How a client with $162,000 of retirement income paid a 4.6% effective tax rate for 2024
This case illustrates how understanding a client’s income sources and tax brackets can guide effective tax planning decisions.
When we work with a client, we make it paramount to understand where they will get their income and how we can utilize or adapt their plan to avoid unnecessary taxes.
Client Profile
- Total Non-IRA Retirement Income: $162,000 (this is made up of tax-free dividends, taxable interest, and capital gains).
- Federal Tax Due: $7,550
- State Tax Due: $0 New Hampshire Residents ($6,000 if they lived in MA).
Tax Analysis
For 2024, the total income of $162,000 translates into an effective federal tax rate of 4.6%. Here’s a breakdown of their tax situation:
- Taxable Income Calculation:
- Their income of $162,000 places them in the 12% federal tax bracket, as their taxable income for the year is roughly $89,000.
- They are very close to crossing into the 22% tax bracket, which starts at $94,000 of taxable income.
Strategic Insights
Current Tax Efficiency:
- With an effective tax rate of only 4.6%, our clients are benefiting from very low tax liabilities in 2024. These clients are taking advantage of tax-free bond income and no taxation on capital gains within the 12% tax bracket.
Limited Room in the 12% Bracket:
- They have approximately $5,000 of room left in the 12% bracket before moving into the 22% bracket. This narrow margin restricts the scope for additional tax strategies within this bracket.
Roth IRA Conversions:
- Although Roth IRA conversions are a viable long-term strategy for future tax savings and potentially avoiding higher Medicare surcharges, they are less attractive in the current year. This is because the immediate tax impact of converting large amounts could be significant, and the benefits will accrue over many years.
Conclusion
In summary, our clients are experiencing a low tax rate in 2024, which allows them to keep their tax liabilities minimal despite their substantial income. While strategies like Roth IRA conversions are valuable, their immediate application may be less advantageous due to the narrow margin before hitting a higher tax bracket.
Key Takeaway
Effective tax planning involves balancing current tax benefits with long-term strategies, considering income levels, tax brackets, potential Medicare surcharges, and investment decisions. This situation demonstrates the importance of aligning tax strategies with both immediate and future financial goals.
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