The skinny on dividend and capital gains taxes, IRA and 401(k) contribution limits, and more.
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By Christine Benz | 01-05-17 | 05:00 AM | Email Article

As 2017 dawns, there's not a lot to get excited about when it comes to taxes and your investments. Contribution limits to IRAs and 401(k)s are the same as they were in 2016, for example, and the long-term capital gains rates for taxable investments is also staying the same.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

But watch this space. President-elect Donald Trump laid out a number of tax-related goals during the campaign, including repealing the Medicare surtax, alternative minimum tax, and estate and gift taxes, while reducing the maximum ordinary income tax rate to 33%. The last proposal, part of a larger plan to simplify income-tax brackets from the current seven to just three, created a flurry of excitement following the election. Not only would it represent a significant tax reduction for high-income earners, but a substantially lower top tax rate would reduce the benefits of strategies such as charitable giving.

However, those tax-cutting plans, in aggregate, would be costly, so it's by no means a given that they'll sail through Congress. By extension, it's a mistake to radically overhaul your financial and investment programs in anticipation of tax changes that may or may not come to fruition. Watchful waiting is a more prudent tack.

Here's an overview of what is changing, vis-a-vis taxes and investments, in 2017, as well as what's staying the same.

Dividend and Capital Gains Taxes
Dividend and capital gains rates are the same for 2017 as they were last year, though the income tax brackets used to determine those rates have been adjusted for inflation. Investors who are in the 39.6% income tax bracket will pay a 20% tax rate on qualified dividends and long-term capital gains; investors in the 25% to 35% brackets will pay a 15% tax rate on qualified dividends and long-term gains; and investors in the 10% and 15% tax brackets for income tax will owe 0% tax on dividends and long-term capital gains. Nonqualified dividends, such as from REITs, and ordinary income from taxable bonds will be taxed at investors' ordinary income tax rates.

As in 2016, investors who are in the 10% and 15% income tax brackets and who also hold taxable assets (that is, nonretirement accounts) have a strong incentive to realize gains pre-emptively, as discussed here; after all, they pay taxes on long-term capital gains at a 0% rate, and it doesn’t get any lower than that! Tax-gain harvesting--and rebuying identical or like-minded securities--resets their cost basis; if they eventually sell and are subject to a higher capital gains tax rate, the gains they owe will be that much less.

Taxpayers who are teetering on the edge of the 15% income tax bracket and who have at least some latitude to control their taxable income may want to take a few steps to land inside of it. For example, retired investors may take a greater percentage of their withdrawals from Roth accounts, as qualified Roth distributions don't count as taxable income. (Doing so, however, will reduce the long-term tax benefits of the Roth account; Roth assets are often considered the best "save for later" accounts because they are tax-free upon withdrawal and can be the most valuable for your heirs to inherit.) Investors hovering around the 15% tax bracket might also "bunch" deductions together in years in which they plan to itemize, thereby receiving the biggest possible bang from those deductions.

IRA Contribution and Income Limits
IRA contribution limits are the same for 2017 as they were in 2016: $5,500 for investors younger than 50 and $6,500 for those 50 or older. That limit is the same for both traditional and Roth IRA contributions. (Because the Roth investor contributes after-tax bucks, the effective contribution rate is higher.) You have until April 18, 2017, to make an IRA contribution and have it count for the 2016 tax year.

Even though the IRA contribution limits are remaining the same for 2017, the income limits to make various types of IRA contributions have increased.

Singles earnings less than $118,000 can make a full Roth IRA contribution, but Roth IRA contributions are out of reach for single filers who earn more than $133,000. (Contributions are reduced if the single taxpayer's income falls between these bands.) Married couples filing jointly can make a full Roth IRA contribution if their income is less than $186,000; they are ineligible to make a Roth contribution if their income exceeds $196,000. (Contributions are reduced for married couples filing jointly who earn between $186,000 and $196,000.)

The income limits to be able to deduct a traditional IRA contribution are also increasing a bit for 2017. Individual filers who can make a retirement-plan contribution at work can make a fully deductible IRA contribution if their 2017 income is under $62,000; they cannot deduct their IRA contribution if their income is more than $72,000. (The amount of the contribution that is deductible is reduced--or phased out--for single taxpayers whose income lands between $62,000 and $72,000.) For married couples filing jointly in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, traditional IRA contributions are fully deductible if their income falls below $99,000; contributions aren't deductible if their income exceeds $119,000. (Contributions are partially deductible if income falls between those thresholds.)

