Why Most Elderly Pay No Federal Tax

[NW-Bound]

For the few years prior to 2015, I paid just some bitty Federal income tax due to living off my after-tax cache. However, the after-tax dividend was not enough for the expenses, and I have been spending down capital too. It was not really a choice, as I could not get to the tax-deferred accounts before 59-1/2 without penalty, and I did not want the hassle of 72(t) distribution.

I could keep going like this for a few more years, but eventually all that before-tax savings will be taxed at some point. And I want to keep some money in the after-tax accounts for some warm fuzzy feeling, and do not want to deplete it too much. So, I started to draw from the IRA, and got hit by taxes again.

You pay now, or you pay later. I want to spread out the pain. If one is lucky to have a lot more after-tax money, he is golden. I am not in that fortunate situation.

 

[ziggy29]

Hell, I am not even very old yet (45) and when we retired our federal taxes went from $60,000 a year to $1,500. Negative if you count ACA subsidy as sort of a tax break.

I was laid off from Megacorp in 2013. In 2014 our federal income tax burden was a whopping $84, and that was only because we had to pay about $650 in ACA subsidies back to Uncle Sam.

 

[fosterscik]

It's called tax bracket management and is a very important part of retirement planning. Fees and taxes are what eat into PF returns. It can be surprising the degree to which taxes can be minimized in retirement.

Taking this statement further: anyone with tax-deferred savings is surely making a mistake if they pay zero taxes. IMHO, you should always withdraw enough tax-deferred money to hit the top of the 10% or 15% tax bracket (after deductions and allowances) to lock in favorable tax rates and avoid LT capital gains on taxable investments. It seems foolish to me to keep tax deferred savings when later RMDs will likely push you into the 25% or higher bracket.

But perhaps I'm missing something (not an unusual occurrence).

 

[ziggy29]

Taking this statement further: anyone with tax-deferred savings is surely making a mistake if they pay zero taxes. IMHO, you should always withdraw enough tax-deferred money to hit the top of the 10% or 15% tax bracket (after deductions and allowances) to lock in favorable tax rates and avoid LT capital gains on taxable investments.

Almost, though for some people the ACA cliff subsidies add complexities to this. For example, you may not want to use *all* of the 15% bracket if it puts you above 400% of the FPL, for example. You may want to stop at just under 300% or 350% or 400% of FPL, since taking just a few more bucks out wouldn't only be taxed at 15% but cost a lot of money in lost ACA subsidies.

Still, in the absence of ACA considerations what you say is pretty much how I've long felt. If taking out as little as possible today was likely to put me in much higher tax brackets (say 25% and up) later, it's better to get as much as you can out while you can lock in 10% and 15% tax rates on the proceeds -- even if you don't need the current income. You can always move the excess to a taxable investment.

But for someone who isn't 59.5 or higher (or 55 with a 401K) and isn't using Rule 72T to take SEPPs from retirement accounts, it's a moot point anyway -- they can't take out tax-deferred distributions to use up lower tax brackets, not unless they want to get socked with a big tax penalty.

 

[athena53]

Taking this statement further: anyone with tax-deferred savings is surely making a mistake if they pay zero taxes. IMHO, you should always withdraw enough tax-deferred money to hit the top of the 10% or 15% tax bracket (after deductions and allowances) to lock in favorable tax rates and avoid LT capital gains on taxable investments. It seems foolish to me to keep tax deferred savings when later RMDs will likely push you into the 25% or higher bracket.

I have to admit I missed the boat on that this year. I was thinking that I could do this conversion in the same time frame as IRA and HSA contributions, by 4/15 of the following year. Nope.

I do plan to do a Roth conversion before the end of this year, so we'll need to ante up the taxes on that a year from now.

 

[Options]

Taking this statement further: anyone with tax-deferred savings is surely making a mistake if they pay zero taxes. IMHO, you should always withdraw enough tax-deferred money to hit the top of the 10% or 15% tax bracket (after deductions and allowances) to lock in favorable tax rates and avoid LT capital gains on taxable investments. It seems foolish to me to keep tax deferred savings when later RMDs will likely push you into the 25% or higher bracket.

But perhaps I'm missing something (not an unusual occurrence).

Yes! This is exactly what I am doing (pulling from a taxable account which has almost no LTCG's while converting/recharacterizing Roths to the top of the 15% bracket) until age 70 while deferring SS. I was just too lazy to post the details.

