By Matt Lewis, President, Western Growers Financial Services

2017 will likely bring sweeping tax changes that could have a significant impact on your financial future.  President-elect Trump’s pledge to “reduce taxes across-the-board, especially for working and middle-income Americans” includes a proposal to simplify the tax code by reducing the number of federal income tax brackets from seven (39.6%, 35%, 33%, 28%, 25%, 15%, 10%) to just three (33%, 25%, 12%). Trump’s proposal would also more than double the standard federal tax deduction from $6,300 to $15,000 for singles, and $12,600 to $30,000 for married couples filing jointly.

Assuming that Trump’s plan is put into effect with the help of a Republican-controlled House and Senate, we could see the “largest tax change since Reagan” according to Steven Mnuchin, Trump’s pick for treasury secretary.  While this plan may lower your overall tax burden in the coming years, it could also have a major impact on the relevance of your current retirement savings and investment strategy.  Let’s explore how Trump’s tax proposals could affect two common investment vehicles—your 401(k) and IRA—and why understanding the difference between the traditional and Roth version of each is critical to getting the most value out of these upcoming tax policy changes.

Although a 401(k) and IRA are both designed to help you save for retirement and may seem very similar at first glance, one primary difference between them is that a 401(k) is an employer-sponsored investment savings account, while an individual retirement account (IRA) can be opened privately through a custodian such as Western Growers Financial Services.  Both traditional 401(k) and traditional IRA contributions are tax-deductible depending on your income and tax-filing status, leaving future distributions subject to taxes. Unlike these traditional versions, neither Roth 401(k) nor Roth IRA contributions are tax-deductible.  Instead, future qualifying distributions are sheltered from taxes.

While there are many important factors to consider before deciding between the traditional or Roth version of a 401(k) and IRA, the key tax implication addressed here is timing.  You can choose to either pay taxes on contributions in the present (Roth), or pay taxes on your distributions in the future (traditional).  Which option makes the most sense depends on when your tax burden will be lowest.

For example, if you and your spouse are currently earning a total of $50,000 a year and filing jointly, the Trump plan would increase your standard deduction from $12,600 to $30,000, while lowering your federal tax bracket from 15 percent to 12 percent.  In past years, when your annual federal income taxes were relatively high compared to your anticipated future retirement tax burden, it may have made sense to go with a traditional 401(k) and IRA in order to maximize your deductions up front.  Now, with the possibility of historically low taxes in the near future, opting to take advantage of a Roth 401(k) and Roth IRA for tax-free earnings during retirement (when tax rates could return to higher levels) may be the best option.  A Roth 401(k) and Roth IRA may also be the better choice for younger, lower-income workers at the beginning of their career who anticipate moving into a higher tax bracket at retirement.

Times of political change present financial opportunities as well as potential pitfalls.  As we transition into the new year and a new presidential administration, it’s more important than ever to fully understand your investment options and adjust your retirement strategy based on changing circumstances.  A retirement plan is not something that can be created once and then put away in a drawer, never to be looked at again.  Financial planning is an ongoing process, one that requires a long-term commitment to keeping up with economic conditions and re-evaluating which options will best help you reach your retirement goals.

Western Growers Financial Services offers a wide array of financial planning assistance, investment tools, and funding options.  We are here to help you and your employees gain a better understanding of how these changing conditions affect your investments, make the best decisions possible for your retirement and estate planning, and draft a roadmap to retirement designed specifically for your unique goals.