Marginal Tax Rates Repost

[kaneohe]

Now I'm beginning to doubt my beliefs!

For example, if $10K of my $50K in dividends/LTCG pushed me over and into the 25% bracket, I always thought I paid tax on the $10K overage, not the full $50K. Am I wrong? Would I pay tax on the full $50K?

You are not wrong but you need to consider interactive effects (such as SS).
If you are 10K away from the 25% bracket and then add 10K of income, you might also add more taxable SS to the mix which would push you over the boundary. Doubt if that would make the whole 50K taxable.

 

[samclem]

These tax programs end up shielding us from this info, rather than enlightening us. I sometimes have to go back and do this manually.

+1. I do quite a bit of "what if-ing" while doing my taxes, but it's hit and miss. Charts like those in the OP would be helpful, as would a bit of automated "what if-ing." Also, of course, a big "value added" would be some calculations that include the impact of ACA subsidies and also some look-aheads at SS/withdrawals/tax rates int he future and assistance with visualizing the impact of withdrawal strategies from after-tax/tIRA/Roth sources. I would think these tax programs would be looking for a way to distinguish themselves in the marketplace, and things like this would elp do that. OTOH, maybe it is a tiny niche market and the added apparent complexity of the displayed info conflicts with their selling point: to make tax time simple. I like simple as much as anyone, but sometimes the best we can do is a well-done explanation of a complex issue.

 

[bingybear]

You are not wrong but you need to consider interactive effects (such as SS).
If you are 10K away from the 25% bracket and then add 10K of income, you might also add more taxable SS to the mix which would push you over the boundary. Doubt if that would make the whole 50K taxable.

If you were 10k away from the 25% bracket, would you not be paying tax on 85% of SS already?

 

[sengsational]

I did a personal marginal tax rate calculation for myself a few years ago and determined that I pop into a 29% bracket if I hit 250% of FPL. Then it stays around that level, then goes to an "infinite" marginal rate when I hit the 400% FPL 'cliff'. Since I was adding $5K of income per iteration, the 'cliff' came out at over 200% marginal rate on that $5K, then settled into the 30% range again.

There are only so many things one has control over, so whatever you can control, you "play" with in your tax software and keep calculating your tax rate.

The federal government should not have the ability to change tax law post facto, but they can change tax law during and after they year they are collecting tax for. Luckily, the changes are usually minor, but with some changes, it could shoot a big hole in a tax saving strategy.

 

[Sandy & Shirley]

You seem to be suggesting that there is a situation where $100 of additional income results in $55 in incremental taxes. I think you are wrong. Please provide the before and after details...sources of income for each scenario.

Go online to TurboTax TaxCaster
https://turbotax.intuit.com/tax-tools/calculators/taxcaster/
And make the following entries:

Single
Head of Household No
Age on 12/31/16 68
Taxable Wages $28,000
Fed Withholdings $0
State Withholdings $0
[Have Investments] Check
[Other taxable income] Check and continue
Short Term Gains $0
Long Term Gains $6,000
Interest $0
Dividends $0
Unemployment $0
IRA/Pension $0
Social Security $30,000
Misc Income $0
Alimony $0
Health Insurance Yes

Result $4,798

[Eidt]
Wages & Withholdings Change wages from $28,000 to $29,000

Result $5,353

That is an increase of $555 in Federal taxes owed because of $1,000 of additional income

 

[Sandy & Shirley]

General unsolicited comment: without some additional explanation, the first spreadsheet/chart is virtually indecipherable.

DW and I file MFJ, so the later charts tell me (I think) that when our taxable income is between $116K and $128K we'll be paying high marginal rates. From a practical standpoint, if I had enough savings to allow our safe withdrawals to put us at, say, $130K every year, it would seem that one way to reduce taxes over the years would be to "bunch" withdrawals: go only up to $115K the first year, then go to $145 the next year, etc. It winds up being the same amount of total withdrawals overall, but only 1/2 as much would be subject to these higher marginal rates.
Other than that--if your withdrawals will put you slightly into "the hump," maybe withdraw from Roth's even in the early years of retirement when you hit the first dollar of the "the hump" (contrary to the boilerplate standard advice of spending taxable and tIRA money until they are gone, then spend the Roth money). "The hump" is fairly narrow, and even a moderate amount of Roth money might effectively avoid taxes at these higher rates for many years.
Other observations:
1) Getting taxed at these rates would be a good problem to have for DW and I. I don't expect that will happen.
2) If a retiree has expected withdrawals well above "the hump", then the relatively small window of high marginal rates shouldn't significantly affect their behavior.

