new issues.

Individuals with a net worth of close to or more than $11 million ($22 million for couples) can still lower the tax hit to their heirs with the use of trusts and estate-planning strategies. With the estate and gift tax still unified, it may also make sense to gift large amounts of assets tax-free to heirs now given the bigger but potentially temporary exemption.

The downside of gifting assets before you die is that heirs do not get a step up to market value in the cost basis of the assets. If and when they sell them, they will be on the hook for capital gains taxes. In a perfect world, people would pay no estate taxes and get a step up in cost basis at death. That sweet spot, however, may require your dying before the exemption reverts back to a lower level.

We suggests that married couples with an estate valued at less than $20 million take a "wait and see" attitude regarding the value of their business or assets before a potential in life transfer.

5. Talk to a financial advisor or CPA. The numerous changes to the tax code provide a lot of income-tax planning opportunities, which can translate into more retirement savings. But it is complicated. Any decision regarding something like a Roth conversion should be made in conjunction with other issues.

At Zhong & Sanchez, we are dedicated to provide high-quality tax and financial reporting services to privately-held entities and small business owners. Our expertise ranges from income tax filing and accounting services to international compliance and financial analysis. Located in the Silicon Valley, you can reach us at 510-458-4451 or schedule your first free consultation today at

Picture credit: USA Today; Source: CNBC

The New Employer 401(k) Match: How Generous Is Your Boss?


Between the corporate tax cut and the tight labor market, more companies are moving to increase pay and benefits, including their contributions to retirement plans.  In a January survey, one out of four employers told Willis Towers Watson that they have increased their 401(k) match this year or plan to do so next year.

But there’s a catch: If you don’t pay attention and pick the right percentage of salary to save, you could miss out on getting the full increase in the match.

Under the most common match formula, an employer contributes $1 for every $1 the employee saves up to some percent of salary---say 6%. Under the next most common arrangement, the employer contributes 50 cents for every $1 the worker puts away, up to some percent.

In a typical match increase, the employer raises the percentage of salary they’ll match—say from 5% to 7%. But to get that increase you’d have to save at least 7% of your salary. It’s called “stretching” the match in retirement-speak. “As an employee, you’ve got to put more skin in the game,” says Rick Unser, a retirement plan consultant in Hermosa Beach, California, who says he sees employers starting to make employees stretch to contributing 8% or 10% in order to get the full match.

Robert Lawton, a retirement plan consultant in Milwaukee, Wisconsin, has seen some radical employers moving to a 25% match on 12%, meaning workers would need to contribute 12% of pay to get the maximum employer matching contribution of 3% of pay. “You get the employees to contribute more even though the employer is contributing the same amount,” Lawton says. Usually, the employer is contributing more, and the employee is contributing more as well.

The rule of thumb is you should save 15% of your salary (including any employer match) each year for 40 years. The problem is that many workers haven’t saved anywhere near that much in the beginning of their careers, some have been in and out of the workforce, and others have been in the gig economy, where they don’t have access to a workplace retirement plan, Lawton points out, noting that a lot of workers need to be saving more than 15% of pay.

That said, here are two ways employers are trying to get their employees to at least 15% of pay saved (employee and employer contributions combined). Honeywell recently announced that in April, for workers currently getting a 75% match on the first 8% of pay, the match will increase to 87.5% (for a maximum employer match of 7%, up from 6%). For workers currently getting a 37.5% match on the first 8% of pay, the match will increase to 43.75% (for a new maximum employer match of 3.5%, up from 3%).

At Visa, employees will have to start saving 5% of salary to get the new, increased employer match, which can bring them to the 15% goal. Today Visa matches 200% of employee contributions up to 3% of salary, for a maximum employer match of 6% of pay. The new Visa match, effective in late February, will be 200% of employee contributions up to 5% of salary, for a maximum employer match of 10% of pay. In a paternalistic move, Visa will be changing its default employee pre-tax contribution from 3% to 5%—for workers who contribute less than 5%.

What if you work for a company—or are considering a job switch to one—that has a match that’s less than $1 for $1 on 6% of pay? Check if there's a profit sharing plan or a pension plan, says Rob Austin, director of research at Alight Solutions. “If not, maybe you’re behind the competition,” he says.

