By Jim Terwilliger
During the months of October and November, the IRS and Social Security/Medicare office published new numbers for 2021 that will impact our tax and retirement planning lives.
The federal tax framework that was put into place starting in 2018 tax year is still intact. No material changes were made for 2021, excepting any moves the president and Congress may have in mind for us this year and beyond.
For the third consecutive year, most income-tax-related numbers were inflation-adjusted by an alternative version of the Consumer Price Index (CPI). Adjustments were based on the so-called Chained CPI. This inflation measure, defined by the Bureau of Labor Statistics, is based on the idea that when prices are rising, consumers will choose less-expensive substitutes. As such, Chained CPI is generally lower than CPI.
While the difference between CPI and Chained CPI is subtle, use of the latter, over time, makes annual income-tax-related adjustments less favorable for taxpayers.
Federal Income Tax
Seven tax brackets, ranging from 10% to 37%, were carried over from 2020 tax year. In 2021, the taxable income range within each of the seven brackets increased by about 1%, resulting in a slightly lower tax bill for the same taxable income compared to 2020.
The standard deduction was increased from $12,400 to $12,550 for single taxpayers and from $24,800 to $25,100 for married filing joint. Additional deductions, available for those who are blind or age 65 and older, were increased by $50.
The generous federal estate tax exclusion saw an increase from $11.58 million to $11.7 million. The portability provision remains, allowing a married couple to now shield $23.4 million from federal estate taxation. The annual federal gift tax exclusion remains at $15,000 for 2020.
The news is mostly flat on this front. One contribution limit was increased for 2021. The defined contribution plan limit (including SEP IRAs) increased from $57,000 to $58,000. Otherwise, most other limits remain unchanged, including the 401(k)/403(b)/457 salary-deferral limit at $19,500 and the SIMPLE IRA limit at $13,500.
The catch-up contribution limit for 401(k)/403(b)/457 plans for taxpayers age 50 and older remains unchanged at $6,500 and the catch-up contribution limit for SIMPLE IRAs remains unchanged at $3,000.
For traditional and Roth IRAs, the 2021 contribution and catch-up limits remain unchanged at $6,000 and $1,000, respectively.
The ability to make a deductible contribution to a traditional IRA now begins to phase out at $105,000 of adjusted gross income (AGI) for joint filers and $66,000 for single if covered by an employer retirement plan (vs. $104,000 and $65,000, respectively, in 2020). If only one of a married couple is covered by an employer plan, the phase out begins at $198,000 AGI for joint filers (vs. $196,000 in 2020). There is no phase-out if neither spouse is covered by an employer plan.
The ability to contribute to a Roth IRA now begins to phase out at $198,000 AGI for joint filers and 125,000 for single (vs. $196,000 and $124,000, respectively, in 2020).
Inflation adjustments for Social Security benefits are based on CPI, not chained. The 2020 to 2021 benefit increase is 1.3%. This follows a 2017 increase of 0.3%, 2018 increase of 2.0%, 2019 increase of 2.8%, and 2020 increase of 1.6%.
The ceiling on wages taxed for Social Security purposes increased from $137,700 in 2020 to $142,800 in 2021. While this 3.7% increase will not make current high-income workers happy, the good news is that it will pump additional funding into the system.
There is great news from our friends at Medicare. After a whopping increase of 6.7% in 2020, the increase in premiums in 2021 is a much-more affordable: 2.7% across all six tiers. The new Tier 1 Part B premium, that most folks now pay, is $148.50 per month compared to $144.60 last year.
Additional good news is that the Part D surcharge for Tiers 2 through 6 (none in Tier 1) increased by less than 1%. Note that Medicare premiums and surcharges for 2021 are based on 2019 Modified AGIs.
The increase in premiums for 2021 is much less than had been expected earlier last year when Medicare spending soared due to COVID-19. Fortunately, Congress stepped in with emergency legislation to offset a projected rise in premiums of as much as $50/month for some beneficiaries.
Remember that the above changes impact the tax return you will file in 2022, not this April. As always, you are encouraged to work with a professional tax preparer and your financial planner to take advantage of tax-planning opportunities when updating your financial plan.
James Terwilliger is senior vice president, senior planning adviser with CNB Wealth Management, Canandaigua National Bank & Trust Company. He is a certified financial planner (CFP). He can reached at 585-419-0670 ext. 50630 or firstname.lastname@example.org.