Retirement Tax Planning - Income Optimization?

[fishfactory]

rkser,
Glad to hear it ! The software seems to be very flexible with ways to work around special situations like yours.

[rkser]

Now I am stuck at the taxable Interest on the 1040,
I do not how the software is coming up with a much higher projected figure, but the Bank & CD interest is 1/4 th of what is shown on 1040.
Maybe it will correct itself as & when the year end Bank 1099s come in, but now the projected taxable income & the Tax are very inflated.

[walkinwood]

Midpack,

I think this is evident, but to be sure - in your 3 scenarios (no conversions, conversions to 22%, and to 24%), the amount of after-tax (federal) annual spending you specify is the same. Right?

Also, do you have state taxes? Does this software allow that to be taken into consideration?

Fascinating thread.

[rkser]

Fishfactory,

Josh added me in the Google Group of First Capital Users. I am still feeling my way through the software, there is lot to input & to learn its workings.

I am getting incorrect Taxable income projection, at least till I find the right input answer in the You Tube Videos.

[Midpack]

See below

Quote:

Originally Posted by walkinwood Midpack, I think this is evident, but to be sure - in your 3 scenarios (no conversions, conversions to 22%, and to 24%), the amount of after-tax (federal) annual spending you specify is the same. Right? Exactly the same, I can't imagine doing a fair comparison otherwise. Also, do you have state taxes? Does this software allow that to be taken into consideration? Yes it asks your state and factors those income taxes in. Fascinating thread.

[Sandy & Shirley]

Line 5 on your 1040 tax return can be extremely costly during retirement. Box 5a asks how much did we get from Social Security and box 5b asks how much of your Social Security Benefits are taxable income. Once we reach a certain income level each additional dollar of income causes an additional 50 cents of our SSB to become taxable income, then at a second income level each dollar causes 85 cents to become taxable until 85% of our total benefit has been taxed.

When one dollar of extra income also cause 85 cent of our SSB to also become taxable, your AGI and taxable income increases by $1.85, not just $1.00. 12% of $1.85 is 22.2 cents and 22% of $1.85 is 40.7 cents. Your Marginal Tax Rates, the taxes you pay on the next dollar of income, are 22.2% then 40.7% then back to 22% once 85% of your SSB has been taxed.

One thing that I have learned during retirement is to start doing my tax returns in January. Not the January of the next year after I got my W2s when I was working, but the January of the current year. By the end of January I know how much Social Security I will get that year and how much my yearly pension income will be, plus other guaranteed income like annuities etc. Using this information I can then calculate how much other income I can create from IRA withdrawals, part time jobs, capital gains, etc. before I reach the top end of the 12% Federal Tax Bracket, the 22.2% Marginal Tax Rate.

I redo my tax return every time BEFORE I create extra income. My goal is to know when to switch from IRA withdrawals to Roth withdrawals so that none of my income will be taxed at the 40.7% Marginal Tax Bracket. I also redo my tax return right after Christmas each year to see if I can withdraw extra IRA funds at the 22.2% Marginal Tax Rate to reduce my taxable income needs for the next year.

The primary reason that I can do this is because I did a number of Roth Conversions prior to starting my Social Security benefits. I also used these conversions to do backdoor Roth Contributions. I told my broker to do the Roth Conversion and to withhold zero taxes, then I immediately went on line and filed state and federal estimated tax returns using non-IRA money. 100% of my IRA funds went into my Roth account, not just 70% after tax, a 30% backdoor contribution!

A special note to married couples; this end of year tax check is a good time to do Roth Conversions. Your surviving spouse will be forced to pay taxes at the single tax bracket rates so the amount of extra taxable income before reaching their 40.7% Marginal Tax Rate will be greatly reduced.

Let’s look at some numbers to see how larger Social Security benefit levels can create larger pre 40.7% retirement income levels with lower IRA withdrawals. Note: read the last column like it is a paragraph that explains the other columns.

