Retirement Income Planning is critical for soon-to-be and current retirees.
Because it is so important you MUST get as specific as you can for YOUR situation.
Need To Understand The Tax Code
This means not relying on rules of thumb. Or financial planning concepts that are somewhat dated. Or generalizations of the tax code.
In the video below, I dissect a recent article in the Atlanta Journal and Constitution where the author completely misses the mark with his analysis of the tax consequence a hypothetical couple will pay.
Because of this error, the couple will engage in part-time employment to generate income when in fact under current tax law they would not need to do that.
Work When You Don’t Need To?
In fact,, with proper tax planning, this couple could have used the time they spent working part-time to do something maybe more meaningful.
In the article, the author has the couple paying a 17.22% tax rate on gross income of $100k which includes $42,000 of Social Security.
This GREATLY over states the taxes these folks will pay, nearly by a factor of 3!
Taxes Under Trump Tax Bill
Under the new Trump tax bill, each taxpayer has a standard deduction of $12,000.
So, immediately, this couple’s taxable income drops to $76,000. For a married couple with taxable income below $77,000 means they are in the bracket.
But it gets better for them.
Social Security Taxes Are Favorable
Social Security is much more tax-favorable than straight ordinary income. Depending on your PROVISIONAL INCOME a significant amount of your Social Security will escape taxation.
Unfortunately, by heeding the author’s advice and working part-time, this couple will pay tax on 85% of their Social Security benefits. This is the maximum allowed by law and actually increases their taxes by 50% as compared if they did not work!
Does that extra income from working give them more needed disposable income though? NO!
The author states they need roughly $83k a year to live comfortably in retirement. He puts them in a 17.22% tax bracket and, lo and behold, $100k of gross income nets them the $83k they need.
Simple Tax Planning Nets Same Results As Working Part Time
But in reality, by NOT working, they have $88k of gross income, pay about $5k in taxes and still net the $83k!
Also, this assumes their investment income is ALL taxed as ordinary income rates. What if were long-term capital gains (LTCG) and/or qualified dividends(QDI)???
In this case, there would be a good chance NONE of that investment income is taxed at all because of the favorable tax treatment for those in the 12% and lower brackets on LTCGs and QDI.
Pay 0% Tax On Qualified Dividends And Long Term Capital Gains
Remember if you are in the 10% and 12% tax brackets, (that means your TAXABLE INCOME is below $77,000 married filing jointly) you pay 0, yes I said 0, in tax on long-term capital gains and qualified dividend income!
So, it’s even likely that I am over-estimating this fictitious couples tax because I don’t know from where their investment income derives.
Either way, on the basis of NOTHING ELSE other than the new Standard Deduction rules we know, for a fact , this couple will only be in the 12% MARGINAL tax bracket.
How Marginal Tax Works
This means, the first $19k is taxed only at 10% and the next $58k of TAXABLE INCOME is taxed at 12%, unless some of that income is LTCGs and QDIs then that part is taxed at 0.
So, what does all this mean for you???
Taxes Are HUGE In Retirement
You’ve got to know the true nature of your taxes. Taxes are one of the largest, if not THE largest, expense retirees have.
If we overestimate taxes we are risking the clients will be too conservative in their spending and not fully enjoy their beginning stages of retirement.
The last thing we want to happen is for a widow to have more money in her accounts than she knows what to do with being disappointed because she and her late husband didn’t do more, out of worry of running out of money.