When in doubt, consult a trustworthy CPA! Zhong and Sanchez is dedicated to provide high-quality tax and financial reporting services to privately-held entities and small business owners. Our expertise ranges from income tax filing and accounting services to international compliance and financial analysis. Located in the Silicon Valley, you can reach us at 510-458-4451 or schedule your first free consultation today at

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When an HSA-First Strategy Makes Sense

Many--perhaps most--articles about health savings accounts suggest that employees with an HSA who participate in a 401(k) plan should first contribute to the 401(k) plan the percentage of their compensation that enables them to obtain the maximum plan sponsor match, such as 3% on the employee's first 6% of compensation. Employees should then max out their HSA account contributions through payroll deductions. Once that's done, they should go back to contributing any additional dollars to their 401(k) plans.

While this strategy is indeed attractive, an even better one would be to change the sequence of the contributions. That is, employees should first max out contributions to their HSAs no matter their tax bracket, and once that's done, contribute to their 401(k) plans.

Break out that trusty old HP 12C and calculate any contribution, time horizon, and interest-rate combination. Then reduce that number by, say, 25% for tax to come up with the 401(k) balance. (An HSA demonstrates even greater superiority over an employer match in a 401(k) plan when withdrawals are made at a tax bracket higher than 28%, thereby illustrating the power of tax-free withdrawals in retirement. That is, the higher an employee's tax bracket, the larger the employer's 401(k) match must be to in order beat contributing to an HSA first.) 

A 401(k) plan will beat an HSA if left to retirement. However, reality intrudes when withdrawals are made from the 401(k) to pay for things like medical expenses and a participant in a 401(k) is slammed with taxes and penalties. This is why it makes the most sense to first max out HSA contributions and thereafter get the maximum company match from the 401(k).

Do the same for an HSA but then factor in a 7.65% (FICA) discount up-front and no tax deduction at the back end. In most calculations, the HSA-first strategy is ahead by one third. Then, add in a typical employer match of 3% on the first 6% in employee compensation and take the balance out at a 35% tax bracket. The result: HSA tax savings even beat the employer's match. And don't forget, 80% of employers that offer an HSA contribute $500-1,500 to an employee's HSA.

Once these two no-brainers are accomplished--max out HSA contributions first and then obtain a full company match for the 401(k) plan--only at that point should employees begin their retirement needs planning for the year and so on into the future.

For those who are uncomfortable with this strategy for whatever reason, perhaps they would prefer contributing simultaneously to both the HSA and the 401(k) account on a regular periodic basis throughout the year.

Apart from the issue of the sequence of contributions to an HSA and a 401(k) plan is the issue of the difference in the amount of contributions. For example, Employee A saves and invests $5,000 (a nice round number used even though it slightly exceeds what an individual 55 or older can currently contribute annually to an HSA) annually for 30 years in an HSA. Employee B also saves and invests $5,000 annually for 30 years in a 401(k) account. Employee A in the HSA will amass $611,729 while Employee B in the 401(k) plan will amass $423,699.

The differential in favor of the HSA of nearly $200,000 is due to avoiding payment of the (up-front) 7.65% FICA tax (or more in certain other states and localities) for 30 years of contributions. (Assumptions for the foregoing terminal amounts include a 25% income tax bracket, an 8% return, an HSA that's in the payroll deduction scenario to avoid paying 7.65% in FICA taxes and HSA assets are used for qualified medical expenses. Also, a 25% income tax bracket was applied for withdrawal of 401(k) money.)

Tax-Deferred Accumulation of Earnings and Interest on Contributions
Any earnings and interest generated on contributions to an HSA accumulate tax-deferred over time. When these accumulations are used to pay for qualified medical expenses or to reimburse an HSA holder for previous qualified medical expenses, they become tax-free distributions.

Tax-Free Distributions to Pay for Qualified Medical Expenses
In essence, HSA assets can be used to pay for anything tax-free. Suppose that HSA holders are able to max out contributions to their HSAs and pay for qualified medical expenses out-of-pocket through some or all of their careers. If the holders have kept their medical expense receipts over time, they can get reimbursed later for those expenses from their HSAs.