Thanks for the post. There's a lot of work here, and I must admit that much of it is wasted on me.

The second chart shows you what it is like if your combined Social Security is $60,000. The third chart shows you that everyone has different income levels where this ultra high tax rate starts and ends. The position of your personal Hump depends on the amount of your personal Social Security Benefits.

The more benefits you get, the more deferred income you have so the more taxes you save in phase 1 of your income. Phase 2, if you remember, is where you are paying about the same as everyone else. Phase 3 is the Hump. The start of and width of your hump are totally dependent on the amount of Social Security you get. The more you get the more you get tax free so the wider the hump so you can give 85% of the tax savings back to the IRS.

 

[FiveDriver]

This would be a good time for one of our Excel Gurus to put together a calculating spreadshieet for both Single and MFJ filers. Enter your Adjusted Gross (or is it Taxable Income ?), Your Dividends, Your SS, and any other that applies.
The Output would show where the break comes in.

Not being an Excel Guru is one of my shortcomings in life.

 

[Sandy & Shirley]

I previously ran these numbers with I think 2015 tax rates for single individuals with $4,000 of LTCGs:

SSB $20,000 Free $35,567 Save $3,096 Hump $55,243 Width $ 3,460 Back $1,946
SSB $25,000 Free $39,733 Save $3,721 Hump $59,095 Width $ 7,111 Back $2,383
SSB $30,000 Free $43,900 Save $4,368 Hump $62,946 Width $10,760 Back $2,843
SSB $35,000 Free $48,067 Save $5,332 Hump $66,797 Width $14,409 Back $3,620

They basically show how, as your SSB increases, you get more tax free income which saves more taxes initially. Your Hump starts at a higher income level and continues for a longer income period so you can give more back to the IRS. The more you save the more you have to give back!

 

[Fedup]

I would think so. Otherwise you could pay a different number using the formula rather than the table. I put a few numbers in Taxcaster and it does as you suggest. Maybe you should say 40-49 since the brackets are 50 wide.

Taxcaster is not good for complex situation as I found out this year. I've could have converted more to Roth IRA. I think using last year tax and do some modification is better in TurboTax.

 

[kaneohe]

If you were 10k away from the 25% bracket, would you not be paying tax on 85% of SS already?

Quite possibly but not necessarily. The usual caveat is to run the numbers thru software/Taxcaster to be sure. Try 60K SS for MFJ.

 

[Fedup]

OP, I noticed this marginal tax rate when I put in different Roth amount for conversion. Like withdraw $60k with $2500 tax or $75k with $5000 tax(not exact amount) , but then what do you do? Do you not converting at $75k? Because it's still under 15% bracket. Unless you are willing to make a decision differently by looking at this marginal tax rate, it's still not useful to me.

 

[RunningBum]

Saving and giving back just doesn't seem relevant to me, if I understand what you mean. You say at early levels this is what retirees save over wage earners, and what they give back when they go through the hump. But it's not really a choice, whether you are a retiree on SS or a wage earner. The tax code is full of examples, LTCGs and QDivs included, where income is taxed differently. I think you just muddy the waters when you talk about things like this.


The hump certainly is important, IF you can control your income. If you have a large pension, you may be stuck accepting the hump as inevitable.


The kind of decisions I see as pertinent are whether you should convert your tIRA to a Roth before you start SS, or take income from other sources rather than a tIRA once you've met MRDs, or any other decision where you might be able to stay short of the hump. If that's even necessary. Some (many?) might never even approach the hump.

 

[RunningBum]

Still, it is interesting to learn of this hump. I just found the presentation and explanation of it very confusing, and believe it or not, I am a numbers person, though clearly not as much of one as you are.