Investors at any income level can contribute to a traditional IRA, though they cannot deduct their contribution if their income exceeds the deductible amounts outlined above. Instead, higher-income investors can take advantage of what's called a back-door Roth IRA, converting their traditional IRA to Roth shortly after funding it. Note that this strategy won't generally make sense for investors with large traditional IRA balances, for reasons outlined here, though there is also a possible workaround in this situation. 

401(k) Contribution and Income Limits
Contribution limits for 401(k), 403(b), and 457 plans are staying the same for 2017: $18,000 for those younger than 50 and $24,000 for those 50 and older. The contribution limit is the same for both traditional and Roth 401(k) contributions. No income limits apply. If you're maxing out and would like to space your contributions throughout the year, bump up your contribution rate as soon as possible. Very high-income investors might also take a look at aftertax 401(k) contributions, provided their plans allow them, but only after maxing out their conventional 401(k) contributions (traditional or Roth). This article takes a closer look at aftertax 401(k)s and how they can be an effective conduit to additional Roth IRA assets.

Saver's Credit
This credit is designed to incentivize individuals and families with earnings under certain thresholds to put money into IRAs (or myRAs) or qualified company retirement plans. For 2017, married couples filing jointly are eligible for at least some credit if their modified adjusted gross income is less than $62,000; single filers can claim the credit if their adjusted gross income is less than $31,000. The lower the income, the higher the credit--up to a maximum level of $1,000 for single filers and $2,000 for married couples filing jointly. This IRS guide provides more detail on the credit.

Health Savings Accounts
High-deductible healthcare plans are an increasingly popular option on many employee benefits menus. For 2017, any plan with a deductible of more than $1,300 for singles and $2,600 for families qualifies as a high-deductible plan. (The out-of-pocket maximums are $6,550 for individuals and $13,100 for families.)

Anyone who’s covered by such a plan should also employ a health savings account, either to cover ongoing expenses or better yet, if household cash flows allow, employ as a long-term investment vehicle. For 2017, those with single coverage can contribute $3,400 to an HSA, while those with family coverage can contribute $6,750. (Investors age 55 and older can make an additional $1,000 HSA catch-up contribution.) For those who are making the maximum allowable contributions to their company retirement plans and IRAs, the HSA provides another way to amass tax-advantaged savings. The investor makes pretax contributions, the money accumulates tax-free, and qualified withdrawals are also tax-free. This article shares tips for wringing the most from your HSA.

Education Savings
Each individual can contribute up to $14,000 a year to a 529 college savings plan on behalf of a specific individual without having that contribution count toward the gift tax. Additionally, people who would like to make a large upfront contribution to a 529 can contribute up to $70,000 on behalf of a single individual in a given year; as long as he or she makes no future contributions on behalf of the same individual for the next five years, the contribution will not count toward the gift tax. (From a practical standpoint, the gift tax is a nonconsideration for the vast majority of people, as discussed here.) Contributors can also earn state tax breaks on money stashed in a 529; by clicking on various states on this map, you can see the tax credits or deductions available in each state. Even if you expect to pull the money out to pay for college expenses in short order, it will probably make sense to run the money through a 529 for the state tax break, as discussed here.

Coverdell Education Savings Account contribution limits are more stringent; they are capped (and have seemingly flatlined) at $2,000 per beneficiary, and income limits apply. For 2017, single filers earning more than $110,000 cannot contribute to a Coverdell, and contributions are reduced for individuals earning between $95,000 and $110,000. Married couples filing jointly can contribute to a Coverdell if they earn less than $220,000; contributions are reduced if the couple's income falls between $190,000 and $220,000.

Medicare Surtax
The income thresholds for the 3.8% Medicare surtax will remain unchanged from 2016 to 2017: $200,000 for single filers and $250,000 for married couples filing jointly.

Gift/Estate Tax
The annual gift tax exclusion amount is staying the same, at $14,000. However, the exclusion amount for the estate tax is jumping up slightly to $5.49 million per person in 2017.

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