Cooling inflation will bring some relief in the form of slightly lower taxes next year.
An average inflationary adjustment of 2.8% under IRS guidance for 2025 released earlier this month came in lower than the 5.4% hike for this year and a boost of more than 7% across the seven federal income brackets in 2023, according to an analysis by the nonpartisan, nonprofit Tax Foundation.
At the same time, the slower rise in cost-of-living expenses this year led the agency's subsequent annual announcement of the level of penalty-free limits on contributions to individual retirement accounts to stay the same, at $7,000.
On the other hand, yearly contribution limits to 401(k), 403(b) and 457 retirement plans, as well as the federal government's Thrift Savings Plan, will each rise by $500 in 2025 to $23,500 and a shift in the rules from the Secure 2.0 Act will give savers aged 60 to 63 a new "super catch-up" option for the first time.
READ MORE: With Congress slow to act, financial advisors plan ahead on estate taxes
The yearly protection against so-called bracket creep and the numbers involved with more than 60 other tax items put a bookend on "a continual conversation during the course of the year" about the question of "whether there are ways to reduce your income by booking losses" or "trying to take advantage of recognizing some income so you pay a lower amount of tax" for 2024 and 2025, according to Alan Weissberger, the senior tax and estate planning solution specialist with West Conshohocken, Pennsylvania-based Hirtle Callaghan. For financial advisors, tax professionals and their clients, the potential expiration of many provisions of the Tax Cuts and Jobs Act after 2025 is adding another layer to the standard year-end planning.
"The actual inflation adjustment is relatively lower compared to what we've seen the last couple of years," Weissberger said in an interview. "All things being equal, any taxpayer with the same amount of income is going to end up paying a little less in taxes."
Experts often point out the significant differences in tax rates that come down to every single dollar worth of income. Via the Tax Foundation analysis, here's how the federal tax brackets will look in 2025:
- 10%: $0 to $11,925 (individuals or married filing separately); $0 to $23,850 (married filing jointly); $0 to $17,000 (heads of households)
- 12%: $11,925 to $48,475; $23,850 to $96,950; $17,000 to $64,850
- 22%: $48,475 to $103,350; $96,950 to $206,700; $64,850 to $103,350
- 24%: $103,350 to $197,300; $206,700 to $394,600; $103,350 to $197,300
- 32%: $197,300 to $250,525; $394,600 to $501,050; $197,300 to $250,500
- 35%: $250,525 to $626,350; $501,050 to $751,600; $250,500 to $626,350
- 37%: $626,350 or more; $751,600 or more; $626,350 or more
In terms of retirement savings, the two Secure Acts have altered many rules around planning. For example, many beneficiaries who have inherited IRAs know that they must begin taking their required minimum distributions in 2025 as part of a 10-year schedule that has replaced the "stretch" strategy after the IRS delayed that obligation for several years in a row.
READ MORE: Final IRS rules to IRA beneficiaries: Get going on those RMDs already
For 2025, the cost-of-living adjustments to retirement contributions did not make any impact on the ceiling on regular IRA contributions and the extra "catch-up" savings available to those 50 or older of $1,000. The "catch-up" contributions for 401(k) and other retirement-plan participants who are aged 50 or above will stay the same at $7,500, too. For those employee-plan participants between the ages of 60 and 63, a new "super catch-up" beginning next year will provide the flexibility to contribute as much as $11,250 on top of their allotted $23,500.
Those decisions could reverberate for decades in a saver's portfolio, according to a blog earlier this year by financial educator Patrick Villanova for advisor matchmaking and personal finance service SmartAsset. Even though they started with the same value of $256,244 in their 401(k) at age 60, a sample investor named "Sam the Super Saver" racked up over $16,000 in additional savings compared to "Ian the Ignorer" by the time she turned 64 through the extra catch-up contributions. By their 90th birthdays, Sam had more than $23,000 more in portfolio value.
"Those extra dollars can add up over the course of a 25-year retirement and continue to compound along with retirement account investment growth," Villanova wrote. "However, the potential long-term growth of those enhanced contributions simply may not be enough to entice some pre-retirees to save the extra money between ages 60 and 63."
Planners and their clients will also be watching closely to see how this week's election and the current sunset date at the end of 2025 for a lot of the Tax Cuts and Jobs Act affect their estate and income taxes. Absent Congressional action, the minimum value of estates subject to taxes as high as 40% will revert back to half its present level.
READ MORE: 30 tax questions to answer by the end of the year
Ultrahigh net worth families that are part of the base of Hirtle Callaghan's clients generally fall into one of three categories around the estate tax, Weissberger noted. Some have been updating their plans every year, others shifted slightly in anticipation of potential tax changes during President Joe Biden's term and the third group includes "some clients who have done absolutely nothing for any estate planning," he said.
"A lot of clients haven't done anything, and they've been waiting and thinking that this problem is eventually going to solve itself — which doesn't look like it's going to happen," Weissberger said.
