Is more income always better?
Almost always...but it may also result in an unexpected bill at tax time. Whether you are in retirement or still working, a critical part of tax planning is being aware of how crossing certain income thresholds affects what you pay. Many people focus solely on their marginal tax bracket, overlooking other changes in their tax liability that change with income. Here are just a few:
- Reduction of Social Security before full retirement age. If you are less than full retirement age and collect Social Security, your benefit will be reduced by $1 for every $2 that you earn from working, in excess of $18,960. (This limit changes annually.) Now to be clear, this is not a reason to not work in early retirement or even to limit your earnings. (Your benefit will increase at your full retirement age to account for benefits withheld due to earlier earnings.) But as you plan your budget, be aware of this. Helpfully, the Social Security Administration provides a simple calculator that you can use to estimate your reduced payment.
- Taxation of Social Security after full retirement age. If you collect a Social Security benefit, up to 85% of the benefit can be taxed if you have other income from working, a pension or a traditional retirement account distribution. The calculation depends on your filing status and is not completely straightforward; there are a number of online calculators available, such as this one, that you can use to see if you may be impacted. Consider opting to have taxes withheld from your monthly Social Security benefit so that you are not surprised by your April 15 bill.
- Everyone’s Medicare Part B premium is $148.50 a month (in 2021)...except when it’s not. If you have just $1 more than $88,000 in income as a single tax filer ($176,000 if married filing jointly), you fall into the IRMAA (Income-Related Monthly Adjustment Amount) camp. Your Medicare Part B monthly premium will jump quite dramatically, as well as the Part D surcharge for prescriptions. You can see the effect here. And remember, just as with Social Security, your pension and traditional retirement account distributions count as income.
- Capital Gains Tax. Obviously this is a bit of a moving target, but as it stands today, if your taxable income exceeds $40,000 as a single filer ($80,000 if married) your long term capital gains tax rate jumps from 0% to 15%. (For very high income earners over $441,450, the rate jumps again to 20%.)
- Education Tax Credit. Perhaps you are considering using a Roth account for retirement, or even converting some of your traditional retirement savings to a Roth-type account. You are aware that this will increase your taxable income for the year. But if you are also paying college expenses, are you aware that your ability to benefit from the American Opportunity Credit phases out completely if your taxable income exceeds $90,000 as a single filer ($180,000 married filing jointly)? (The less generous Lifetime Learning Credit phases out at $69,000/$138,000.) As you consider the Roth option, have you included this in your calculation?
- Child and Dependent Care Tax Credit. Similar to education tax credits, tax credits for child and dependent care begin to phase out above $125,000 Adjusted Gross Income (AGI). Again, as you consider the pros and cons of a Roth account, and especially a Roth conversion, bear this in mind.
As you can see, while not completely inscrutable, tax planning can be confusing. The “right” decision for today may come with unintended consequences tomorrow. At Your Money Line, we always encourage you to seek out the assistance of a tax professional to help you navigate these waters.