 

[marko]

Years ago a friend's grandfather just stopped paying his taxes. "I've paid enough in my life!!" (harumpff!)

He got a few bills and legal notices and wrote "Deceased" on them and returned them! It was years before computers were chasing down these things and I doubt he'd not get bagged nowadays.

Despite a fairly good income he probably went 5 or 6 years without paying any taxes and then died before there were any consequences!

 

[travelover]

.......
Despite a fairly good income he probably went 5 or 6 years without paying any taxes and then died before there were any consequences!

I guess the old death and taxes saw is only half right...........

 

[kombat]

Not poor, not wealthy, but 40-50 years of working and doing without has them still paying tax after all these years.

Why shouldn't they? Are they not still benefitting from the security provided by the infrastructure their taxes go to support? Is there some sort of arbitrary cutoff limit (monetary or age?) where someone has paid "enough" and should get to freeload off of the system while they run out the clock?

 

[LARS]

Years ago a friend's grandfather just stopped paying his taxes. "I've paid enough in my life!!" (harumpff!)

He got a few bills and legal notices and wrote "Deceased" on them and returned them! It was years before computers were chasing down these things and I doubt he'd not get bagged nowadays.

Despite a fairly good income he probably went 5 or 6 years without paying any taxes and then died before there were any consequences!

Surprised that SS and Medicare wouldn't fairly quickly be stopped given his "strategy".


Sent from my iPad using Early Retirement Forum

 

[frayne]

I've always thought it kind of sucked the SS distributions can be taxed because after all you paid tax on it when it went to Uncle Sam the first time. Isn 't this in reality a form of double taxation ?

On the other side of the coin I suppose we shouldn't bitch and be thankful because we have additional income streams that give us a higher standard of living.

Done with rant.

 

[target2019]

Why shouldn't they? Are they not still benefitting from the security provided by the infrastructure their taxes go to support? Is there some sort of arbitrary cutoff limit (monetary or age?) where someone has paid "enough" and should get to freeload off of the system while they run out the clock?

Wasn't complaining. My response and actual taxes paid was to counter the original topic. They are far from freeloading.

Sometimes the point gets lost.

To directly answer your question, in their case I think they have paid long, and enough. They both served. One was a nurse for like forever. Worked shift work as a supervisor in state institution. They raised 4 children who all work continuously and pay taxes.

I can't give you an absolute number, but I think they've done enough now that they are losing hold of life. But I am not holding my breath waiting for tax man to get out of way.

 

[MichaelB]

I've always thought it kind of sucked the SS distributions can be taxed because after all you paid tax on it when it went to Uncle Sam the first time. Isn 't this in reality a form of double taxation ?

I've not done the math, perhaps someone else has. That is, to compare how of the SS benefit is untaxed vs how much one contributed. If it were an annuity the entire amount, less the contribution, would be taxable income.

 

[youbet]

She can afford it and she would refuse help anyway. But it is still a slap in the face (and the wallet) to see your tax burden doubled on lower income the year after grieving the loss of a spouse.

I'm completely sympathetic to your mom Ziggy. But, remember you mom has a higher individual income now if you consider that before your dad's passing the income was divided by two. That is, she has more than 50% of the income today than she and your dad had while he was alive.

I think one of the hurdles a surviving spouse has to overcome is sizing most expenses down to one half. Live in less square footage, go to one car, consume groceries and household goods at half the previous rate, etc., etc.

We went through this with my MIL and it was tough. She eventually sold the house and moved to a small condo and made several other similar moves. It goes beyond the single vs MFJ tax rates.

I guess the other alternative would be to find a roommate.

 

[youbet]

I've not done the math, perhaps someone else has. That is, to compare how of the SS benefit is untaxed vs how much one contributed. If it were an annuity the entire amount, less the contribution, would be taxable income.

My understanding is that Congress considered taxing SS the same way annuities are: return of capital (your contribution) is untaxed and the rest is. But there is an issue with doing it that way for SS. With annuities, you receive a payment directly linked to the amount you contribute and the age you begin payments. With SS, there are a lot of social engineering and welfare-like payments involved. You might be collecting a spousal benefit. You might be a child under 18 (or a full time student) whose parent is collecting SS. You might be collecting SS due to a disability. And the SS formula is built so that low level contributors receive a higher percentage of their contribution than high level contributions. And on and on.

So they just came up with today's rules and called it a day.......... (That's the urban legend around here anyway.)