Social Security	$54,000	$60,000	$70,000	Larger SSB levels
IRA / Pen / etc	$61,838	$60,460	$58,163	require less other income
Gross Income	$115,838	$120,460	$128,163	resulting in more gross income.
Taxable SS Basis	$88,838	$90,459	$93,162	This increases your "Basis" for
Taxable SSB	$44,112	$45,490	$47,787	the amount of your taxable SSB.
Taxable %	81.69%	75.82%	68.27%	Lower % taxed
Tax Free %	18.31%	24.18%	31.73%	Higher % tax free
AGI	$105,950	$105,950	$105,950	The target for all of this is the
Deductions	$27,000	$27,000	$27,000	after standard age 65 deductions
Taxable	$78,950	$78,950	$78,950	maximum taxable income at
Fed Tax Bracket	12%	12%	12%	the 12% federal tax bracket.
Federal Tax Due	$9,086	$9,086	$9,086	Everyone pay the same taxes
After Fed Tax	$106,752	$111,374	$119,077	but after tax income is higher,
Overal Tax Rate	7.84%	7.54%	7.09%	and your overall tax rate is lower.
Hump Width	$2,104	$6,482	$13,780	BUT the 40.7% tax hump is larger
At 40.7%	$856	$2,638	$5,608	costing more if you didn't plan for it.

I call the graph line of the 22.2% to 40.7% back to 22% Marginal Tax Rates the Tax Hump, I think that this is what you call the Tax Torpedo on this forum.

A special note here: if you have LTCGs the top end of the 12% standard tax bracket causes those gains to also become taxable at 15% for a total Marginal Tax Rate of 27% without the taxation of your Social Security. This 27% rate becomes 49.95% when each extra dollar of income increases your taxable income to $1.85.

The Tax Hump, Torpedo, becomes 22.2% to 49.95% to 40.7% back to 22%! Even more reason to plan ahead and start your tax returns in January of the CURRENT year, not next year!

[Dtail]

Quote:

Originally Posted by Sandy & Shirley Line 5 on your 1040 tax return can be extremely costly during retirement. Box 5a asks how much did we get from Social Security and box 5b asks how much of your Social Security Benefits are taxable income. Once we reach a certain income level each additional dollar of income causes an additional 50 cents of our SSB to become taxable income, then at a second income level each dollar causes 85 cents to become taxable until 85% of our total benefit has been taxed. When one dollar of extra income also cause 85 cent of our SSB to also become taxable, your AGI and taxable income increases by $1.85, not just $1.00. 12% of $1.85 is 22.2 cents and 22% of $1.85 is 40.7 cents. Your Marginal Tax Rates, the taxes you pay on the next dollar of income, are 22.2% then 40.7% then back to 22% once 85% of your SSB has been taxed. One thing that I have learned during retirement is to start doing my tax returns in January. Not the January of the next year after I got my W2s when I was working, but the January of the current year. By the end of January I know how much Social Security I will get that year and how much my yearly pension income will be, plus other guaranteed income like annuities etc. Using this information I can then calculate how much other income I can create from IRA withdrawals, part time jobs, capital gains, etc. before I reach the top end of the 12% Federal Tax Bracket, the 22.2% Marginal Tax Rate. I redo my tax return every time BEFORE I create extra income. My goal is to know when to switch from IRA withdrawals to Roth withdrawals so that none of my income will be taxed at the 40.7% Marginal Tax Bracket. I also redo my tax return right after Christmas each year to see if I can withdraw extra IRA funds at the 22.2% Marginal Tax Rate to reduce my taxable income needs for the next year. The primary reason that I can do this is because I did a number of Roth Conversions prior to starting my Social Security benefits. I also used these conversions to do backdoor Roth Contributions. I told my broker to do the Roth Conversion and to withhold zero taxes, then I immediately went on line and filed state and federal estimated tax returns using non-IRA money. 100% of my IRA funds went into my Roth account, not just 70% after tax, a 30% backdoor contribution! A special note to married couples; this end of year tax check is a good time to do Roth Conversions. Your surviving spouse will be forced to pay taxes at the single tax bracket rates so the amount of extra taxable income before reaching their 40.7% Marginal Tax Rate will be greatly reduced. Let’s look at some numbers to see how larger Social Security benefit levels can create larger pre 40.7% retirement income levels with lower IRA withdrawals. Note: read the last column like it is a paragraph that explains the other columns. Social Security $54,000 $60,000 $70,000 Larger SSB levels IRA / Pen / etc $61,838 $60,460 $58,163 require less other income Gross Income $115,838 $120,460 $128,163 resulting in more gross income. Taxable SS Basis $88,838 $90,459 $93,162 This increases your "Basis" for Taxable SSB $44,112 $45,490 $47,787 the amount of your taxable SSB. Taxable % 81.69% 75.82% 68.27% Lower % taxed Tax Free % 18.31% 24.18% 31.73% Higher % tax free AGI $105,950 $105,950 $105,950 The target for all of this is the Deductions $27,000 $27,000 $27,000 after standard age 65 deductions Taxable $78,950 $78,950 $78,950 maximum taxable income at Fed Tax Bracket 12% 12% 12% the 12% federal tax bracket. Federal Tax Due $9,086 $9,086 $9,086 Everyone pay the same taxes After Fed Tax $106,752 $111,374 $119,077 but after tax income is higher, Overal Tax Rate 7.84% 7.54% 7.09% and your overall tax rate is lower. Hump Width $2,104 $6,482 $13,780 BUT the 40.7% tax hump is larger At 40.7% $856 $2,638 $5,608 costing more if you didn't plan for it.         I call the graph line of the 22.2% to 40.7% back to 22% Marginal Tax Rates the Tax Hump, I think that this is what you call the Tax Torpedo on this forum. A special note here: if you have LTCGs the top end of the 12% standard tax bracket causes those gains to also become taxable at 15% for a total Marginal Tax Rate of 27% without the taxation of your Social Security. This 27% rate becomes 49.95% when each extra dollar of income increases your taxable income to $1.85. The Tax Hump, Torpedo, becomes 22.2% to 49.95% to 40.7% back to 22%! Even more reason to plan ahead and start your tax returns in January of the CURRENT year, not next year!

