Your taxes should get simpler in retirement, right? Nope! Today’s tax code is full of tax breaks that phase out at certain income levels. If you’re not paying attention to these breakpoints, it can cost you a lot in taxes.
Let me give you a few examples. Capital gains are taxed at 0% up to a certain level federally. Both the IRS and MN agree that low-income people shouldn’t have to pay taxes on their Social Security benefits. It would be nice if they had similar rules over when it should be taxed. They don’t. Even Medicare charges you more for premiums when your income hits certain levels.
We use tax software to help us analyze our clients’ tax returns. This helps us optimize not only what securities to sell for cash from in retirement but also what accounts to draw from. The chart above is an actual client’s marginal tax rate on the next $500 of ordinary income. They are in the 12% tax bracket, but the tax on their next dollar goes as high as 140% at one point.
A marginal tax rate of 140%! That means for the next $1 of income they owe $1.40 in taxes. How is that possible? Minnesota taxes a higher percentage of Social Security for every $4,000 of income. The dollar that brings you over the next breakpoint causes quite a bit of tax due. For this client, that same dollar pushes 0% capital gains to be taxed at 15%, their Social Security gets taxed at a higher rate, and they pay their stated 12% Federal taxes. Needless to say, we’ll be keeping them below that level.
Many clients often wonder if they can take more income in a year without moving to a higher bracket, or whether a Roth conversion might make sense. The key is to know where your income falls and identify whether there may be a strategic reason to optimize the tax bracket in your favor.
It’s worth taking a few minutes to review where you’re at. If you want help, you know where to reach me.
About the Author: John O’Connor
John has more than ten years experience as an Investment Advisor. He focuses on devising and maintaining portfolios that meet individuals’ needs, investment research, and investment strategy. John has been recognized as a “FIVE STAR wealth manager” by Twin Cities Business Magazine 2016-2024. He is a CFA charterholder and CERTIFIED FINANCIAL PLANNER™ Professional.
Legal Disclaimer: These posts do not constitute an offer or recommendation to buy or sell any securities or instruments or to participate in any particular investment or trading strategy. They are for informational purposes only. CTW gathers its data from sources it considers reliable. However, CTW makes no express or implied warranties regarding the accuracy of this information or any opinions expressed by the author and may update or change them without prior notification.