Take A Tax Based Profit On Your Retirement Contribution If Your Income Drops Significantly

Take A Tax-Based Profit On Your Retirement Contribution If Your Income Drops Significantly

by

Shane Flait

Government-regulated retirement plans offer you a tax-advantage – a way to put more into your retirement savings when you contribute. These contributions are tax-deductible; and then, for added benefit, their earnings grow tax-deferred. Your eventual withdrawals are taxed as ordinary income at hopefully a lower tax bracket.

But even over a very short time to retirement or to being laid off when your taxable income drops significantly, you can make a \’tax-based\’ profit by taking withdrawals at a lower tax rate than the tax rate at which you contributed during higher income times. And you don\’t need to rely on any tax-deferred growth of your earnings, either. Here\’s how…

Your taxable income is subject to income tax brackets. This is income above your filing threshold amount – made up your standard deduction and personal exemption.

For 2014, your personal exemption is $3,950. If you are filing single then your standard deduction is $6,200. This amount added to your personal exemption totals $10,150. So, if you\’re filing as \’single\’ then $10,150 is your tax threshold; you\’re only taxed on income greater than this.

If you\’re filing married, your standard deduction is $12,400 – twice the single standard deduction. Increasing this amount by two times the personal exemption – 1 exemption for each of you – makes the married tax threshold $20,300. That turns out just 2 times the single tax threshold amount.

Your tax brackets that determine the tax you pay in excess of your filing threshold are:

Single filing status, excess income range – tax rate for each bracket:

10% – $0 to below $9,075

15% – $9,075 to below $36,900

25% – $36,900 to below $89,350

28% – $89,350 to below $186,350

33% – $186,350 to below $405,100

35% – $405,100 to below $406,750

39.6% -Over $406,750

Married filing status, excess income range – tax rate for each bracket:

10% – $0 to below $18,150

15% – $18,150 to below $73,800

25% – $73,800 to below $148,850

28% – $148,850 to below $226,850

33% – $226,850 to below $405,100

35% – $405,100 to below $457,600

39.6% – Over $457,600 – 39.6%

As an example, a single person under age 65 has a $10,150 income threshold; only income additional to this is taxed. His next $9,065 of taxable income is taxed at a 10% rate, and the next $26,750 (= $36,900- $10,150) is taxed at 15%, etc.

*How the tax-based profit works:

Let\’s assume this person had a working income of $110,000. Subtracting off his filing threshold amount of $10,150, gives him $99,850 (= $110,000 – $10,150) of income that will be taxed according the tax brackets. You can see by the above rates that his highest tax bracket rate is 28% since that $99,850 is above the $89,350 level. So the excess of $10,500 (= $99,850 – $89,350) will be taxed at 28%.

If he contributes that $10,500 as a deductible contribution to his retirement plan, he\’ll save income tax of $2,940 (= 28% of $10,500) for doing so and have the full $10,500 in his retirement plan. But recognize that contributing this amount has taken only $7,560 (= 72% of $10,500) out of his take-home pay – not the full $10,500. Aside from the future tax liability on withdrawals, the $7,560 is the actual cost to him of making his retirement plan investment of $10,500. That\’s the first tax benefit of using a retirement plan contribution.

If he retires or laid off to a lower income job a year later – clearly a short term – though still under 65 but over 55 (so there are no early withdrawal penalties to contend with) and his income drops to $35,000, let\’s see how much he\’s left with after income taxes if he decides to withdraw that $10,500 from his retirement plan to supplement that $35,000. We\’ll assume that he earned nothing on that $10,500 contribution to illustrate just the benefit of withdrawing it under a lower income tax bracket.

Before doing so, let\’s see where in the tax bracket his $35,000 income puts him because withdrawing that $10,500 will be taxed as ordinary income on top of his $35,000 income. So, subtract his threshold filing amount of $10,150 from that $35,000 which gives $24,850 as taxable income.

Now the first $9,075 of this is taxed at 10%, while the remainder of $15,775 (= $24,850 – $9,075) is taxed at 15%. So his $35,000 income has used up only $15,775 of his 15% tax bracket (which goes from $9,075 to $36,900 – a spread of $27,825). So, he still has 15% tax bracket \’room\’ for additional income of $12,050 (= $27,825 – $15,775). That means he could have a total income of $47,050 ($35,000 + $12,050) and be taxed only at 15% for his highest tax bracket.

So you can see that if he does withdraw his $10,500 from his retirement plan with gives him a total income of $45,500, he\’ll only pay 15% tax ($1,575) on that $10,500 withdrawal leaving him with $8,925 (= 85% of $10,500) of it after tax for his pocket.

*Tax bracket Shift- based profit:

Recalling from above, that $10,500 contribution really cost him only $7,560 from his take home pay because it was deductible at a 28% marginal tax bracket rate when he had that working income of $110,000. Now, withdrawing that $10,500 from his retirement plan subjects him to only a 15% tax bracket rate with his lower total income of $45,500 which includes his $10,500 withdrawal. So after that 15% tax on the $10,500, he receives $8,925 into his pocket.

That $10,500 contribution over just one year due to his transition to a significantly lower income produced a tax bracket shift-based profit of $1,365 (= $8,925 – $7,560) which is 18%.

If he had retired and turned 65 receiving Social Security, his profit would have been substantially higher. That\’s why it\’s advantageous to make those tax-deductible contributions to your qualified retirement plans even if you could be laid off.

Shane Flait gives you workable strategies to accomplish your goals in financial, legal, tax, retirement and protection issues. . Get his FREE report on Managing Your Retirement =>http://www.easyretirementknowhow.com/FreeReportandSignUp.htmRead his ebook: \’Wise Way to Financial Independence\’ =>http://www.SovereignU.com

Article Source:

ArticleRich.com