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Need advice on taking advantage 15% Fed tax bracket "headroom"
Old 07-14-2012, 07:47 PM   #1
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Need advice on taking advantage 15% Fed tax bracket "headroom"

I am looking for advice on the best way to take advantage of the 15% tax bracket that I will be in for 2012 (and probably 2013).
Background – Single head of household, DD (turns 23 soon) in college FT, should complete Fall 2013. I have about $13K in “headroom” before moving the 25/28% for 2012 and 2013. My 40K cash is about 5% of my AA but only earning 0.5% interest at the CU.
I need about 13K more than my dividends (that I am rolling over) and pension provide to cover her education (she does work P/T, but that goes to gas, cosmetic, clothes, entertainment… ). I am also looking at a kitchen remodel (prepping house for sale in 2014) and possibly new or newer more reliable car. I do like to keep 30-40K in easy access cash.
The options I see are as follows:
1. Pull money out of 401K (tax only no 10% penalty). Actual my megacorp 401K is not all the great and I have already moved quite a bit to IRA Vanguard accounts.
2. Utilize the fairly low rate Govt. backed loans at about 2% that are available $11K for 2012 school year (fall/spring) And transfer ~13K from Traditional IRA to Roth IRA.
3. Withdraw funds as needed from after tax accounts and do the Traditional IRA to Roth IRA.
I am actually leaning towards option 1 because it is the least complicated and the amount of dollars involved is only moderately significant. Even though I believe the loan (Stafford loan?) seems to make the most financial sense. Anyway I plan to take advantage of the 15% Fed tax bracket I will be in this year and 2013 one way or another. After that it becomes OBE.
Any advice or options I missed would be much appreciated.
Thank you in advance
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Old 07-14-2012, 09:18 PM   #2
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Those after-tax accounts: Do you have any assets with lots of accrued Cap Gains? If so, this might be a good (and your last) opportunity to avoid paying any taxes on them. For people in the 15% tax bracket, the LTCG rate through Dec 31, 2012 is 0%. If there are no changes, after that date those in the 15% income tax bracket will pay 10% on their LTCGs (those above the 15% line will pay a 20% LTCG rate).

Or so I understand. Check it out for yourself to be sure.

For a couple of years now I've been contributing extra to a solo401K just to reduce my earned income and buy myself some "headroom" below the 15%/25% line. With that space I've been selling mutual funds that are in taxable accounts and have accrued hefty LTCG over the years, thereby paying zero taxes on the gains right up to the 15%/25% line. I think I've avoided some taxes through this maneuver, but that craziness will stop this year unless the lower tax rates are extended.
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Old 07-15-2012, 07:45 AM   #3
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Whatever you choose, you might want to run your scenario thru tax software or a tax calculator like TurboTax® TaxCaster - Free Tax Calculator - Free Tax Estimator just to be sure. If you overfill your headroom by mistake, you may end up paying an effective rate of 30% (vs 15%) if filling w/ ordinary income or a LTCG rate of 15% (vs 0%) if filling w/ LTCG on the overfilled part.
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Old 07-15-2012, 08:51 AM   #4
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Thanks for the responses, actually I ran the numbers through TT 2011 several times and adjusted the best I could for known changes such as the planned LTCG change. Anyway with ~$500K of 401k/IRA, and having two years (2012, 2013 as single head of household status with an extra dependent, it just seems like a good time to take what I can (which really is not a lot percentage wise) out of my 401K since that one has 10% penalty while I'm the 15% Fed rate status. My pension is a non-COLA but will keep me over the 15% line for quite a while starting in 2014 depending on how fast inflation goes up and/or tax changes are made. I am leaning towards the 401K withdrawal. The Roth IRA conversion just makes me a little nervous since the money will be "stuck" for a while and I really don't trust our leaders not make changes in this area over the next few years. I will be on the conservative side but even if I go one or two thousand over into the 25%/28% region, then a lesson learned for 2013 with minimal "damage".
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Old 07-15-2012, 12:37 PM   #5
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You may want to consider the impact, IF ANY, of state taxes and on the health care insurance cost in 2014 (which will at least provisionally be based on 2012 tax return data).

