Tax Categories

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Redlion
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Joined: Sat May 04, 2019 10:31 am

Tax Categories

Post by Redlion » Sun Apr 19, 2020 10:12 am

I am recently retired single Federal Employee with a 39K a year pension and 36K a year in withdrawals from a Traditional TSP account which comes out to 75K a year.
According to the 2019 Tax brackets a single making over 39,476 a year is taxed at 22%. I reviewed of my taxes which stated I only paid 7K in taxes which is 9%
I was considering doing a Conversion of 500K from the TSP to my Roth IRA account with Vanguard. However my CPA advised against it since my tax bracket is under 12%
Here is a break down of my earnings for 2019.

Pensions and Annuities 75K
Taxable Amount 67K
Standard deduction single (12K)
HSA Contribution (4.5K)
Total 50.5K

My question is why am under 12% (no complaints) when the IRS tax brackets for a single making over 39K a year is is 22% , even after the Standard deduction and HSA deduction? Are Retirement Pensions and Annuity withdrawals taxed at a different rate.
Thanks in advance for any feedback.

livesoft
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Re: Tax Categories

Post by livesoft » Sun Apr 19, 2020 10:41 am

If one looks at their tax return Form 1040 and goes through it line-by-line, then they may find it enlightening. There is Income, Adjusted Gross Income, and Taxable Income which are all different. There are tax credits as well. You will have to read your Form 1040 and see the numbers.

If you do a $500K Roth Conversion, then I think that is practically suicidal because your Adjusted Gross Income and Taxable Income would go up by $500,000 and a significant fraction of your $500K would be owed to the IRS. Worse is that you would have to withdraw from the Roth to pay the $150,000+ that would be the likely extra taxes.
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delamer
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Re: Tax Categories

Post by delamer » Sun Apr 19, 2020 10:43 am

Assuming your breakdown is accurate, your CPA is wrong. (Which makes me wonder how good s/he is.)

You don’t want to do a conversion of $500K all in one year. You’d end up paying a 35% federal tax rate on a big chunk of it. Spread it out over several years, to keep it in the 22% or 24% bracket.

Silk McCue
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Re: Tax Categories

Post by Silk McCue » Sun Apr 19, 2020 10:44 am

A $500k conversion is going carry you into the 35% bracket. No way that can make sense.

You mention 9% tax rate. That is an effective rate and is worthless for these type of analyses.

You are definitely in the 22% marginal bracket. Suggest you ask your CPA to explain.

Your pension and tax deferred annuity withdrawals are taxed as at standard rates.

Cheers

22twain
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Re: Tax Categories

Post by 22twain » Sun Apr 19, 2020 11:08 am

Nit-pick: the standard deduction for 2019 is $12.2K, so your "total" should be $50.3K. This is your taxable income, which is what the tax brackets apply to. Your tax breaks down as:

10% on the first $9,700 = $970
plus 12% on $39,475-$9,700 = $3,573
plus 22% on $50,300-$39,475 = $2,381

total tax = $6,924

You appear to have the common misconception that the "tax bracket %" applies to all of your taxable income.
Last edited by 22twain on Sun Apr 19, 2020 11:11 am, edited 1 time in total.
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iceport
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Re: Tax Categories

Post by iceport » Sun Apr 19, 2020 11:10 am

Silk McCue wrote:
Sun Apr 19, 2020 10:44 am
A $500k conversion is going carry you into the 35% bracket. No way that can make sense.
With the other income, wouldn't the OP be in the 37% bracket?

Either way, it makes no sense. I don't know what tax bracket the OP was in when the contributions were made, but I'd be extremely reluctant to convert them at a higher rate. (This is why i-ORP seemed to spew out nonsense before they let you set a tax bracket ceiling for conversions.)
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#Cruncher
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Re: Tax Categories

Post by #Cruncher » Sun Apr 19, 2020 11:18 am

Redlion wrote:
Sun Apr 19, 2020 10:12 am
According to the 2019 Tax brackets a single making over 39,476 a year is taxed at 22%. I reviewed of my taxes which stated I only paid 7K in taxes which is 9%[.]
That is 9% of $75,000, but 13.8% of your taxable income (6925 / 50300 as shown in the first column below). A Roth conversion or any other additional ordinary income would indeed be taxed at a 22% marginal rate. For example, a $1,000 conversion would increase your tax $220 as shown in the 2nd column below.

Code: Select all

Rate: ord income bracket 1            10%       10%
Rate: ord income bracket 2            12%       12%
Rate: ord income bracket 3            22%       22%
Floor: ord income bracket 2         9,700     9,700
Floor: ord income bracket 3        39,475    39,475

Non-SS Ordinary Income             62,500    63,500
Adjusted gross income              62,500    63,500
Deductions plus Exemptions         12,200    12,200
Taxable Income                     50,300    51,300

Code: Select all

Taxable: ord income bracket 3      10,825    11,825
Taxable: ord income bracket 2      29,775    29,775
Taxable: ord income bracket 1       9,700     9,700

Tax: ord income bracket 3           2,382     2,602
Tax: ord income bracket 2           3,573     3,573
Tax: ord income bracket 1             970       970
Total tax                           6,925     7,145

Increased income                         1,000
Increased tax                              220
Marginal tax rate                          22%
(Prepared with the "Compare" sheet of my Marginal Tax Rates spreadsheet.)

