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Make the most of your tax brackets

Nate Lovik, CFP®, AIF®

Financial Planner-Strategic Tax and Retirement

Found within the pages of Seneca’s “On the Shortness of Life” a certain passage may be applied to how you mitigate your tax situation, both now and in the future.

“Life is divided into three parts: what was, what is, and what shall be”

Within the context of Seneca’s writings, the quote specifically pertains to individuals who squander their time by only living in the present. One must recall their past with clear conscience to understand what has led them to the present and utilize that experience toward advancing their future. Keeping this thought in mind, we’ll look at the past and explore ideas to hopefully maximize your current and future tax situation.

What was

Looking back at history, one can see (per the chart below) that during our lifetime, we’ve been taxed at lesser rates than our predecessors.

Further expounding on the chart, according to IRS data, the effective tax rate in 1980 was 15.5% for all tax returns* while as of 2015 the effective rate being 13.5%**. Reminder that the effective tax rate is the average rate at which earned income, such as wages, and unearned income such as dividends or interest are taxed. A simple method to determine your effective rate is to divide your total tax burden by your income. For example, if you earned $75,000 and had a tax liability of $9000 your effective rate would be 12%. I don’t enjoy paying taxes any more than you do, however, I’d much rather pay taxes at today’s historically lower rates for as long as possible.

What is

A quick fact set regarding our countries current state of financial affairs:

1. Approximately 10,000 Baby Boomers born between 1946 and 1964 are retiring daily.

2. According to the Insured Retirement Institute, 45% of Baby Boomers have no retirement savings of their own. The remaining 55% of Baby Boomers have some retirement savings, and of those, 28% have less than $100,000. *

3. By 2023, our unfunded liabilities (Social Security, Medicare Parts A, B, & D, federal debt, and federal employee and veteran benefits) will be $157 trillion.

a. For reference, it would take over 31,000 YEARS just to count out loud to one trillion.

4. If not properly planned for, up to 85% of your Social Security income may be added to overall taxable income.

Bottom line, more and more baby boomers are retiring with less retirement savings and less people working to support the system. Two options exist to address this ticking time bomb. The first would address benefits, specifically how much people will receive and how long they must wait prior to collecting. Secondly, our Federal Government could increase the tax rates in hopes of creating more revenue to supplement the promises made. It’s my opinion that a combination of these two will take place. For instance, someone currently in their 30’s or 40’s might have their full retirement age pushed back to 70 with the negative consequence of facing reduced benefits if taken prior.

What shall be

Written into the tax code during the late 1970’s the 401K was created as a means for highly compensated individuals to sock away year-end bonuses without paying income tax during the year. The very core of the 401K plan is a means to delay paying taxes on money received now until later with the hopes you will be in a lower tax bracket. The 401K or 403B (same premise as the 401K, used for Non-Profit companies) has since morphed into the most typical vehicle for people to save for retirement.

If you are a participant in such a retirement plan, have you ever asked yourself how you will withdraw your savings efficiently during retirement? This question is glaringly overlooked in the financial planning arena. During my time in the industry, the general advice given directs a person to max out their 401K or 403B, followed by contributing to an IRA to delay paying taxes on the savings with little to no thought of current or future tax implications. Think about it this way; if you’re currently deferring taxes into a 401k and are in the 22% tax bracket, how certain are you will withdraw at a lower tax bracket? Expounding on this example, if your income will be similar in the future compared to today, by 2025 when the current tax laws change your tax bracket will automatically increase to 25%. Congratulations, you’ve successfully deferred paying taxes today only to pay more later.

A major priority should be to “optimize” your tax bracket for both your working and retirement years. Accomplishing such a task requires diligent planning to determine where and how to save for retirement. For instance, if your income is far enough below the next highest tax bracket, it may make sense now to consider a ROTH IRA conversion, where you pay taxes now to convert a future taxable account into a potentially 100% tax-free income source. This is just one of many examples of how incorporating tax planning into your retirement plan can strive to provide a more tax-efficient outcome.

Consequently, your team at Strategic Tax and Retirement now only employs retirement planning professionals, but also a team of tax professionals to review strategies to keep more of your money in your own pocket. Call today to schedule a no-obligation consultation and experience how our patent-pending Retirement Positioning System (RPS) can help you navigate your financial future.



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