IIRC if your income is near the limit (400% of poverty level) or just over the limit the implications on your health care insurance costs can be drastically different, so the economic cost of those last dollars of IRA withdrawals are outrageous.
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Old 07-15-2012, 01:32 PM   #6
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fwiw, here's a calculator for those health care costs
Health Reform Subsidy Calculator - Kaiser Health Reform

kind of looked like the subsidy (and thus the cost) are phased out gradually as income increases.......didn't appear to be any cliffs in the few minutes I played with it but a delta of 13K in income could produce another 10-15% in subsidy decrease in addition to the income tax increase. ymmv
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Old 07-15-2012, 01:39 PM   #7
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There is a definite cliff. Look at a 56 year old single adult at 46,000 income and 47,000 income. the tax credit goes from 4.451 to zero so even ignoring income taxes on that additional 1,000 of income is an increase of 4,451 in health insurance costs!! Ugly!!

"Thanks boss but I'll pass on the raise you want to give me from 46k to 47k"

Hopefully, this cliff will be one of the things that gets fixed before the subsidies are effective.
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Old 07-15-2012, 01:47 PM   #8
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Quote:
Originally Posted by kaneohe View Post
fwiw, here's a calculator for those health care costs
Health Reform Subsidy Calculator - Kaiser Health Reform

kind of looked like the subsidy (and thus the cost) are phased out gradually as income increases.......didn't appear to be any cliffs in the few minutes I played with it but a delta of 13K in income could produce another 10-15% in subsidy decrease in addition to the income tax increase. ymmv
There is a huge cliff at the 400% of poverty level income. One more dollar of income reduces the government subsidy to zero
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Old 07-15-2012, 01:52 PM   #9
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Make sure you have enough value in your after-tax and 401k/IRA to live on until any possible 5-year waiting period is complete on your Roth's. Lot's of oddball rules for that.

#3 is standard practice in this case. That's what I'm planning to do once DW finally decides to stop raising our income.

#1 is standard practice when after-tax accounts have been drained. You can fill in with Roth withdrawals as needed, provided the 5-year rules are met.

#2 is what I would do. But that's the old pay off the mortgage vs. invest the principal tradeoff. If you are comfortable with the risk that your investment gains will exceed the 2% loan cost (and any rate variability if that's the case), then this should provide you a little extra net worth when all is said and done. And you get a little more into the Roth.
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Old 07-15-2012, 02:00 PM   #10
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There is a definite cliff. Look at a 56 year old single adult at 46,000 income and 47,000 income. the tax credit goes from 4.451 to zero so even ignoring income taxes on that additional 1,000 of income is an increase of 4,451 in health insurance costs!! Ugly!!

"Thanks boss but I'll pass on the raise you want to give me from 46k to 47k"

Hopefully, this cliff will be one of the things that gets fixed before the subsidies are effective.
confirmed your #s. I had input 40 y.o. and got a nice linear looking phaseout. I will plead my ymmv is my cya. Can you confirm the 40 y.o.
model or is my mind going?
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Old 07-15-2012, 02:11 PM   #11
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Quote:
Originally Posted by pb4uski View Post
You may want to consider the impact, IF ANY, of state taxes and on the health care insurance cost in 2014 (which will at least provisionally be based on 2012 tax return data).

IIRC if your income is near the limit (400% of poverty level) or just over the limit the implications on your health care insurance costs can be drastically different, so the economic cost of those last dollars of IRA withdrawals are outrageous.

Thanks pb4uski and Gumby, I needed that reminder and will add it to my list of things to do/check-on.

I actually started to look at that last night but was too tired and starting to fall asleep and went to bed. Sort of remember seeing what looked like some kind of 400% cliff. Someone needs to publish "An Affordable Health Act" for dummies. There's so much in those 2700 pages.

EDIT - I am well over the 400% on Income already (48+K pension plus a few $K in other odds and ends). It wasn't clear from the calculator (or I just missed it), if you use total income or taxable income. I'll have to go over and read the thread on this health care plan.
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Old 07-15-2012, 03:07 PM   #12
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confirmed your #s. I had input 40 y.o. and got a nice linear looking phaseout. I will plead my ymmv is my cya. Can you confirm the 40 y.o.
model or is my mind going?
You are right that the cliff is minimal at 40 yo but is extreme at 50-60. You can see it clearly if you click the "Click here for table showing results by income and age". Screwing the ol folks!
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Old 07-15-2012, 03:24 PM   #13
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You are right that the cliff is minimal at 40 yo but is extreme at 50-60. You can see it clearly if you click the "Click here for table showing results by income and age". Screwing the ol folks!
Thanks......didn't notice that link before. Lot easier to see in ready-made table than making your own.
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Old 07-15-2012, 03:49 PM   #14
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Anyone care to comment on the wisdom of utilizing a small, ($30K) low interest bank loan to back oneself away from the cliff...I'll eventually need three years to get to Medicare, then I could pay it back in full.

