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By Bob Moeller
WEAC Member Benefits
March 2008
Financial
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It may all come down to line 43 By Bob Moeller |
By Bob Moeller
It is income tax time. You should look at what your tax situation is and what you can do to help it.
First, most people don’t know exactly what their marginal tax rate is. In other words, if you received a $1,000 raise this year, how much of that would be taken away in taxes. Once you know this, you can do some planning.
Look at line 43 of the form 1040 you file this spring. This line is “taxable income.” If that line is over $65,100 for 2008 (up from $63,700 for 2007), and you are married filing jointly, your new $1,000 raise would be taxed at 25% federal. If you are single, the threshold for a 25% tax rate on line 43 number is $32,550. This taxation rate for your new raise is called your “marginal” tax bracket. Of course you also pay state taxes. Your rate there is well over 6%, but since you can deduct it on your federal taxes, I count it at just 5% net to make it easier to understand. So, your marginal income tax bracket if your line 43 income is high enough is 30%. If your line 43 income is less, you are in the 15% federal plus 5% net state rate. Your 30% net rate lasts until line 43 exceeds $131,450 married, $78,850 single (2008).
Now, with a simple look at one line of your tax return, you know what marginal tax rate you are paying. Recently tax laws have been changed to allow you to invest in either a pre-tax TSA, or a Roth TSA (or a Roth IRA), to which you contribute after-tax dollars. Sometimes it sounds like the Roth choice is much superior, because you never pay taxes on what you earn. Before you decide you need to do a little analysis.
First, realize this mathematical fact. If your tax rate stays the same, and the investment choices were the same, your after-tax net proceeds will be identical under either a Roth or regular TSA. In other words you would have exactly the same spending money when you retire. But perhaps your tax bracket won’t stay the same. That’s what you have to think about a little.
Next, realize that the principle of your retirement system is that with a full career, you will receive about half of your salary when you retire, perhaps a little less if you choose a joint survivor benefit, or a little more if you choose the accelerated option.
Particularly if you are within say five years from considering retirement, you need to ask yourself what is likely to be your income level when you retire. For a simple example, take 60% of your salary income. (The accelerated pension frequently comes out to about that). Add in your spouse’s likely income and your interest/dividend income. If you find that your result is below $65,100 ($32,550 single), you may be better off not doing a Roth TSA, but sticking to the regular TSA. Why? Because you may be saving 30% taxes now by doing the pre-tax TSA and paying only 20% taxes later when you take the money out.
You may have noticed that the marginal tax rate change comes at a higher income level each year. It is indexed. That means that five years from now, with just 3% per year inflation increases, that $65,100 figure would be $75,400. So, if you retired in five years, and withdrew TSA money in an amount that still made your total taxable income less than $75,400, you would be paying only 20% marginal taxes on your withdrawals.
If you are now in the 20% combined bracket, younger, with a rising salary, etc., you are almost always better off doing the Roth TSA or IRA. You pay your 20% taxes now, and may end up taking out the money and not having to pay a 30% tax later.
Posted February 27, 2008