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The Impact of ATRA on Retirement & Estate Planning

The American Taxpayer Relief Act of 2012 (ATRA) brought major changes to federal tax law, and it profoundly impacted retirement and estate planning. Here is an overview of seven big changes particularly relevant to retirees and/or those approaching retirement age.

Federal income tax brackets were altered. Where we once had six tax brackets, we now have seven for the foreseeable future. In addition to the 10%, 15%, 25%, 28%, 33% and 35% brackets, we now have a 39.6% top bracket for individuals with incomes greater than $400,000 and married joint filers with incomes exceeding $450,000.

Additionally, a health care surtax kicked in for high earners. In 2013, a 3.8% Medicare surtax will be levied on the lesser of either a) net investment income or b) the amount of MAGI exceeding $200,000 for single filers, $250,000 for couples filing jointly, and $125,000 for spouses filing separately. MAGI is not simply your wages; it can also include bonuses, taxable interest, RMDs taken from a traditional IRA or an employer-sponsored retirement plan, “unearned” net investment income such as dividends or net capital gains, passive income from a partnership, and even rents and royalties.

The Medicare payroll tax also rises 0.9% for employees after their MAGIs exceed the $200,000 individual threshold this year. Your employer will deduct 1.45% in Medicare payroll taxes from your paycheck up until that threshold, and 0.9% more from your paycheck once your wages surpass it. While individuals may have MAGIs of $200,000 or less, a married couple filing jointly may have a MAGI that surpasses the applicable $250,000 threshold, with the 0.9% surtax therefore applying.

Federal estate tax laws were modified. Estate taxes have risen; we now have a 40% top estate tax rate and a $5.25 million individual exemption (which is indexed for inflation, of course).

The big news here: the individual estate tax exemption remains portable. In other words, any unused portion of a $5.25 million individual exemption may be transferred to the surviving spouse at the death of the first deceased spouse.

Taxes on investment income are higher for the wealthy. Capital gains and dividend taxes are still set at 0% for those in the 10% and 15% federal income tax brackets, 15% for filers in the 25%, 28%, 33% and 35% brackets, and 20% for those in the new 39.6% bracket. Previously, those in the highest tax bracket faced 15% capital gains and dividend taxes.

IRA charitable rollovers have returned. Gone in 2012, they are back for 2013 (and could stick around for subsequent tax years). If you are an IRA owner who will be 70½ or older in 2013, you may arrange an IRA charitable rollover (technically called a Qualified Charitable Donation) of up to $100,000 this year. You do this by asking your IRA custodian to send the amount of the donation directly to the charity or qualified non-profit organization. You can thereby subtract the gifted amount from your adjusted gross income, and the donation can also count toward your RMD. (Don’t just take a distribution from your IRA and give the money to charity yourself – then the money will be taxed as regular income.)

Roth conversion rules were expanded for workplace retirement plans. It is now easier to make an in-plan Roth rollover inside your 401(k), 403(b), or 457(b) plan – although so far, this option has been met with a shrug by most retirement plan participants who are eligible. (The retirement plan has to allow a Roth option in the first place.) The conversion is permissible at any age and may include all pre-tax salary deferrals. Any account balance so converted must be included in the income of the taxpayer in the year of the Roth conversion.

The AMT was finally indexed for inflation. The irritating Alternative Minimum Tax has been permanently patched, and the patch is retroactive to the beginning of 2012, thereby saving about 34 million taxpayers from an AMT threat on their 2012 1040s. For 2013, AMT exemption levels are $51,900 for single filers, $40,400 for those married and filing separately, and $80,800 for joint filers and qualifying widowers.