Retirement Planning Spreadsheets with a Tax Bracket Warning

[Sandy & Shirley]

I’m looking for some good retirement planning spreadsheets that will warn me when my combined income sources are getting me close to the 25%, now 22%, tax bracket.

When you combine the new 22% bracket with the 85% taxability of your Social Security benefits you end up in a 40.7% marginal tax bracket until 85% of your benefits have been taxed. If some of your income is from Dividends or Long Term Gains, pushing those into the 22% bracket can result in a marginal tax bracket of 49.95%.

I want to make sure that the spreadsheet I use tells me how close I am getting to those brackets so that I can make alternative decisions to avoid those huge tax rates.

I have a spreadsheet that attempts to do this, but I’m looking for other spreadsheets that might show me better ways to do the calculations.

 

[pjigar]

I made a simple spreadsheet that accounts for deductions and child credit (things that only apply to me) but you are welcome to build on it.

One comment though: I consider the optional work as a choice. You work if you like or stop if you don't like regardless of the tax patently of working. You are doing mental accounting when you consider tax penalty of optional income into the equation.

 

[joeea]

When you combine the new 22% bracket with the 85% taxability of your Social Security benefits you end up in a 40.7% marginal tax bracket until 85% of your benefits have been taxed. If some of your income is from Dividends or Long Term Gains, pushing those into the 22% bracket can result in a marginal tax bracket of 49.95%.

Can you explain how a 22% marginal rate equals a 40.7% marginal tax bracket? Perhaps it's the terminology but I don't understand what you are saying at all.

 

[MichaelB]

Can you explain how a 22% marginal rate equals a 40.7% marginal tax bracket? Perhaps it's the terminology but I don't understand what you are saying at all.

You’ll probably find an explanation in these threads
http://www.early-retirement.org/forums/f28/social-security-marriage-hump-penalty-88579.html
http://www.early-retirement.org/forums/f27/marginal-tax-rates-repost-86048.html

 

[Sandy & Shirley]

Can you explain how a 22% marginal rate equals a 40.7% marginal tax bracket? Perhaps it's the terminology but I don't understand what you are saying at all.

Legislation was passed in 1983 that defined a “basis” for the taxation of your Social Security benefits as half of your SS benefit plus your other taxable income, including government bonds and dividends and LTCGs. When that basis crosses over $25,000 for single tax payers and $32,000 for married, you enter the 50% taxability bracket until 50% of your SS benefits have been taxed.

The legislation taxes dollar for dollar, but I like to use $100 as an example to make the results easier to follow.

If you are in that “taxability” bracket and take an additional $100 out of your IRA or any other taxable source, $50 of your previously tax free SS benefit becomes taxable income, so a $100 withdraw increases your taxable income by $150. If you are in the new 12% tax bracket, 12% of $150 results in a $18 increase in your taxes and $18 is 18% of $100. Your tax bracket is 12%, but your “Marginal” tax rate is 18%.

The 1993 legislation added a second taxability category of 85% taxability until 85% of your SS benefits have been taxed. This second category starts at $34,000 if you are single and $44,000 if you are married.

All of the taxability points, $25,000, $32,000, $34,000, and $44,000 are NOT COLA adjusted. The lack of a COLA adjustment was done so that the amount of taxation would increase with inflation.

Can you explain how a 22% marginal rate equals a 40.7% marginal tax bracket? Perhaps it's the terminology but I don't understand what you are saying at all.

OK, now to your specific question: If 85% of your SS benefit is not already being taxed, taking $100 out of your IRA makes an additional $85 of your SS benefit taxable so your taxable income will increase $185 and 22% of $185 is $40.70. $40.70 if 40.7% of the $100 that you withdrew. Your actual “Marginal Tax Bracket” would also include your state and local taxes, but I am giving this example for Federal taxes only. Your Marginal tax bracket is the total amount of additional taxes you pay for each additional dollar of income.

Bare with me on this one, it is a bit complex: Dividend and LTCG income is also tax deferred until that income is pushed into the 22% bracket at which time it is then taxed at 15% (that tax rate did not change with the new law).

Let’s say that you are single and your total taxable income plus taxable SS is $38,400 and your tax free dividend income in $300, your total income would be $38,700 which is the start of the 22% bracket. You would be in the 12% bracket at the $38,400 level and 0% for your dividends since they have not crossed the 22% bracket level.

