Question on marginal tax rate when dividends/LTCG are included

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theRoCK
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Question on marginal tax rate when dividends/LTCG are included

Post by theRoCK »

Hi,

I am trying to figure out whether to do a partial Roth 401k contribution, or make it fully in traditional 401k. I am in the cusp of the 24%/32% tax bracket. I am trying to see if I can make a partial Roth and still be in the 24% bracket. I am in the 15% LTCG tax rate.

MAGI beyond $326,600 (MFJ) is taxed at the 32% rate. Our W2 income+interest is ~365k. Hypothetically, if I have dividends + LTCG distributions at 30k, that puts our total income at 395k. With a $39,000 traditional 401k contribution and 24,800 standard deduction, it puts our taxable income at 331,200, which is in the 32% bracket. If I decide to do Roth 401k, then I will be increasing the taxable income.

But is it really taxed at 32%? If I remove the 30k div+LTCG which will be taxed at 15%, then my taxable income would only be 301,200, which gives me about 25k that can be in a Roth 401k and still be in the 24% bracket.

Which is the correct scenario?
rkhusky
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Re: Question on marginal tax rate when dividends/LTCG are included

Post by rkhusky »

You generally only get a different marginal rate if some dividends/LTCG are being pushed into a higher bracket. The LTCG rate of 20% kicks in at a MAGI > $496,600.

There is also the Net Investment Income Tax (NIIT) of 3.8% that kicks in with a MAGI > $250K for MFJ.

Does the AMT affect you?

What percent of your dividends are qualified?

It is probably best to run your numbers through tax software.

edit: If you look at the Qualified Dividends and Capital Gain Tax Worksheet, you will see that you subtract off the QD/LTCG from your taxable income, compute income tax on the remainder, compute CG tax on the QD+LTCG, and add the two together. So, the 24%/32% rates do not apply to the QD/LTCG amounts of your taxable income, and you would have extra room to do some Roth 401k before the 32% rate was applied. Whether you want to do Roth 401k in the 24% bracket is another matter.
Last edited by rkhusky on Mon Sep 14, 2020 7:01 am, edited 6 times in total.
crefwatch
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Re: Question on marginal tax rate when dividends/LTCG are included

Post by crefwatch »

This long thread is highly recommended. Look for useful links in it, too.

viewtopic.php?f=10&t=320854&hilit=Roth
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#Cruncher
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Re: Question on marginal tax rate when dividends/LTCG are included

Post by #Cruncher »

theRoCK wrote: Mon Sep 14, 2020 1:17 amBut is it really taxed at 32%? If I remove the 30k div+LTCG which will be taxed at 15%, then my taxable income would only be 301,200, which gives me about 25k that can be in a Roth 401k and still be in the 24% bracket.
This is correct. With your assumptions, RoCK, you can reduce your traditional IRA contribution $25,400 (and thereby increase your AGI by that amount) before reaching the 32% tax bracket. Note below the difference between "Taxable income" and "Ordinary income taxable".

Code: Select all

Floor: ord income 10% bracket           0   ------>
Floor: ord income 12% bracket      19,750   ------>
Floor: ord income 22% bracket      80,250   ------>
Floor: ord income 24% bracket     171,050   ------>
Floor: ord income 32% bracket     326,600   ------>        -         -  
Floor: LTCG & QDI 15% bracket      80,000   ------>

Wages + Interest                  365,000   365,000
Traditional IRA contrib           (39,000)  (13,600)
Net wages + interest              326,000   351,400
LTCG & QDI                         30,000    30,000
Adjusted gross income             356,000   381,400

Code: Select all

Standard deduction                 24,800    24,800
Taxable Income                    331,200   356,600  <===
LTCG & QDI Taxable                 30,000    30,000
Ordinary income taxable           301,200   326,600  <===

Taxable: ord income 32% bracket         0         0
Taxable: ord income 24% bracket   130,150   155,550
Taxable: ord income 22% bracket    90,800    90,800
Taxable: ord income 12% bracket    60,500    60,500
Taxable: ord income 10% bracket    19,750    19,750

Taxable: LTCG & QDI 15% bracket    30,000    30,000
Taxable: LTCG & QDI  0% bracket         0         0

Code: Select all

Tax: ord income 32% bracket             0         0
Tax: ord income 24% bracket        31,236    37,332
Tax: ord income 22% bracket        19,976    19,976
Tax: ord income 12% bracket         7,260     7,260
Tax: ord income 10% bracket         1,975     1,975
Tax: LTCG & QDI 15% bracket         4,500     4,500
Total tax                          64,947    71,043

Increased income                        25,400               -  
Increased tax                            6,096
Marginal tax rate                       24.00%
Most of these figures are from the Compare sheet of my Marginal Tax Rates Excel workbook.
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theRoCK
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Re: Question on marginal tax rate when dividends/LTCG are included

Post by theRoCK »

rkhusky wrote: Mon Sep 14, 2020 6:36 am You generally only get a different marginal rate if some dividends/LTCG are being pushed into a higher bracket. The LTCG rate of 20% kicks in at a MAGI > $496,600.

