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Marginal Tax Rates FYI
Old 03-24-2017, 04:44 AM   #1
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Marginal Tax Rates FYI

In my opinion, Marginal Tax Rates are an extremely important concept that many of us need to understand while preparing for and living in retirement.

I am 70 and when I talk to my friends about the 55.5% and 46.25% Federal Tax Brackets almost all of them have the same response, “I don’t make anywhere near that amount of money”! When I tell them that those tax rates start at gross income levels of 50 to 60 thousand dollars, they are shocked and very interested in learning more. So I am bringing to this group the things that I talk to my friends about.

These extreme tax rates are caused by what I like to call the Parallel Taxation of your Parallel Taxation.



Looking at the worse case in this chart, at the top end of the 15% Federal Tax Bracket, when you earn or withdraw $100 of taxable income it causes $85 of your tax deferred Social Security to also become taxable income which causes the combined $185 of your tax deferred Long Term Gains to also become taxable income at the same 15% level. That is a total of a $370 increase in your taxable income at 15%, $55.50, which is 55.5% of the actual $100 increase in your income. A marginal tax rate is the amount of additional tax paid on an additional dollar of income.


I used an Excel spreadsheet to prepare the 3 graphs that I am about to use to illustrate this concept to the members of this forum.




Using the published 2017 federal tax brackets and deductions, this first graph shows the marginal rates paid by a single individual who is getting $30,000 from Social Security, $6,000 from LTCGs, plus other income from taxable sources like TIRA withdrawals or MRDs.

The graph is divided into 4 sections as illustrated by the numbers under the graph.

Due to the deferred taxation of Social Security and LTCGs, for about the first $45,280 of gross income, the retired individual is paying zero taxes while a working individual at the same $45,280 income level with no LTCGs would pay about $4,533 in Federal Tax.

This is where the “Marginal” tax rates start. The parallel sources of the “Marginal” rates are represented by the 3 dotted lines in the graph: Red for your normal tax bracket, plus Green for the taxation of your Social Security Benefits, plus Blue for the taxation of your Long Term Capital Gains. Every dollar of income can cause multiple income sources to be taxed at the same time, in parallel!

During the next $17,720 of your taxable retirement income, the solid red marginal brackets are close to the dashed blue standard brackets, a retired individual is paying about the same in taxes as a working individual during this income range. In this illustration only about $288 of the $4,533 of tax savings is given back to the IRS.

Everything changes drastically at the $63,000 gross income level. The solid red line definitely illustrates why I call the marginal tax rates paid over the next $10,240 “The Hump”. During this income range a working individual is in the 25% bracket and pays $2,560 in federal taxes while the retired individual is in the 55.5% and 46.25% marginal brackets and pays $5,080 in federal taxes giving $2,520 of their tax savings back to the IRS.

Once 85% of your Social Security has been taxed, all of the parallel taxation stops and everyone is back in the 25% Federal Tax Bracket. At this point you can just look back over your shoulder and say that 15% of your Social Security was tax free for a savings of $1,125 and your LTCGs were only taxed at 15% for another savings of $600.

The question to the group is simple, do you want to save $4,533 or $1,725?

As we will see shortly, all of these numbers are totally dependent on the size of your Social Security Benefit and the sources of your other income. The downloadable spreadsheet gives you a nice picture of what happens, but it is not necessary for doing your retirement planning. The Hump starts at the 25% federal bracket, either as your LTCGs are pushed into that bracket, 55.5%, or when your taxable income reaches that bracket, 46.25%. All you have to do is treat any long term gains or dividends as ordinary taxable income and calculate your tax bracket. If you are close to the 25% bracket, see what you can do to change your income sources from taxable to non-taxable.

The Marriage Penalty

OK, we have seen how this effects a retired individual who is single. There is still a marriage penalty when retired because the taxability of your Social Security benefits starts when half of your benefits plus your other income reaches $25,000 for a single person and only $32,000 for a married couple, not $50,000 as it would be for 2 single individuals.