I could likely SAVE $30K in that time by staying < 400% FPL within the HC subsidies.
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Old 07-15-2012, 04:03 PM   #15
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Anyone care to comment on the wisdom of utilizing a small, ($30K) low interest bank loan to back oneself away from the cliff...I'll eventually need three years to get to Medicare, then I could pay it back in full.

I could likely SAVE $30K in that time by staying < 400% FPL within the HC subsidies.
You mean borrowing money to live on (which wouldn't be shown as income) rather than withdrawing money from an IRA or 401K (which would bump you over the "cliff")? A very interesting idea. Have you got any other options (after-tax accounts, ROTH funds) that you could spend and which wouldn't increase your income?

This subsidy, and the mechanics of its computation, is going to turn the >>other<< half of America, folks who pay little/no income taxes, into income gamesters just like their high-roller cousins already are. Cash transactions will become very popular. We'll be a nation of sharpies and cheats constantly looking for another angle.
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Old 07-15-2012, 04:18 PM   #16
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You mean borrowing money to live on (which wouldn't be shown as income) rather than withdrawing money from an IRA or 401K (which would bump you over the "cliff")? A very interesting idea. Have you got any other options (after-tax accounts, ROTH funds) that you could spend and which wouldn't increase your income?

This subsidy, and the mechanics of its computation, is going to turn the >>other<< half of America, folks who pay little/no income taxes, into income gamesters just like their high-roller cousins already are. Cash transactions will become very popular. We'll be a nation of sharpies and cheats constantly looking for another angle.
Yes, I mean borrowing money at a low rate for a few years to drop myself below the 400% FPL. I have other options in after tax accounts but why not take a 3% loan when I could make 6-7-8% on that money in those accounts? The subsidies represent anywhere from $4K to $15K to the bottom line!

I"m more wondering aloud at this point, but.......??
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Old 07-15-2012, 04:29 PM   #17
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Yes, I mean borrowing money at a low rates for a few years to drop myself below the 400% FPL. I have other options in after tax accounts but why not take a 3% loan when I could make 6-7-8% on that money in those accounts? The subsidies represent anywhere from $4K to $15K to the bottom line!

I"m more wondering aloud at this point, but.......??
If you were sure you could make 6-8% then you should borrow money at today's rates regardless of the health care law. I'm not so sure so I don't do it. But the "free" and sure-thing subsidy money changes things a bit.
1) Worst option: Withdraw from 401Ks/TIRAs. You get taxed on the withdrawal and lose big HC subsidies.
2) Tied for "better option": Leave 401K/TIRAs funds in place. Withdraw from Roths, taxable accounts, or get a low-interest loan to pay for living expenses. Slurp up those subsidies.

There's going to be lots of "bunching" of income going on, with folks arranging their affairs so they can grab the subsidies every other year.

Somebody is going to invent software to help people extract every possible dollar from this machine.
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Old 07-15-2012, 05:03 PM   #18
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Yes, I mean borrowing money at a low rate for a few years to drop myself below the 400% FPL. I have other options in after tax accounts but why not take a 3% loan when I could make 6-7-8% on that money in those accounts? The subsidies represent anywhere from $4K to $15K to the bottom line!

I"m more wondering aloud at this point, but.......??
Uh oh.... I see another should you have a mortgage debate

Do you have any assets other than tax deferred accounts that you could use as collateral for the loan? 3% is a pretty good rate... suspect in reality it would be higher.
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Old 07-15-2012, 05:38 PM   #19
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Uh oh.... I see another should you have a mortgage debate

Do you have any assets other than tax deferred accounts that you could use as collateral for the loan? 3% is a pretty good rate... suspect in reality it would be higher.
Getting an agressive rate won't be a problem. Again, if one can save ~$10K a year by backing away from the cliff, options open up tremendously.

Frankly, I suspect our illustrious leaders will modify this aspect of the subsidy once they realize this hole exists.
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