There's not even a need to have a current qualified medical expense; the HSA holder merely needs to have a receipt from any time in the past to get reimbursed. Qualified medical expenses, then, can arise from any year--not just the current one. This proactive strategy allows an HSA holder to augment retirement income tax-free rather than first pulling money from, say, its taxable 401(k) plan account. This could be helpful in cases where withdrawals from a 401(k) account could bump the holder into a higher tax bracket which could also result in higher Medicare premiums

Other instances of the versatility and flexibility of the HSA abound. For example, the fact that an HSA holder can contribute to an HSA until April 15 for the previous tax year (like an IRA) allows for a post-calendar year tax avoidance strategy. Suppose that a 56-year old self-employed worker had $4,000 in medical expenses and paid for them with (after-tax) out-of-pocket money because the worker didn't know that he or she was eligible for an HSA. A savvy investment advisor informed the worker about eligibility.

So before tax-time in April, the worker establishes an HSA and contributes $4,000, thereby avoiding payment of federal and state income taxes. (But not FICA taxes because the self-employed cannot establish an IRS section 125 cafeteria plan. However, LLC or LLP members might be able to establish a 125 plan if they have elected to be taxed as a Subchapter C Corporation; competent professional counsel should be consulted in such cases.) The worker then took out $4,000 from his or her HSA to reimburse himself/herself.

The result: a wash that saves a lot in taxes. This post-calendar year tax avoidance strategy demonstrates again that having a receipt for qualified medical expenses that were paid even far in the past allows an HSA holder to get reimbursed--assuming, of course, that the holder has been able to pay for its medical expenses out-of-pocket along the way.

Additional Advantages of HSAs
The Tax Cuts and Jobs Act passed by Congress last year failed to further expand the advantages of HSAs. However, it's thought that there will be a Medicaid/Medicare HSA provision as well as one to increase HSA contribution limits included in the 2018 Budget Reconciliation Act. In the meantime, here are some additional advantages of an HSA.

Full Vesting. Any contributions made to an employee's HSA by either the employee or its employer are immediately vested in the employee.

Portability. An HSA can be opened by a worker anywhere. For example, if employees don't like their employer-sponsored HSAs, say, because it's pricey and/or the investments are suboptimal (which is often the case), they can pull the assets from it and invest them elsewhere in an optimal HSA (within 60 days but without the rigmarole of a rollover). The downside to this non-payroll deduction scenario, of course, is that employees cannot take the 7.65% (or more) deduction for FICA taxes. Even if employees are currently ineligible to make contributions to their HSAs, the HSA always stays with them not their employers.

Flexibility. HSA holders can withdraw HSA assets or change them at any time while letting the HSA accounts accumulate, regardless of their current employer or current eligibility. In addition, there are no required minimum distribution rules or requirements to begin taking withdrawals at a certain age.

Sources of Contributions. Those other than HSA holders can contribute to a holder's HSA including a family member and, as noted, their employers.

Coverage for Family. HSA holders can use assets from their own HSAs to pay for qualified medical expenses incurred by spouses and their tax dependents even if they aren't eligible to establish their own HSAs or even if they have health insurance different than the holder.

At Death. At an employee's death, the HSA can be rolled over to a spouse tax-free, plus that spouse can continue to save and invest in the HSA. But if the HSA is rolled over to a nonspouse, the HSA balance is fully taxable like the balance in a 401(k) plan.

Medicare/Retirement. The Medicare Part B monthly premium (for visits to the doctor) is deducted from a recipient's monthly Social Security check. In such cases, however, an HSA holder can get reimbursed from HSA assets for these premiums as well as Part D monthly premiums (for drug prescriptions).


Use This Hack to Get the Most Out of Social Security

Getting the most out of Social Security is all about waiting as long as possible to start filing for benefits, right?

Not quite--especially if, as a business owner, you get to decide how you are paid.
You can actually live on a lot more money in retirement if you make some changes right now to your salary and take some steps to adjust your current tax bills, says Matthew Allen, a co-founder of New York City-based Social Security Advisors.

"Self-employed people generally have more flexibility in how to structure their income," he says. "That gives you a lot of good opportunities because of the way Social Security benefits are calculated."

The main tactic that Allen lays out below isn't over­whelmingly complex: Start replacing some of your salary with dividends, as long as you have a legitimate business reason to do so. (There's no required schedule for dividends, but you may wish to take them quarterly, for regular cash flow.) Meanwhile, boost your contributions to retirement savings accounts.
It's a simple enough change--but it's not a very obvious strategy until you understand how the Social Security and income tax systems work, and how the two interact.