I appreciate your reminders from time to time of this tax hump concept.
It is often an overlooked concept. Many folks worry about the tax torpedo of SS/RMD's pushing them into higher marginal tax brackets.
Your concept is effectively a subset of the tax torpedo "hidden" within lower tax brackets.

[RunningBum]

Quote:

Originally Posted by Sandy & Shirley Line 5 on your 1040 tax return can be extremely costly during retirement. ...

My abbreviated take on this is that you should figure out whether the max 85% of your SS benefits will be taxed. If not, extra income will be taxed and also push more SS benefits to be taxed--the SS tax hump. At lower income levels, the hump may be less or non-existent, but I haven't done the calcs to figure out where that is.

A good way to avoid this is to have no RMDs, which means converting your tIRA to a Roth before you start taking SS. I think some who are gun shy about not paying Roth conversion taxes now are going to be in for a nasty tax surprise later.

That's not a single determinant for whether and how much to convert, but it certainly is a tie breaker if you think your tax rate in later years will otherwise be the same as you're in now. It's hard to calculate the actual numbers. I've tried but gave up, but I saw enough to convince me to try to convert all of my tIRA by age 70, though not at the expense of the ACA subsidy.

Once you are taking SS it's still worth figuring this out to decide whether to take cap gains, tIRA withdrawals (if you still have a tIRA) or Roth withdrawals as S&S says.

[Sandy & Shirley]

It is also important to remember MAGI when you are doing your Roth Conversions!

MAGI is not the name of your mother in law! It stands for Modified Adjusted Gross Income which Fed uses to determine how much they are going to charge you for your Medicare coverage. They get this number from your tax return from two tax years prior each year. The year you turn 65 and start your Medicare, they look at your tax return for the year you turned 63. The next year you will be 66 and they look at your age 64 return, etc. So, if possible you should try to do your largest Conversions the year your turn 62 or earlier. If not you have to also consider your extra Medicare costs as part of the cost of the conversion.

[Sandy & Shirley]

Related to the Hump or Torpedo or whatever you want to call it is what far too many married couples fail to plan for, The Survivor Penalty!

If you do not plan your inheritance properly, your surviving spouse could have the same income as you did as a married couple while being faced with higher tax rates because they will have to file the same income levels as a single individual instead of a married couple.




In this example we see a married couple with $25,000 and $30,000 Social Security benefits plus additional taxable income of $45,000 from pensions, annuities, IRA withdrawals, etc. Their total annual married income is $100,000 and the top graph shows that their income level is more than $15,000 below their personal 40.7% Marginal Tax Hump. Their federal taxes will be $5,452.