The gross income scale on the graph represents per-capita income. Note how the married couple, green line, starts paying taxes earlier because their joint taxable income is increasing faster. Their marginal rate starts at 18.5% because they are already in their 85% taxability bracket before their income reaches the 10% federal tax bracket. Since they started paying taxes earlier, they saved less taxes so their Tax Hump is therefore smaller because they have less to give back to the IRS.

The numbers above the graph and the tick marks on the graph illustrate the per capita income levels where The Humps start. The first set of numbers under the graph illustrate what happens when other income is doubled. The married couple is now paying their full Hump tax while the single individual is not. When the per capita gross income levels are pushed to $74,000 everyone is over the hump and is paying close to the same tax rate. A small difference still remains because the over 65 addition to standard deductions is $300 more for a single individual.

Your Social Security level defines The Hump


The red line illustrates how a lower Social Security Benefit gives you less tax deferred income which makes you start paying taxes at a lower gross income level which saves you less taxes which makes your hump smaller because you have less to give back.

This post is aimed at a very specific segment of the retired population. If you have a great pension plan and you are “Over The Hump” it can show you how you got to your after tax retirement income level, but does nothing to help you change it. If your retirement income level is small just about anything you can do could easily be counter productive.

If your retirement income is going to put you at, near, or slightly into “The Hump”, knowing the marginal tax brackets you could be facing can help you to plan for and take steps to avoid paying those ultra high tax rates.
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Old 03-24-2017, 06:11 AM   #2
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I can certainly see how for anyone close to those various odd humps the marginal rates might be really important, especially if they have some control over their income.

The "good thing" about those marginal rates is that they at least disappear once your income gets high enough, unlike the ordinary income tax rates, AMT, the net investment income tax, and the increasing capital gains tax rates, all which increase and persist once you cross the specified threshold.

You are missing some images perhaps?
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Old 03-24-2017, 09:13 AM   #3
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Looking at the worse case in this chart, at the top end of the 15% Federal Tax Bracket, when you earn or withdraw $100 of taxable income it causes $85 of your tax deferred Social Security to also become taxable income which causes the combined $185 of your tax deferred Long Term Gains to also become taxable income at the same 15% level. That is a total of a $370 increase in your taxable income at 15%, $55.50, which is 55.5% of the actual $100 increase in your income. A marginal tax rate is the amount of additional tax paid on an additional dollar of income.
While I agree that marginal tax rate is the amount of additional tax paid on the additional dollar of income... your calculations are incorrect.

If you are at the top of the 15% tax bracket then 85% of your SS is already being included so $100 of additional income does not change how much SS is taxable at all.

Assuming that some of your income to the top of the 15% bracket is qualified, then $100 of additional ordinary income is taxed at 15% and then pushes $100 of qualified income over the 15% bracket, and that $100 of qualified income over the top of the 15% tax bracket is then taxed at the 15% capital gains tax rate.... for a total marginal tax rate of 30%. Not anyway near the 55% that you claim... WADR, you don't know what you are talking about.

I'm a prime example... in 2016 our taxable income is exactly the $75,300 top of the 15% tax bracket (through the magic of Roth conversions and recharacterizations)... in our case in 2016 our marginal ordinary tax rate is 10% because we had a lot of LTCG so our ordinary income is in the 10% tax bracket... if I do a What-If worksheet in TT and add $100 of ordinary income then our taxes increase by $25... the $100 of ordinary income is taxed at 10% and the $100 of qualified income that pops into the 25% tax bracket is taxed at the 15% capital gains tax rate... 10% + 15% = 25%.

I couldn't get to the images either.
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Old 03-24-2017, 09:43 AM   #4
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I have more moving parts in my marginal income tax rates than is shown above, so trying to figure out just what mine is for each type of income is pretty much pointless.