OK, now you withdraw an additional $100 from your taxable IRA which makes an additional $85 of your SSB taxable. Your taxable income increases from $38,400 to $38,585, a $185 increase at 12% which increases your taxes by $22.20. $185 of the $300 of dividends that were below the 22% boundary have also been pushed over the 22% boundary. $115 is still below 22% and are still tax free, and the $185 that was pushed over into the 22% bracket are now taxed at the 15% dividend bracket. 15% of $185 also increases your taxes by an additional $27.75 AND $22.20 plus $27.75 results in a $49.95 tax increase because you withdrew $100 which results in a 49.95% marginal tax bracket.

Any guesses why I am so interested in when my taxable retirement income crosses into the 22% bracket!

 

[Sandy & Shirley]

You’ll probably find an explanation in these threads
http://www.early-retirement.org/forums/f28/social-security-marriage-hump-penalty-88579.html
http://www.early-retirement.org/forums/f27/marginal-tax-rates-repost-86048.html

Thanks for finding my previous posts Michael. Those posts are for the 2017 25% bracket, and the new 22% bracket is basically just a replacement for the 25% bracket!

 

[43210]

I just posted in one of those old threads but maybe I should say it here. (Responding to people who are surprised at high marginal rates.)

You could forfeit up to $6,444 in EITC if you go over the Investment Income Limit by $0.01.
https://www.irs.gov/credits-deducti...ncome-limits-maximum-credit-amounts-next-year

So that's a 64,440,000% (sixty four million four hundred and forty thousand percent) tax bracket!

There are plenty of examples like this. Watch out.

 

[Sandy & Shirley]

Thanks 43210, these are the kinds of tax loopholes and traps that we all need to be aware of. That is the reason why I am so passionate about the thing I have labeled as “The Tax Hump”. Shirley and I are both retired now and no longer have any dependent children. Since our income levels are not in the 6 figure range it is difficult to find affordable professional help to point out those traps.

I won’t give any actual numbers, but I made about 20% more than Shirley while working. I retired first and did not know about the loopholes and traps and made some wrong choices. Having a lot of free time I started researching the proper way to plan for retirement. The end result is that Shirley will have a locked in retirement income 20% higher than mine, a complete 180 degree result based on knowing about the traps in advance and proper planning to avoid them.

For example, when BRexit happened I learned all about Roth Conversions and recharacterizations. We were able to do conversions at about double the amount we could afford at her 25% bracket level and my Medicare income cap. At the end of the year we merely looked at which conversions had the highest rates of return and used recharacterizations to “keep the best and undo the rest”. Too bad that recharacterization is no longer legal under the new tax laws.

 

[joeea]

OK, now you withdraw an additional $100 from your taxable IRA which makes an additional $85 of your SSB taxable. Your taxable income increases from $38,400 to $38,585, a $185 increase at 12% which increases your taxes by $22.20. $185 of the $300 of dividends that were below the 22% boundary have also been pushed over the 22% boundary. $115 is still below 22% and are still tax free, and the $185 that was pushed over into the 22% bracket are now taxed at the 15% dividend bracket. 15% of $185 also increases your taxes by an additional $27.75 AND $22.20 plus $27.75 results in a $49.95 tax increase because you withdrew $100 which results in a 49.95% marginal tax bracket.

Any guesses why I am so interested in when my taxable retirement income crosses into the 22% bracket!

I see what you meant now. Thanks.

 

[Sandy & Shirley]

That is $49.95 in taxes for every $100 of dividend income and then $40.70 for every $100 of IRA withdrawals until 85% of your SSB has been taxed. At higher SSB levels the width of those high marginal brackets can be thousands of dollars wide.

There can be cases where you need an extra $2,000 to cover a home repair and you have to withdraw $4,000 or $5,000 to cover your Federal and State taxes and have $2,000 left to cover the expense!

 

[43210]

I see it now. You desperately want to avoid paying an extra $49.95 in taxes.

An interesting goal.

That's a mean comment. Obviously OP used a $100 increment to demonstrate the effect of the change. A much bigger increment could have been used, as you surely realize.

 

[joeea]

That's a mean comment. Obviously OP used a $100 increment to demonstrate the effect of the change. A much bigger increment could have been used, as you surely realize.

It wasn't intended to be mean, just observational.