There is also the Net Investment Income Tax (NIIT) of 3.8% that kicks in with a MAGI > $250K for MFJ.

Does the AMT affect you?

What percent of your dividends are qualified?

It is probably best to run your numbers through tax software.

edit: If you look at the Qualified Dividends and Capital Gain Tax Worksheet, you will see that you subtract off the QD/LTCG from your taxable income, compute income tax on the remainder, compute CG tax on the QD+LTCG, and add the two together. So, the 24%/32% rates do not apply to the QD/LTCG amounts of your taxable income, and you would have extra room to do some Roth 401k before the 32% rate was applied. Whether you want to do Roth 401k in the 24% bracket is another matter.
Thanks. I am discounting the NIIT since I will be over the 250k limit even with traditional 401k, and from what I understand, W2 income isnt subject to NIIT even if above 250k. Only a small % of my dividends is non-qualified. I plan to look at my last years 1040 as a guide to the NQD/QD/LTCG amounts from funds. I havent been subject to AMT yet, so hopefully it stays that way.

I plan to do a lot of travelling and other activities in the early years of retirement, assuming financial plans and health hold up, so expect to be in the 24% or higher tax bracket at least during the early years. Hence, I like to diverisfy on my contributions also to have some freedom in where I take my withdrawals from. As of now, that diversification has come from a backdoor Roth over the last few years and traditional 401k, but would like to have more in my roth bucket.
crefwatch wrote: Mon Sep 14, 2020 6:39 am This long thread is highly recommended. Look for useful links in it, too.

viewtopic.php?f=10&t=320854&hilit=Roth
Thanks, will take a look.
#Cruncher wrote: Mon Sep 14, 2020 7:16 am
theRoCK wrote: Mon Sep 14, 2020 1:17 amBut is it really taxed at 32%? If I remove the 30k div+LTCG which will be taxed at 15%, then my taxable income would only be 301,200, which gives me about 25k that can be in a Roth 401k and still be in the 24% bracket.
This is correct. With your assumptions, RoCK, you can shift $25,400 from a traditional to a Roth IRA contribution before reaching the 32% tax bracket. Note below the difference between "Taxable income" and "Ordinary income taxable".

Code: Select all

Floor: ord income 10% bracket           0   ------>
Floor: ord income 12% bracket      19,750   ------>
Floor: ord income 22% bracket      80,250   ------>
Floor: ord income 24% bracket     171,050   ------>
Floor: ord income 32% bracket     326,600   ------>        -         -  
Floor: LTCG & QDI 15% bracket      80,000   ------>

Wages + Interest                  365,000   365,000
Traditional IRA contrib           (39,000)  (13,600)
Net wages + interest              326,000   351,400
LTCG & QDI                         30,000    30,000
Adjusted gross income             356,000   381,400

Code: Select all

Standard deduction                 24,800    24,800
Taxable Income                    331,200   356,600  <===
LTCG & QDI Taxable                 30,000    30,000
Ordinary income taxable           301,200   326,600  <===

Taxable: ord income 32% bracket         0         0
Taxable: ord income 24% bracket   130,150   155,550
Taxable: ord income 22% bracket    90,800    90,800
Taxable: ord income 12% bracket    60,500    60,500
Taxable: ord income 10% bracket    19,750    19,750

Taxable: LTCG & QDI 15% bracket    30,000    30,000
Taxable: LTCG & QDI  0% bracket         0         0

Code: Select all

Tax: ord income 32% bracket             0         0
Tax: ord income 24% bracket        31,236    37,332
Tax: ord income 22% bracket        19,976    19,976
Tax: ord income 12% bracket         7,260     7,260
Tax: ord income 10% bracket         1,975     1,975
Tax: LTCG & QDI 15% bracket         4,500     4,500
Total tax                          64,947    71,043

Increased income                        25,400               -  
Increased tax                            6,096
Marginal tax rate                       24.00%
Most of these figures are from the Compare sheet of my Marginal Tax Rates Excel workbook.
Thanks, that will be very useful. This year since I have already contributed a bunch to traditional, my roth 401k will be a small amount, but I plan to do the same exercise next year and do some of the 401k as Roth.
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