Luckywon
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Re: Tax Categories

Post by Luckywon » Sun Apr 19, 2020 11:20 am

Generally, Roth conversions make sense when you expect to be at a higher marginal tax bracket in the future. This does not appear to be likely in your case (unless you are speculating income taxes may be legislatively increased in the future). If I were in your shoes, I would not spend much time thinking about Roth conversions.

retiredjg
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Re: Tax Categories

Post by retiredjg » Sun Apr 19, 2020 11:35 am

Redlion wrote:
Sun Apr 19, 2020 10:12 am
I am recently retired single Federal Employee with a 39K a year pension and 36K a year in withdrawals from a Traditional TSP account which comes out to 75K a year.
According to the 2019 Tax brackets a single making over 39,476 a year is taxed at 22%.
The 22% only applies to the amount over $39,476 (2018 numbers). That income would put you in the 22% tax bracket for 2018.

I reviewed of my taxes which stated I only paid 7K in taxes which is 9%
This is not your tax bracket. It is an effective tax rate.

Some of your income is not taxed. Some is taxed at 10%. Some is taxed at 12%. And the remainder is taxed at 22%. In your case, it sort of averages out to 9%.


I was considering doing a Conversion of 500K from the TSP to my Roth IRA account with Vanguard. However my CPA advised against it since my tax bracket is under 12%
Your CPA seems to have forgotten where the boundary is between 12% and 22%. But your CPA is absolutely correct that you should not do a Roth conversion that large.

This would cause some of your money to be taxed at 24%, some at 32%, some at 35%, and some at 37% and some would have an additional 3.8% tax for NIIT. It would also increase your Medicare payments if you are 63 years old or older.

You may want to do Roth conversions, but they should probably be small, keeping you under the IRMAA limit of $85k for AGI if you are 63 or older.

Topic Author
Redlion
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Re: Tax Categories

Post by Redlion » Sun Apr 19, 2020 6:09 pm

22twain wrote:
Sun Apr 19, 2020 11:08 am
Nit-pick: the standard deduction for 2019 is $12.2K, so your "total" should be $50.3K. This is your taxable income, which is what the tax brackets apply to. Your tax breaks down as:

10% on the first $9,700 = $970
plus 12% on $39,475-$9,700 = $3,573
plus 22% on $50,300-$39,475 = $2,381

total tax = $6,924

You appear to have the common misconception that the "tax bracket %" applies to all of your taxable income.
Thanks, I never looked at it that way, the range you quoted is about what I paid in taxes for 2019.

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WoodSpinner
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Re: Tax Categories

Post by WoodSpinner » Sun Apr 19, 2020 9:09 pm

OP,

How big is your overall IRA/401K?

Future RMDs are a key piece of the puzzle for figuring out Roth Conversions.

WoodSpinner

Topic Author
Redlion
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Re: Tax Categories

Post by Redlion » Mon Apr 20, 2020 10:33 am

Thanks everyone for the replies, I now have a better understanding that the 22% tax is applicable after the 39K for single status.
The 500K Roth conversion was being considered but never intended to take place all at once, but now it looks like its not necessary.

Topic Author
Redlion
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Re: Tax Categories

Post by Redlion » Mon Apr 20, 2020 10:37 am

WoodSpinner wrote:
Sun Apr 19, 2020 9:09 pm
OP,

How big is your overall IRA/401K?

Future RMDs are a key piece of the puzzle for figuring out Roth Conversions.

WoodSpinner
About 550K in Traditional accounts with TSP (which I withdraw 36K a year) and 450K in Roth IRA accounts.
I'm 58 so I have a while before RMDs

retiredjg
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Re: Tax Categories

Post by retiredjg » Mon Apr 20, 2020 10:56 am

I don't think you need to do Roth conversions because your tax-deferred TSP account is not so large that it will cause you problems. I think you could do some small Roth conversions each year if you want.

I like the idea of keeping some money in tax-deferred to use to pay for long term care or major medical later on in life. If the bills are large enough, withdrawals could be tax free or at least partially tax free.

02nz
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Re: Tax Categories

Post by 02nz » Mon Apr 20, 2020 11:08 am

Redlion wrote:
Mon Apr 20, 2020 10:37 am
WoodSpinner wrote:
Sun Apr 19, 2020 9:09 pm
OP,

How big is your overall IRA/401K?

Future RMDs are a key piece of the puzzle for figuring out Roth Conversions.

WoodSpinner
About 550K in Traditional accounts with TSP (which I withdraw 36K a year) and 450K in Roth IRA accounts.
I'm 58 so I have a while before RMDs
At a 6.5% withdrawal rate, you're likely to draw down most of your TSP traditional balance by the time you start SS (depends on how you're invested and how the markets do, obviously). That may work out pretty well, as reducing the tax-deferred balance now will tend to reduce the amount of SS benefits subject to income tax (this gets complicated, see https://www.bogleheads.org/wiki/Taxatio ... y_benefits). As retiredjg noted it may be good to have a chunk of traditional TSP left for medical expenses. Some small Roth conversions (spread out, not in one huge chunk) MAY make sense but it won't make a huge difference.

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Re: Tax Categories

Post by grabiner » Mon Apr 20, 2020 10:28 pm

02nz wrote:
Mon Apr 20, 2020 11:08 am
At a 6.5% withdrawal rate, you're likely to draw down most of your TSP traditional balance by the time you start SS (depends on how you're invested and how the markets do, obviously). That may work out pretty well, as reducing the tax-deferred balance now will tend to reduce the amount of SS benefits subject to income tax (this gets complicated, see https://www.bogleheads.org/wiki/Taxatio ... y_benefits).
With your FERS pension, and RMDs from even a small TSP, you are likely to hit the top of the Social Security phase-in by the time you start taking Social Security. (The phase-in is not adjusted for inflation.) Thus it makes sense to assume that 85% of whatever Social Security you get will be taxable.
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