IMO if you want people to understand it easier, you start with post 30 info, to prove it exists; then you explain how it happens (pushing SS and LTCGs into taxable along with the extra income), then you show the graphs to show how wide the hump is. Forget about any comparisons with someone with earned income, it does nothing but confuse.

 

[RunningBum]

OP, I noticed this marginal tax rate when I put in different Roth amount for conversion. Like withdraw $60k with $2500 tax or $75k with $5000 tax(not exact amount) , but then what do you do? Do you not converting at $75k? Because it's still under 15% bracket. Unless you are willing to make a decision differently by looking at this marginal tax rate, it's still not useful to me.

I think you exactly want to make decisions based on marginal tax rates. The question isn't whether you convert 0 or $75K, it usually is more that it make sense to convert some, but is there a point at which an extra $1 or $1000 gets taxed too high that it isn't worth it. If that extra $1000 is still taxed at 15%, it's probably good, but if it's 25% or 30% or maybe even higher, you might stop. $1000 isn't a big deal in itself and won't tip the overall tax rate that much, but what if you are thinking about converting another $100K? It seems to me that you might as well know what each additional $1 or $1000 will be taxed at so you can optimize it.

And the reason to stop is that in 5 years you might have it all converted. In that case, you might rather have had some left to convert at 15% and not converted some of it 5 years ago at 30%.

Everyone's case is different because if you have a lot to convert, 25 or 30% may not be a deal breaker if it means avoiding high MRDs later in retirement, pushing you into higher tax brackets and hump situations like the OP shows.

 

[pb4uski]

Now I'm beginning to doubt my beliefs!

For example, if $10K of my $50K in dividends/LTCG pushed me over and into the 25% bracket, I always thought I paid tax on the $10K overage, not the full $50K. Am I wrong? Would I pay tax on the full $50K?

You would pay an additional $1,500 in tax... your ordinary income comes first, then your qualified income... which in your case would be 0% to the top of the 15% tax bracket and 15% to the extent it broaches the top of the 15% tax bracket.

 

[Fedup]

I think you exactly want to make decisions based on marginal tax rates. The question isn't whether you convert 0 or $75K, it usually is more that it make sense to convert some, but is there a point at which an extra $1 or $1000 gets taxed too high that it isn't worth it. If that extra $1000 is still taxed at 15%, it's probably good, but if it's 25% or 30% or maybe even higher, you might stop. $1000 isn't a big deal in itself and won't tip the overall tax rate that much, but what if you are thinking about converting another $100K? It seems to me that you might as well know what each additional $1 or $1000 will be taxed at so you can optimize it.

And the reason to stop is that in 5 years you might have it all converted. In that case, you might rather have had some left to convert at 15% and not converted some of it 5 years ago at 30%.

Everyone's case is different because if you have a lot to convert, 25 or 30% may not be a deal breaker if it means avoiding high MRDs later in retirement, pushing you into higher tax brackets and hump situations like the OP shows.

That's the point. It's not like our tax situation is going to be better in years later. I mean what choice do we have if we don't convert? Marginal tax rate means nothing.
For me, that means I have to create multiple scenarios from many different age points and simulate using TT.
I've done some cases, but it doesn't look like I will be able to exhaust the taxable account easily.

 

[Sandy & Shirley]

OP, I noticed this marginal tax rate when I put in different Roth amount for conversion. Like withdraw $60k with $2500 tax or $75k with $5000 tax(not exact amount) , but then what do you do? Do you not converting at $75k? Because it's still under 15% bracket. Unless you are willing to make a decision differently by looking at this marginal tax rate, it's still not useful to me.

My ex said that I was certifiable, but I am not certified in any financial areas. My knowledge comes from personal research on what I could have done better and what I can now do better for Shirley as she plans to retire in a year or two.

As for Roth conversions, the real profit in doing a conversion is the difference between your marginal tax rate at the time you do the conversion vs your marginal tax rate at the time you use the money.

If you do a conversion today at the 10% or 15% level, convert everything to Roth, then your only other income source during retirement is your Social Security, your marginal rate during retirement will be 0%, so converting at 10% was a loss.

If you convert today at 25% and use the money in retirement when you have a lot of other income and your marginal rate is 46.25% or 55.5%, then your conversion will be very profitable.