When one of them passes away, the survivor will lose the $25,000 SSB and keep the larger SSB. Assuming that all of their pensions, annuities and other taxable income sources continue for the survivor, the additional income will remain at $45,000. The Widow’s annual gross income will drop to $75,000 and the lower graph shows that her income level will be higher than the top end of her personal 40.7% tax hump created as a single individual vs. a married couple. Her federal taxes will be $8,454!

The Widow is not only losing the $25,000 SSB, but also has to pay an additional $3,002 in taxes!

Note how the dotted green Taxable SS line starts well before and even jumps to 85% before the red married Marginal Tax Rates in the first graph.

Note also that the survivor’s Tax Hump is larger because the 85% taxation of their benefits started well after the start of their single Marginal Tax line and therefore extended further to reach the total 85% taxation of their benefits.

The Economic Growth and Tax Relief Reconciliation Act of 2001 eliminate most of marriage penalties that existed in our tax laws prior to that time. The Income Tax Bracket for middle income married couples are now double those of a Single Individual and the Medicare premiums paid by retired married individuals are also based on double the income levels of single individuals.

Unfortunately, the penalty still exists for the income levels defined in 1983 and 1993 for the taxation of our Social Security benefits!




If the Marriage Penalty for Social Security taxation was eliminated in 2001 the first Married line would be the same as the Domestic Partners line.

[SecondCor521]

Another part of the what S&S list above as the survivor penalty is that the IRMAA surcharge tiers are at lower income levels for single than for MFJ. So a couple that was paying an IRMAA surcharge at the first tier when MFJ may pay at the second or third tier two years after the first spouse passes.

[Midpack]

The software I was using factors in actual SS taxes, IRMAA, MAGI, survivor tax impact*, etc. That, and the detail, was the primary benefit to me - there is no way I'd be capable of writing a spreadsheet that includes all the variables and regs.

* though you'd have to use a range of different survivor years to get a sense of impact - e.g. my plan started with a 2 year survivor span at the end but I also did another where one she survived me by 10 years. You can do as many different scenarios as you'd like.

[pb4uski]

Ah... our one-trick pony is back!

Yes, it is good to remind people that SS is taxed.... however, for many people who are positioned to retire early their income is high enough that it will be taxed at 85% anyway so it is a bit of a moot issue... especially since the income hurdle for that purpose includes 1/2 of social security.

Quote:

You will pay tax on only 85 percent of your Social Security benefits, based on Internal Revenue Service (IRS) rules. If you: file a federal tax return as an "individual" and your combined income* is between $25,000 and $34,000, you may have to pay income tax on up to 50 percent of your benefits. more than $34,000, up to 85 percent of your benefits may be taxable. file a joint return, and you and your spouse have a combined income* that is between $32,000 and $44,000, you may have to pay income tax on up to 50 percent of your benefits. more than $44,000, up to 85 percent of your benefits may be taxable. are married and file a separate tax return, you probably will pay taxes on your benefits. Your adjusted gross income + Nontaxable interest + ½ of your Social Security benefits = Your "combined income"

[RunningBum]

Quote:

Originally Posted by pb4uski Ah... our one-trick pony is back! Yes, it is good to remind people that SS is taxed.... however, for many people who are positioned to retire early their income is high enough that it will be taxed at 85% anyway so it is a bit of a moot issue... especially since the income hurdle for that purpose includes 1/2 of social security.

LOL, S&S does seem to have just one topic, don't they?

But note in that chart, the more than $34000single/$45000joint, it says "up to 85%" may be taxed. It means you have at least $1 in the 85% range, but may have some at 50%, and even some untaxed. If I was taking SS (even waiting until 70), my pension, and my expected divs/int/CGs this year, I wouldn't have all of my SS benefits in the 85% taxability range. So I would have some kind of SS hump. Unsure what will happen in 12 years, because the $34K/$45K number hasn't been inflation adjusted while my earnings are. And for all I know they may wind up making all SS benefits taxable.

It can be worth finding a SS taxability calculator or doing a pro forma return to see where one actually falls.

[Gumby]

Our two pensions put us over the 85% taxable level right from the start, so I have never spent a second trying to delve into the oddly fixated S&S posts.

