Retirement Planning Spreadsheets with a Tax Bracket Warning

[SoReady]

The problem in the US is what I like to call parallel taxation. The 49.95% marginal rate happens when, for example, you get $100 from a taxable source. That is the only extra money that you get, but that extra $100 makes $85 of your Social Security taxable, at the same time, in parallel. That combined $185 also makes $185 of your dividend income taxable, again at the same time, what I call the parallel taxation of your parallel taxation.

You only got $100 from a single source, but that causes the IRS to tax you on 3 separate sources of income.

Thanks, this is interesting. I'm just ramping up on learning taxes and this explanation was helpful to me, but at the same time makes me realize how complex it is!

Bob

 

[Brett_Cameron]

I'm not in that league but it is same principal except smaller numbers.

My Excel based retirement planning spreadsheet is a 40+ year deterministic projection of the progression of our taxable, tax-deferred and tax-free assets considering our spending, my pension, SS, mortgage payments, etc.

Embedded within that projection is a simplified tax calculation that projects taxable income, ordinary and qualified income and federal and state income taxes.

The taxable income includes taxable account dividends, capital gains from sales of assets to support spending, pension, 85% of SS, Roth conversions, IRA withdrawals, RMDs, less the higher of the standard deduction or the sum of property taxes, state income taxes, mortgage interest, and contributions... less 2 exemptions.

Since going forward under the new law we'll likely be using the standard deduction, it will be much simpler. In 2018 I'll probably reconstruct it from scratch since our financial life is more simple now than it was when I first put it together.

I did this too.

 

[Brett_Cameron]

Ooh, ooh!! And maybe include comments/notes in the cells to explain what is going on? Again, only if it is convenient for you.

 

[RunningBum]

The problem in the US is what I like to call parallel taxation.

That's a good term to describe the concept.

 

[Al18]

Sandy & Shirley,
Thanks for posting the graph this morning - it was very helpful. This chart really shows the results of doing Roth Conversions prior to collecting SS.

Sorry for my earlier criticism - I was not fully understanding the concept of high marginal tax rates causing the hump.

 

[Jerry1]

I'm sorry, given the holidays and all, I may have missed a response regarding my question. Is there a software or link to a spreadsheet that one can use to model this "hump" type of impact? I did read that some just use a tax software and tweak the numbers to see the impact, but the simplicity of the graph above and inputting gross numbers for LTCG, Ordinary income, etc is nice. At least something I can start to understand.

Bob

I think so far, the best alternative is the tax software. I went to a seminar and the FA had some slick software but it wasn't free - well, maybe if you let him manage your funds for 1%. The seminar was very enlightening on how complex this tipis is and how important it is. If I wasn't willing to do the research and use the tax software, I might be willing to pay (on an hourly basis) an FA to run some scenarios a couple times a year. People say the decision on when to take SS is complex. IMO, it's nothing compared to how best to keep your taxes in check. I've got most of my savings in tax deferred vehicles. Minimizing the tax as I take it out is as meaningful (maybe more so) than my actual earnings.

 

[43210]

The best alternative is really to understand the math directly. Then the tax software or spreadsheets, graphs, info on web, etc, can reinforce that.

 

[SoReady]

I think so far, the best alternative is the tax software. I went to a seminar and the FA had some slick software but it wasn't free - well, maybe if you let him manage your funds for 1%. The seminar was very enlightening on how complex this tipis is and how important it is. If I wasn't willing to do the research and use the tax software, I might be willing to pay (on an hourly basis) an FA to run some scenarios a couple times a year. People say the decision on when to take SS is complex. IMO, it's nothing compared to how best to keep your taxes in check. I've got most of my savings in tax deferred vehicles. Minimizing the tax as I take it out is as meaningful (maybe more so) than my actual earnings.

Which tax software are you using?

 

[Scuba]

The best alternative is really to understand the math directly. Then the tax software or spreadsheets, graphs, info on web, etc, can reinforce that.

Agreed. What do you think is the easiest way to gain this understanding? I don’t understand it now, would have no chance of modeling our situation accurately.

 

[daylatedollarshort]

I use Taxcaster online and plug the results into a custom spreadsheet.

 

[RunningBum]

Agreed. What do you think is the easiest way to gain this understanding? I don’t understand it now, would have no chance of modeling our situation accurately.

I would use Turbo Tax, and try to understand the pieces that make up your tax amount, such as the QDiv & LTCG worksheet which explains how the 15% tax on Divs and LTCGs can parallel the 15% income tax to make 30%. I'm not collecting SS yet so I'm not sure where the taxability of that is calculated but it shouldn't be hard to find. Same with subsidies. If you understand the pieces and just want to see the bottom line, TaxCaster should be fine but I don't think it shows the underlying forms and worksheets.

 

[43210]

The best alternative is really to understand the math directly. Then the tax software or spreadsheets, graphs, info on web, etc, can reinforce that.

Agreed. What do you think is the easiest way to gain this understanding? I don’t understand it now, would have no chance of modeling our situation accurately.

One key math concept to understand is "Piecewise Functions". You can google it, but here are a few links.
https://en.wikipedia.org/wiki/Piecewise
Piecewise Functions | Coolmath.com
https://www.khanacademy.org/tag/piecewise-functions

Then understand that things like
max(f(x),g(x))
min(f(x),g(x))
can be viewed as piecewise functions.

Also marginal rates are like derivatives (from calculus), except there is often some rounding.

Also there are really more than one variable (e.g. different forms of income taxed differently) so you actually have partial derivatives of multivariable functions.