Whenever there are breakpoints in any tax situation, you'll end up with odd marginal rates for certain segments. But worrying about marginal rates makes no sense to me. The total amount you spend on taxes is important and might make sense to worry about.

In looking at some of the previous threads regarding this "hump" and marginal rate situation, I see that others have made a similar point to mine. So I won't bother any longer.

 

[43210]

Here's a list of some phaseins and phaseouts. These will change, but the phenomena remain. There are "cliffs" too.
How do phase outs of tax benefits affect taxpayers? | Tax Policy Center.

 

[racy]

...Whenever there are breakpoints in any tax situation, you'll end up with odd marginal rates for certain segments. But worrying about marginal rates makes no sense to me. The total amount you spend on taxes is important and might make sense to worry about...

+1 my thought, too.

Do the reverse thought experiment: I have a dollar in my piggy bank. I put in a dollar. I have a 100% increase!
Later, I have $100 in my piggy bank. I put in a dollar. Nuts, only a 1% increase.

 

[PatrickA5]

I’m looking for some good retirement planning spreadsheets that will warn me when my combined income sources are getting me close to the 25%, now 22%, tax bracket.

When you combine the new 22% bracket with the 85% taxability of your Social Security benefits you end up in a 40.7% marginal tax bracket until 85% of your benefits have been taxed. If some of your income is from Dividends or Long Term Gains, pushing those into the 22% bracket can result in a marginal tax bracket of 49.95%.

I want to make sure that the spreadsheet I use tells me how close I am getting to those brackets so that I can make alternative decisions to avoid those huge tax rates.

I have a spreadsheet that attempts to do this, but I’m looking for other spreadsheets that might show me better ways to do the calculations.

I haven't tried to come up with a spreadsheet (yet) since I'm not taking SS and have no LTCG. There's a fairly narrow band where this is important over which SS is 85% taxable and/or LTCG's are taxed above 0%. Instead of making a spreadsheet, couldn't you just plug some number in TurboTax and see at what point these issues begin and end? Admittedly, combining SS and LTCG and ACA and EITC and Savers Credit, etc could be a pretty complex spreadsheet

 

[pb4uski]

..... For example, when BRexit happened I learned all about Roth Conversions and recharacterizations. We were able to do conversions at about double the amount we could afford at her 25% bracket level and my Medicare income cap. At the end of the year we merely looked at which conversions had the highest rates of return and used recharacterizations to “keep the best and undo the rest”. ....

Yeah... the horse-race jockeys ruined it all for the rest of us.

 

[CaliforniaMan]

...
Whenever there are breakpoints in any tax situation, you'll end up with odd marginal rates for certain segments. But worrying about marginal rates makes no sense to me. The total amount you spend on taxes is important and might make sense to worry about.
...

+1
Ever since before I retired almost 4 years ago I have had a spreadsheet which shows my withdrawal rate and estimated taxes, with a red warning when the taxable annual income goes over the specified marginal bracket. Well so far, every year I have gotten that red warning. So what am I supposed to do, spend less just so I don't get the warning, even though I am already spending less than FireCalc says I can? I am a data and calculation nut so I like to see my estimated my total taxes (Fed + State) and marginal tax rates automatically computed on my spreadsheet, but have found the marginal tax rate to be pretty useless for taking any actual action.

 

[bobandsherry]

+1
Ever since before I retired almost 4 years ago I have had a spreadsheet which shows my withdrawal rate and estimated taxes, with a red warning when the taxable annual income goes over the specified marginal bracket. Well so far, every year I have gotten that red warning. So what am I supposed to do, spend less just so I don't get the warning, even though I am already spending less than FireCalc says I can? I am a data and calculation nut so I like to see my estimated my total taxes (Fed + State) and marginal tax rates automatically computed on my spreadsheet, but have found the marginal tax rate to be pretty useless for taking any actual action.

Well you could plan for one year to be larger withdrawal then you need, then keep subsequent years back under the red zone. Similar to when people bunch up deductions, but the reverse.

 

[Sandy & Shirley]

The size of the hump varies for each individual. This is an image using the 2017 or 2016 tax brackets, but it shows what I am saying. The horizontal scale is per capita and has to be doubled for a married couple. The married couple (red line) starts paying taxes earlier than a single individual because their SS benefits are taxed earlier. Single taxability starts at $25,000 while married starts at $32,000 ($16,000 per capita). Since taxability starts earlier it also ends earlier, but the width of the red Hump is from about $58,000 to $63,000, $5,000 each or $10,000 for the couple. That is a lot of $100 increments!