You also have to take state tax considerations into account. Converting today in a high state tax state like California, then retiring to a no state tax state could result in a huge loss, or not, it all depends on your personal situation, your personal Social Security levels.

 

[kaneohe]

I can see the 46.25%... essentially 185% of 25% marginal tax bracket.

I'm not seeing anything like that in my situation either.

Is it possible that when you have SS income and QDIV/LTCG in the "base" income, adding more income not only makes more SS taxable (the 1.85X factor) but also pushes 0% taxable income into the 15% range adding to the
46.25% rate.

 

[Fedup]

My ex said that I was certifiable, but I am not certified in any financial areas. My knowledge comes from personal research on what I could have done better and what I can now do better for Shirley as she plans to retire in a year or two.

As for Roth conversions, the real profit in doing a conversion is the difference between your marginal tax rate at the time you do the conversion vs your marginal tax rate at the time you use the money.

If you do a conversion today at the 10% or 15% level, convert everything to Roth, then your only other income source during retirement is your Social Security, your marginal rate during retirement will be 0%, so converting at 10% was a loss.

If you convert today at 25% and use the money in retirement when you have a lot of other income and your marginal rate is 46.25% or 55.5%, then your conversion will be very profitable.

You also have to take state tax considerations into account. Converting today in a high state tax state like California, then retiring to a no state tax state could result in a huge loss, or not, it all depends on your personal situation, your personal Social Security levels.

Thank you for your explanation. I don't plan to move out of California, but it's a pain to have to pay more state tax than necessary for these conversion. I need to keep an eye out for both.

 

[pb4uski]

Go online to TurboTax TaxCaster
https://turbotax.intuit.com/tax-tools/calculators/taxcaster/
And make the following entries:

Single
Head of Household No
Age on 12/31/16 68
Taxable Wages $28,000
Fed Withholdings $0
State Withholdings $0
[Have Investments] Check
[Other taxable income] Check and continue
Short Term Gains $0
Long Term Gains $6,000
Interest $0
Dividends $0
Unemployment $0
IRA/Pension $0
Social Security $30,000
Misc Income $0
Alimony $0
Health Insurance Yes

Result $4,798

[Eidt]
Wages & Withholdings Change wages from $28,000 to $29,000

Result $5,353

That is an increase of $555 in Federal taxes owed because of $1,000 of additional income

I stand corrected. I was aware of the 30% marginal tax rate for a while once one broached the top of the 15% tax bracket as I am in that area now... I would have thought that at that level that SS was already at 85% but it isn't in some circumstances... the 55.5% is 1.85*30%.

 

[samclem]

I stand corrected.

I hope nobody rudely tells you to "learn to read."

 

[pb4uski]

I hope nobody rudely tells you to "learn to read."

Whatever... I didn't attempt to bring up a bunch of irrelevant, extraneous things like SS tax, medicare tax, state income taxes, etc in a feeble attempt to try to make a political point.... I stayed on point and referred to federal income taxes which is what the OP has written about the whole time.

 

[Souschef]

What really gets me upset is the fact I have to pay taxes on my SS, even thought the money has already been taxed! Truth be told, my RMD's are the real driver.
I do understand the concept of marginal tax rate, my AGI was 130K, and my total tax rate was 12.4%.

 

[samclem]

What really gets me upset is the fact I have to pay taxes on my SS, even thought the money has already been taxed!

I'll just be happy to see any of that FICA money coming home to papa. It's "found money," so having it taxed hurts a little less.

 

[Texas Proud]

That's the point. It's not like our tax situation is going to be better in years later. I mean what choice do we have if we don't convert? Marginal tax rate means nothing.
For me, that means I have to create multiple scenarios from many different age points and simulate using TT.
I've done some cases, but it doesn't look like I will be able to exhaust the taxable account easily.

That is a problem that I have... I have more than 50% gain in all my funds... so if I sell I have LTCG... now, I do not have to worry about paying income tax on it, but I lose ACA credits at a decent clip...

But, any type of income will affect the credit, so I have to see what is the best... at least I only have to take my gain as income as opposed to an IRA where it is all 'income' against the credit...