Several years ago, early on in my ER, I received a LTCG distribution at the end of the year. I knew I was in the 0% bracket for LTCG so when I updated my tax return spreadsheet, I expected my federal tax bill to be unchanged. Instead, it rose slightly because my AGI rose so the excluded amount for my medical expense deduction rose so my deductible medical expenses dropped a little so my taxable income rose a little so my federal income tax bill rose a little.


And this doesn't include how my state income tax bill will rise in the following year which will increase my state income tax deduction the following year (if I keep itemizing) which will decrease my federal taxable income the following year which will decrease my federal income tax bill the following year.


With the ACA premium subsidy around now, that's another big moving part affected by not only LTCG but by tax-free muni bond income, both part of one's MAGI. So, even some extra income which is tax-free at the federal and state levels will raise my overall federal tax bill because the ACA subsidy will drop. Here, just like my other example, a 0% marginal tax rate isn't really 0%.
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Old 03-24-2017, 09:55 AM   #5
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I agree... there can be a lot of moving parts with phase-out of itemized deductions, AMT, etc. .... I was responding to the OP's comment at the top of the 15% tax bracket... a subject that I am very familiar with... I agree that at lower income levels if someone is on the ACA subsidy cliff and/or in a range where SS isn't taxable that the real marginal rate can be very onerous... it can be well over 100% for people who fall off the ACA cliff.

But people who are at the top of the 15% tax bracket will be far beyond the cliff and 85% SS taxable so those are not factors in a marginal rate.
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Old 03-24-2017, 10:25 AM   #6
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I can't see the graphs, just small icons. Am I doing something wrong?
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Old 03-24-2017, 10:35 AM   #7
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Originally Posted by BrianB View Post
I can't see the graphs, just small icons. Am I doing something wrong?
No - the graphs are missing.
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Old 03-24-2017, 10:49 AM   #8
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I don't know if I care. Whatever TT shows me what I pay. So far, even with high income this year, I pay zero tax. I wish I knew that last year so I could do more Roth conversion.
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Old 03-24-2017, 11:03 AM   #9
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I think the graphs are probably in the bogleheads wiki page he wrote which I remember seeing a link for earlier, but now looks to have been removed.


I ran a quick calc with some numbers I figure will be close to mine when I hit SS, and I found the same thing as pb4 found, that when my income is high enough to be at the top of the 15% bracket, my SS benefits are already taxed at 85%. It's possible that there is some combination, probably with most SS income and not much of other, which could push you from 50% to 85%, but I really doubt there is anything that could push you from 0 to 85%. This so-called 55.5% bracket for middle income seniors either doesn't exist or is very small. The 30% bracket (15% income + 15% divs pushed into taxable) is very real and worth looking out for.


The message here is (or should be) that there are odd places where you can push yourself into a higher than typical tax rate for some of your money, and if you have control over some income such as IRA distributions or conversions, it is worth running scenarios on your returns to model what could happen.


I stopped reading in detail after the first scenario, which already seemed flawed, and the missing images also made it impossible to follow, but I guess the second message is that you might want to look at some of those scenarios to see whether you pay a financial penalty by getting married.


The message given though, seems to be some scary big numbers that probably don't apply to most people.
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Old 03-24-2017, 12:07 PM   #10
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Originally Posted by pb4uski View Post
If you are at the top of the 15% tax bracket then 85% of your SS is already being included so $100 of additional income does not change how much SS is taxable at all.
When your income reaches $30,000 SSB plus $6,000 LTCG plus $37,705 other taxable income your total gross income will be $73,705. The basis for the taxation of your benefits is half of your benefits plus your other income. $15,000 plus $6,000 plus $37,705 is $58,705. The first $25,000 of that basis is non-taxable. The next $9,000 is 50% taxability ($4,500) and the remaining $24,705 is 85% taxability ($20,999). That makes a total of $25,499 of your Social Security taxable income and 85% of $30,000 is $25,500.

