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Income Tax Planning – What Tax Bracket Will You Likely Be in in Retirement?

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What income tax bracket do you think you will be in when you retire?

Well…, before you answer that, let’s take a look at the two key factors that could affect the answer.

  1. What state will you be living in when you retire?

    Some people will stay in the state they are currently living and some will move to retirement destination states.

    Let’s look at the top state income tax rates of some popular retirement states:

    Florida, Texas, Nevada: 0%

    Arizona: 4.54%

    California: 13.3%

  2. What federal tax bracket will you be in in retirement?

    Here are 2019 tax rates.

    $0-$9,525                             10%
    $9,526-$38,700                    12%
    $38,701-$82,500                  22%
    $82,501-$157,500                24%
    $157,501-$200,000              32%
    $200,001-$500,000              35%
    $500,000+                            37%

  3. What sources of income in retirement will drive your tax rate?

  • Social Security—for a single person, if the retirement income (which includes 50% of your Social Security benefits) is between $25,000-$34,000, you may have to pay taxes on up to 50% of your benefits (up to 85% if your income is over $34,000). If married filing jointly, the tax issues are the same except the income amount bumps to $32,000-$44,000, and over $44,000 respectively.
  • Non-qualified annuity—an NQ annuity allows money to grow without capital gains or income taxes. However, if you take withdrawals from the annuity the investment gains are taxed as ordinary income.
  • 401(k) Plans, IRAs, and other tax-deferred retirement accounts—all of the money coming from these sources is treated as ordinary income and will be subject to income taxes.
  • Roth IRAs—contributions to Roth IRAs are not deductible but then the money is allowed to grow tax-free and be removed tax-free in retirement. The main problem with a Roth is the funding limits which are low.
  • Brokerage accounts—many people have money in non-qualified brokerage accounts. These accounts are subject to short- and long-term capital gains taxes and income taxes on dividends.
  • Cash Value Life (CVL) insurance—CVL is a unique wealth-building tool in that cash is allowed to grow tax-free and can be removed tax-free not only in retirement but even before age 59.5 without income taxes. It sounds like an unlimited Roth IRA even though it’s just a CVL.

The key is using the best type of CVL and working with an advisor who designs it for your best interest, not his/her own best interest.

  • Already in retirement—if you are reading this and you are in retirement, there’s not much you can do to reduce your income taxes short of taking less money from taxable sources or moving to a state that has less income taxes.
  • Not yet in retirement—if you have not yet reached retirement, you have options.
    • You can choose to stop contributing to tax-deferred plans like IRAs and 401(k) plans.
    • Instead of contributing to a tax-deferred plan, you could allocate money to CVL.
    • You could transition money from taxable brokerage accounts to a more tax-favorable source like CVL.

Are income tax rates going up?

The honest answer is we have no idea. If more Democrats get elected or if our country continues deficit spending which grows our national debt, many think tax rates will certainly go up.

However, even if income tax rates go up, will retirees be in a higher tax bracket than they were when gainfully employed?

I would argue that many will not. Why? Because when most people go from gainful employment to living on retirement assets, the income from those assets will be less than or substantially less than what they made when working full time.

Paying as little income tax as possible—regardless of whether you think you’ll be in a higher tax bracket in retirement or not, if you are like most, you would prefer to pay as little in taxes as possible.

As stated, using Cash Value Life as an asset class to grow a bucket of wealth that can be a tax-free source in retirement can make sense for many people. It’s a proactive way to reduce taxes in retirement.

If you’d like to learn more about the proper use of Cash Value Life as a tax-free retirement tool, please contact us, or book a call with an advisor on our website.

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