What your current salary means

To survive in retirement, you'll obviously have to replace some of your current wages with other sources of income, including savings or pensions or government benefits. Social Security, of course, is the nation's cornerstone retirement safety net; it provided some 50.3 million retirees and survivors, or about 15 percent of Americans, with benefits in 2016. If you're planning on relying on Social Security, you probably already know that the amount you'll get at retirement varies depending on how much you've earned and paid into the system. What is less well advertised is that Social Security's benefit formula favors lower-income retirees, the assumption being that those who haven't earned high wages don't have much in savings.

Since low-wage workers are less likely to have other sources of retirement income, Social Security's graduated benefit formula gives them the highest "wage replacement" rates. Specifically, those who earned average monthly wages of $885, or $10,620 per year, get 90 percent of those wages replaced by Social Security benefits. But the replacement rate drops as you earn more, falling to just 15 percent for those earning more than $64,000 per year.

In other words, if you earn an average of $10,620 in each of the 35 years that Social Security will use to calculate your benefits, you'll be due a monthly Social Security payment of $796.50 at normal retirement age.

But if you earn 10 times that much--and pay 10 times as much in employment taxes--your monthly benefit would increase only by 3.5 times, to $2,747.92.

Can you pay yourself dividends instead?

Here's where your current tax bill comes in. You're paying Social Security taxes only on your salary, or earned income; dividend and investment income is exempt. So, as Allen suggests, you can minimize your employment tax by paying yourself partly through dividends, rather than through regular wages.

However, because this strategy will reduce your future Social Security income, it is wise to boost contributions to your retirement plans at the same time.

Let's say your business earns you $100,000 annually, of which you contribute $10,000 to your retirement plan. If you take the rest of your earnings in wages, you'll pay roughly 33 percent in employment and income taxes. But if you take $15,000 as dividends and increase your retirement contributions by $5,000 annually--thus cutting your wages by $20,000 a year--your overall tax rate drops to roughly 27 percent, for wages and dividends combined. In both cases, your after-tax take home is around $60,000--but if you adopt the latter strategy, you'll save about $5,000 in taxes each year.

Then, when retirement rolls around, you'll get slightly less in monthly Social Security benefits--about $316 per month in this example. But you'll also have dramatically more saved for retirement: about $750,000 more, assuming a 7 percent average return over 35 years. That's enough to pay you $3,322 per month for 35 years--about $3,000 more than you "lost" in Social Security benefits.

Make your dividends count

There's one big caveat. You need legitimate reasons to pay yourself dividends, rather than simply wages, for this to pass muster with the Internal Revenue Service, says Philip J. Holthouse, partner with the Los Angeles accounting firm Holthouse Carlin & Van Trigt. Otherwise, the IRS is likely to challenge your strategy and "recharacterize" your income as wages, levying the appropriate taxes and penalties in the process. And a tax court may agree.

So what are legitimate reasons to pay yourself dividends rather than wages? When a portion of your company's profits are derived from something other than your work as a "key employee."

If you employ anyone other than yourself (and any co-owners), or if you invest in machinery or equipment that is responsible for generating a portion of your company's revenue, it's considered reasonable to take wages for your work and dividends for the profit that was derived from your other employees or company assets.

There's no set formula for determining what portion of your income should be claimed as wages versus dividends. But realize that you may have to justify whatever formula you choose, so you should have a reasonable approach. You could research competitive wages in your industry and take any excess profit over that amount as a dividend, for instance. Or if you're able to directly attribute revenue to employees--or assets--that could work too.

However, the more of the company's earnings you take as dividends versus wages, the more likely you are to be questioned by the IRS, warns Holthouse. And if you run your business full time, you always have to pay yourself at least some wages.

"The idea that you could earn no wages from a business where you work full time has been pretty universally rejected by the IRS and the courts," says Holthouse. "Otherwise, if you have an argument with economic substance, you could very well win. It gets very fact-specific."

Given that this sort of dividend-income strategy could pique IRS scrutiny if misused, you may want to consult a tax professional before adopting it.

"Social Security is essentially one big math problem layered with 2,000 different rules," says Allen. However, he adds, many couples could end up collecting around $1 million in benefits over their lifetimes: "I can't think of anything else where it's as important to get it right the first time around."