Not including your LTCGs, your AGI at this point will be $37,705 plus $20,999, taxable income plus taxable SSB, which is $58,704. That AGI is way above the top of the 15% tax bracket which ends at $37,950.

As the last image indicates, the size of your personal hump is totally dependent on the size of your Social Security Benefit. There is no hump when your benefit is only $15,000 and is very small at $20,000. All of the images in this example show larger benefits levels.

This is a large part of planning for retirement. Do you take a smaller SSB at an early age or a larger SSB at an older age. Do you want $300 a week for the rest of your life starting at age 62, $400 a week starting at age 66, of $528 a week starting at age 70.
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Old 03-24-2017, 12:56 PM   #11
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... As the last image indicates ...
Unfortunately, nobody but you can see the images. The rest of us are just seeing the "broken image" icons.
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Old 03-24-2017, 12:58 PM   #12
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Obviously some image difficulties. We'll try to work them out.
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Old 03-24-2017, 01:56 PM   #13
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Originally Posted by Sandy & Shirley View Post
When your income reaches $30,000 SSB plus $6,000 LTCG plus $37,705 other taxable income your total gross income will be $73,705. The basis for the taxation of your benefits is half of your benefits plus your other income. $15,000 plus $6,000 plus $37,705 is $58,705. The first $25,000 of that basis is non-taxable. The next $9,000 is 50% taxability ($4,500) and the remaining $24,705 is 85% taxability ($20,999). That makes a total of $25,499 of your Social Security taxable income and 85% of $30,000 is $25,500.

Not including your LTCGs, your AGI at this point will be $37,705 plus $20,999, taxable income plus taxable SSB, which is $58,704. That AGI is way above the top of the 15% tax bracket which ends at $37,950.

As the last image indicates, the size of your personal hump is totally dependent on the size of your Social Security Benefit. There is no hump when your benefit is only $15,000 and is very small at $20,000. All of the images in this example show larger benefits levels.

This is a large part of planning for retirement. Do you take a smaller SSB at an early age or a larger SSB at an older age. Do you want $300 a week for the rest of your life starting at age 62, $400 a week starting at age 66, of $528 a week starting at age 70.
I don't think that you understand the difference between AGI and taxable income. While the top of the 15% tax bracket for a single is $37,950 for 2017, assuming standard deduction for someone 65 or older, that would be AGI of $49,600 ($37,950 + $7,600 + $4,050).

If I use your $30,000 of SS income, $6,000 of LTCG and $37,705 of other income in Taxcaster, I get tax of $9,503:

Quote:
Total Income ? $69,204.25
Total Deductions ? $7,850
Total Exemptions ? $4,050
Taxable Income ? $57,304.25
Regular Taxes ? $9,503
Alt. Minimum Tax ? 0
Additional Taxes ? 0
Tax Credits ? 0
Tax Payments ? 0
You Owe ? $9,503
Marginal Tax Rate ? 25%
The total income $69,205 is 85% of $30,000 SS benefits + $6,000 LTCG and $37,705 of other income.... or alternatively the $73,705 of income less 15% of SS.

If I then add $100 of additional income, the tax increases from $9,503 to $9,528, so the taxpayer's marginal tax rate is 25%.

Quote:
Total Income ? $69,305
Total Deductions ? $7,850
Total Exemptions ? $4,050
Taxable Income ? $57,405
Regular Taxes ? $9,528
Alt. Minimum Tax ? 0
Additional Taxes ? 0
Tax Credits ? 0
Tax Payments ? 0
You Owe ? $9,528
Marginal Tax Rate ? 25%
Note that Taxcaster uses 2016 deductions, exemptions and tax rates but if you run it using 2017 you'll still get a 25% marginal tax rate... not anywhere near 55%.

We can't see the images so your continued reference to them just add confusion.
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Old 03-24-2017, 02:45 PM   #14
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I reposted this thread.

The new thread is Marginal Tax Rates - Repost
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