In 2017, the Tax Cuts and Job Act was passed, significantly lowering personal tax rates. While most people see this as an opportunity to get a larger refund check, there is a lot more you can do to take advantage of these rates.
Understanding tax rates, the rate you’ve paid in the past, and what counts as taxable income is essential to understanding how to make your money go the furthest, especially in retirement.
What are marginal tax rates?
The federal income tax system is currently made up of seven tax brackets. Your taxable income will determine what bracket you fall into.
Taxable income is going to be any money you haven’t paid taxes on yet. Commonly, this is wages and bonuses, capital gains, and interest or dividends from investments. In retirement, this will include IRA and 401k withdrawals, Social Security, and possibly pension payments.
The basic rule of thumb is that if you have not paid taxes on the money yet, it is going to count as taxable income.
The federal tax system is progressive, meaning that your taxable income will fall into more than one of the brackets. You will only pay the tax rate on the money that falls into each bracket, not the money below. Your marginal tax rate is the highest backet rate that applies to your income (see example below).
The history of marginal tax rates
Do you know what your tax rates have been in the past? Many people don’t remember the tax brackets that they have fallen into throughout their lifetime. To understand how you can take advantage of current tax rates, we need to look at the tax rates you have paid throughout your career.
Taxes in 1980
Many people in or near retirement were just starting their career in 1980. A single person in 1980 earning $50,000 per year paid a marginal federal tax rate of 55%. A married couple filing jointly earning $100,000 per year paid a marginal federal tax rate of 59%.
As you can see in the chart, there were also a lot more brackets than the current seven in 1980.
Single | Married Filing Jointly | ||
Marginal tax rate | Income | Marginal tax rate | Income |
0.0% | $0-$2,300 | 0.0% | $0-$3,400 |
14% | $2,301-$3,400 | 14% | $3,401-$5,500 |
16% | $3,401-$4,400 | 16% | $5,501-$7,600 |
18% | $4,401-$6,500 | 18% | $7,601-$11,900 |
19% | $6,501-$8,500 | 21% | $11,901-$16,000 |
21% | $8,501-$10,800 | 24% | $16,001-$20,200 |
24% | $10,801-$12,900 | 28% | $20,201-$24,600 |
26% | $12,901-$15,000 | 32% | $24,601-$29,900 |
30% | $15,001-$18,200 | 37% | $29,901-$35,200 |
34% | $18,201-$23,500 | 43% | $35,201-$45,800 |
39% | $23,501-$28,800 | 49% | $45,801-$60,000 |
44% | $28,801-$34,100 | 54% | $60,001-$85,600 |
49% | $34,101-$41,500 | 59% | $85,601-$109,400 |
55% | $41,501-$55,300 | 64% | $109,401-$162,400 |
63% | $55,301-$81,800 | 68% | $162,401-$215,400 |
68% | $81,801 -$108,300 | 70% | $215,401+ |
70% | $108,301+ |
Taxes in 2000
In 2000, the single person’s marginal tax rate on $50,000 was 28% and the married couple’s rate on $100,000 was also 28%.
Single | Married Filing Jointly | ||
15% | $0-$26,250 | 15% | $0-$43,850 |
28% | $26,251-$63,550 | 28% | $43,851-$105,950 |
31% | $63,551-$132,600 | 31% | $105,951-$161,450 |
36% | $132,601-$288,350 | 36% | $161,451-$288,350 |
39.6% | $288,351+ | 39.6% | $288,351+ |
Taxes in 2020
In 2020, the single person making $50,000 is at 22% and the married couple making $100,000 is also at 22%. Their marginal tax rate would be 22% since that is the highest bracket they fall into.
Single | Married Filing Jointly | ||
10% | $0-$9,700 | 10% | $0–$19,400 |
12% | $9,701–$39,475 | 12% | $19,401–$78,950 |
22% | $39,476–$84,200 | 22% | $78,951–$168,400 |
24% | $84,201–$160,725 | 24% | $168,401–$321,450 |
32% | $160,726–$204,100 | 32% | $321,451–$408,200 |
35% | $204,101–$510,300 | 35% | $408,201–$612,350 |
37% | $510,301+ | 37% | $612,351+ |
The Tax Cuts and Jobs Act created a 5 year window for very low marginal tax rates. There is a sunset provision in the act in which the new brackets, rates and income levels expire on Dec. 31, 2025. We cannot predict if any new legislation will increase or expand these cuts.
Taking advantage of the current tax cuts
As you can see from the tax charts above, if you are in or near retirement, marginal tax rates have actually come way down over the course of your career.
If you have been contributing to your 401k, 403b, or IRA over many years, those early contributions have really benefited from tax deferral. Since tax rates have dramatically decreased, you will be paying less now than if you would have paid taxes on this money when you originally put it into the account.
Now is the time to consider paying some of the taxes due on these accounts. Converting the money into a tax-free retirement account, such as a Roth IRA or highly funded cash value life insurance, could provide you with tax-free income in retirement as well as a tax-free inheritance for your heirs.
To do this, you would withdraw the money out of your taxable accounts, such as your 401k or traditional IRA, pay the taxes on the withdrawal now, and then put it into a tax-free account.
Everything from Social Security to Medicare can be affected by your taxable income in retirement. If you can make sure the majority of your income is coming in tax-free, it can save you a significant amount of money.
While it seems counter intuitive to pay more now, it could really work out in your favor if tax rates go up. Whether or not this strategy is for you is going to depend on what you believe is going to happen with tax rates in the future. While we expect that rates are probably not going to get further lowered, if you believe this will happen, it might be better to wait and pay the taxes later or let your heirs pay them.
With the current lower tax rates, now could be the time to make sure you are set up for a tax free or low tax retirement. Consult a professional before making any moves, tax planning can be tricky and one mistake can cost you a good amount of money.