The single individual’s (blue line) Hump goes from about $63,000 to $74,000. This Hump is wider because the single individual starts paying taxes on the SSB later.



This is better illustration of how everyone’s Hump is different. Note how the higher Social Security benefit levels make the green, blue and red lines start later which causes their Humps to start later and also causes their Humps to be wider. Again, this is an older chart based on 2016 or 2017 tax brackets and benefits levels based on age at retirement.

 

[Al18]

The planner in me understands the concept of trying to keep taxes low, but my better half says live a little - you can afford the taxes. My goal in my retirement (in a few months), is to enjoy myself - not tweaking my finances to pay the least amount of taxes possible.

 

[joeea]

So what am I supposed to do, spend less just so I don't get the warning, even though I am already spending less than FireCalc says I can? I am a data and calculation nut so I like to see my estimated my total taxes (Fed + State) and marginal tax rates automatically computed on my spreadsheet, but have found the marginal tax rate to be pretty useless for taking any actual action.

Just don't worry about it. (Or at least I wouldn't.)

You don't run out of money because your marginal tax rate is "high" or "higher than it was" or if you are in a "hump". You run out of money if you are spending too much.

In your case, you aren't spending too much, no matter what the marginal rate calculator says.

 

[bobandsherry]

The planner in me understands the concept of trying to keep taxes low, but my better half says live a little - you can afford the taxes. My goal in my retirement (in a few months), is to enjoy myself - not tweaking my finances to pay the least amount of taxes possible.

Agree - however being aware of these humps helps with withdrawal strategy. Say, take more one year and lower your withdrawals the subsequent years. But do what makes you feel good.

 

[Jerry1]

Whenever there are breakpoints in any tax situation, you'll end up with odd marginal rates for certain segments. But worrying about marginal rates makes no sense to me. The total amount you spend on taxes is important and might make sense to worry about.

Worrying about marginal tax rates didn't make sense to me either as a young CPA. I kept thinking in terms of averages. However, marginal tax rates are very significant when a client asks you to help them make a decision. Let's say I need a new roof. Let's say it's $10,000. If I'm right on the edge of a tax bracket, say 28%, if I do it this year, I have to pay an extra $2,800 in taxes. Sure, that only increases my average tax rate to say something like 16%, but if you only waited until after the first of the year, you'd have saved $2,800. I bet when you shopped for the roof, all other things being equal, you'd jump at the opportunity to have it done for $2,800 less.

As a community of people who generally live below their means or live frugally, I can't imagine ignoring tax consequents of certain actions.

On the other hand, income was also mentioned. Let's say you do some extra work and because of the tax situation, you have to fork over 40% to the tax man. This is different than the expense example. At least your work nets you additional money. You can decide if the large tax bit makes it no longer worth your time to do the work, but in the end, you're at least financially better off. When it's an expense (repair), you're out additional money that you could have potentially planned better and not spent.

Marginal tax rates should not prevent you from doing anything (spending or earning), but when you're making a decision to do either, it's an important piece of information to have.

 

[pb4uski]

That is always the dilemma. For example, this year I did a $30k Roth conversion (to the top of the 15% tax bracket with our other income) and will pay 8.6% in tax on that $30k. Not bad.

If I take another $30k (so $60k in total) then I will pay 19.3% on the $60k.. that doesn't sound so bad either..... until you figure out that the marginal rate on that second $30k is 30%! Ouch!

(50%*8.6%) + (50%*30%) = 19.3%

 

[bingybear]

OP - The alert planning for the SS tax hump will likely not benefit me. It is so many years off and RMDs will likely dictate if we hit the hump.

IIRC you wanted to track income, CG, dividends, etc. So you need to plan all your income from all sources that effect the hump. You also need a second set of books. You should also add maybe one extra place to put additional income for each month. You populate the plan with expected incomes and you create a mirror plan with all blanks. The mirror is where you populate the actual incomes as they come in. If something on the plan is not going to be funded you would fill the mirror with 0.
You then sum up all the income using the mirrors if they have a value in them, other wise the plan cell will be used. Your alarm is triggered the this sum is too close or above your threshold. It should be simple after you have a budget.

It could be difficult to avoid the hump depending upon your situation