Quote:

Originally Posted by RunningBum It can be worth finding a SS taxability calculator or doing a pro forma return to see where one actually falls.

Here's a very simple calculation:

For MFJ, start with $44k. Add 85% of your social security benefit. If you make more than that, 85% of your social security benefit is taxable.

Here's the link to the IRS form so you can do your own calculation (it's on page 16):
https://www.irs.gov/pub/irs-pdf/p915.pdf#page=16

Essentially, you put in your assumed social security amount on line 1, your other income on line 4 and then crank through the form

[audreyh1]

Our current income pushes us into 85% of our SS being taxed. I spent more of my time reviewing cap gains tax thresholds.

[Sandy & Shirley]

Pb4uski, Ah YES … your one-trick pony is back!


RunningBum, Yes most of my posts relate to avoiding the double taxation of SS and other income.


Audreyh1, The triple taxation of LTCGs, SS and other income creates a marginal tax rate of 49.95%

Here is the graph that is provided by statista.com that shows the “Percentage distribution of household income in the United States in 2018”.


I color coded the bars to make my point. Early retirement is not restricted to the 8.5% of income earners represented by the red bar on the right where the 85% taxation of their benefits is something in their rear view mirror. Many of us in the combined 44.6% green bars in the middle also think about and plan for early retirement where the 40.7% Marginal Tax Rate can become a significant factor, and the huge Marginal Tax Rates can even extend into the 19% combined yellow bars on either side.

My posts and my research are aimed at those with middle to upper middle income who can avoid paying taxes on the full 85% of their Social Security Benefits, if they plan properly for that situation.

Case in point: Shirley is a widow. She retired early and is now getting about 80% of her late husband’s SS benefits. Yes, her Hump Taxes are relatively small right now. When she turns 70 she will switch to 130% of her own SS benefits and her personal Hump Taxes will be substantial without the proper planning. That is the reason I started all of my research and I just want to share it with others.

[Midpack]

Quote:

Originally Posted by Sandy & Shirley Pb4uski, Ah YES … your one-trick pony is back! RunningBum, Yes most of my posts relate to avoiding the double taxation of SS and other income. Audreyh1, The triple taxation of LTCGs, SS and other income creates a marginal tax rate of 49.95% Here is the graph that is provided by statista.com that shows the “Percentage distribution of household income in the United States in 2018”. I color coded the bars to make my point. Early retirement is not restricted to the 8.5% of income earners represented by the red bar on the right where the 85% taxation of their benefits is something in their rear view mirror. Many of us in the combined 44.6% green bars in the middle also think about and plan for early retirement where the 40.7% Marginal Tax Rate can become a significant factor, and the huge Marginal Tax Rates can even extend into the 19% combined yellow bars on either side. My posts and my research are aimed at those with middle to upper middle income who can avoid paying taxes on the full 85% of their Social Security Benefits, if they plan properly for that situation. Case in point: Shirley is a widow. She retired early and is now getting about 80% of her late husband’s SS benefits. Yes, her Hump Taxes are relatively small right now. When she turns 70 she will switch to 130% of her own SS benefits and her personal Hump Taxes will be substantial without the proper planning. That is the reason I started all of my research and I just want to share it with others.

Would you mind starting your own thread instead of hijacking this one? Moderators?

[RetireBy90]

While on the topic of the thread and cliffs I finally found the cliff for rental properties. Seems from reading
https://www.irs.gov/pub/irs-pdf/i8582.pdf Starting on Page 9, Passive Income Loss (PAL) is fully phased out at MAGI of $150K. Hard to get the bottom line from these instructions but matching it with my return from last year found magic number for me. So another cliff if you file schedule E then above $150K MAGI kicks you into not claiming a loss on property. Good news for me at least, now that property is producing a profit past losses can be used to offset the profit this year and going forward.

[target2019]

This may be of interest for the thread topic, or at least half of the topic.
https://www.doughroller.net/financia...om-mark-zoril/

I did not find a mention of this in the thread. The link came from B-Heads.

The first year cost is a bit higher than $96 now, but still afoordable. But I don't think the service fills the income optimization part of the thread topic.

I thought the discussion revealed some insight about paid FPs.