 

[Hermit]

It's called tax bracket management and is a very important part of retirement planning. Fees and taxes are what eat into PF returns. It can be surprising the degree to which taxes can be minimized in retirement.

I'm listening!! How do I minimize taxes on a pension and SS that puts me solidly in the 25% tax bracket? BTW I'm over 65 so I get a large standard deduction that takes care of that side of taxes.

 

[Souschef]

It is hard to do

We both collect SS and have small pensions. The thing that pushes us up into the higher bracket was our RMD's. I should not complain, because there is still plenty left after taxes.
The shock I got last year was a large CG distribution by one of our funds. That really pushed us up into the 25% bracket.

 

[Sarpy]

We both collect SS and have small pensions. The thing that pushes us up into the higher bracket was our RMD's. I should not complain, because there is still plenty left after taxes.
The shock I got last year was a large CG distribution by one of our funds. That really pushed us up into the 25% bracket.

Re. the large CG distribution, same thing happened to us. IMO, we really need to get a tax advisor--we've both been retired several years and are getting killed on taxes. Now to convince DH.

 

[athena53]

The shock I got last year was a large CG distribution by one of our funds. That really pushed us up into the 25% bracket.

We've had that- totally out of our control and generally a "surprise" at year-end.

Early on I bought Berkshire in an IRA because that was where I had free cash. I realized how silly that was- Berkshire pays no dividends so it generates zero taxable income. As we put new money into the after-tax accounts and bought BRK and sold the shares in the IRA. As DH noted, Berkshire is basically a giant mutual fund. Bonus: occasionally we drive to Omaha for the annual meeting.

 

[ziggy29]

Early on I bought Berkshire in an IRA because that was where I had free cash. I realized how silly that was- Berkshire pays no dividends so it generates zero taxable income. As we put new money into the after-tax accounts and bought BRK and sold the shares in the IRA. As DH noted, Berkshire is basically a giant mutual fund. Bonus: occasionally we drive to Omaha for the annual meeting.

Yeah, Berkshire is an ideal stock to hold in a taxable account. I once knew someone who held a bond fund in their taxable retirement investment account and Berkshire in their IRA. Oops.

 

[Hamlet]

I'll never get below the 25% tax bracket. Personally, I think its not such a bad problem to have.

Hear, hear.

Paying high taxes is like aging- no one likes it but it sure beats the alternative.

 

[Fermion]

I read a lot about people saying they would rather pay a lot of tax than little or no tax (because the thinking is they have more income).

I have found recently the opposite feeling. Before, when we were paying an effective tax rate of 26% or so (higher if you count all the little add-ins) I would get upset when I saw what I perceived as unfairness, cheating and waste. Now it rolls off and I don't stress about it because I know I am not paying for it.

One of the last unavoidable taxes, high property tax, we hopefully will also be jettisoning on the sale of our house. No more looking at the swimming pool size potholes in our neighborhood street and wondering why some of the $5,000 a year doesn't go for that instead of a bonus for the city council.

 

[friar1610]

Has nothing to do with Federal taxes, but we moved from VT to MA several years ago. VT taxes EVERYTHING! MA doesn't tax SS or federal/military pensions. The bulk of our income is from a Navy pension and SS, so that was a nice pay raise. Like others who have commented, we will perpetually be in our current tax bracket thanks to those income sources and, now, RMDs.



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[Car-Guy]

And don't forget about the Medicare "income relate premiums". (a.k.a means testing for Medicare premiums) It doesn't take much for your MAGI to start bumping up your monthly premiums. It looks like I'm going to be paying more in monthly Medicare premiums than I did for my private medical insurance coverage before I turned 65, and I "had" really good insurance.

https://www.ssa.gov/pubs/EN-05-10536.pdf (See page 8)

I've read that the income used in determining your Medicare Part B premium is taken from income reported two years prior on your IRS income tax return. Part D goes up too.

 

[youbet]

IMO, we really need to get a tax advisor--we've both been retired several years and are getting killed on taxes. Now to convince DH.

I tried the tax advisor route briefly years ago and it didn't help. Unless we wanted to venture into activities (own a business or apartment buildings or such) that as retiress we had no interest in, there was no relief. We were already doing the basics of tax managing our investments, SS and pensions and came to realize the penalty for having these is paying taxes.

You might want to have a highly recommended CPA look over your taxes during the slow season and ask if he/she has any ideas on moves you could make or strategies you could embrace. But you'll find that most of the basics are widely publicized and you're probably taking advantage of them already.