2017 Tax Rates - How to Use Them in Your Retirement Planning

How to use tax brackets in your retirement planning.

Couple studying tax rates.
How to use tax rates in your retirement planning. Courtney Keating/E+Getty Images

Many Americans do not understand how tax brackets work.

The applicable tax rate applies only to the amount of taxable income (income after your standard or itemized deductions and exemptions are applied) that falls in the respective single or married range. For example, if your taxable income is $92,000 and you are single, here is how your tax is calculated in 2017:

How 2017 Tax Brackets Work for Singles

  • The first $9,325 is taxed at 10%, so you pay $932.50 on that amount
  • The next $28,625 is taxed at 15% so you pay $4,293.75 on that portion
  • The next $53,950 is taxed at 25% so you pay $13,487.50
  • And the last $100 is taxed at 28% so you pay $28
  • Total taxes owed would be $18,741.75

In this situation, you would be at the 28% marginal rate, but notice only $850 of your income is taxed at that rate. Your effective rate (taxes paid divided by taxable income) would be about 20.4%.

How 2017 Tax Brackets Work for Marrieds Filing Jointly

If you are married and your taxable income is $92,000, here is how the tax is calculated:

  • The first $18,650 is taxed at 10%, so you pay $1,865 on that amount
  • The next $57,250 is taxed at 15% so you pay $8,587.50 on that portion
  • That leaves $16,100 of taxable income, which will be taxed at 25% so you pay $4,025 on that portion.
  • Total taxes owed would be $14,477.50.

In this situation, you would be at the 25% marginal rate, but notice only $16,100 of your income is taxed at that rate.

Your effective tax rate would be about 15.7%.

The 2017 tax brackets are only slightly different from 2016 - as each year the breakpoints between the rates are adjusted based on an inflation factor. Understanding how tax rates work is important to building a successful retirement plan. 

2017 Capital Gains Tax Rates - Zero to 20%

There is a 0% tax rate that applies to long-term capital gains and qualified dividends for those that fall in the 15% or lower tax bracket.

That means for those with taxable income under about $37,950 for singles and $75,900 for marrieds, by managing capital gains you may be able to pay very little tax on your investment gains.

For example, assume a married couple has $50,000 of taxable income. They could realize another $25,900 of long-term capital gains and pay no tax on the gain. Realizing gain in years where you will pay no tax on the gain is one of the few ways to earn tax-free investment income.

Tax-free gains are not available to everyone. Those in the 25% to 35% marginal rate will pay 15% on cap gains and qualified dividends, and those at the highest marginal rate will pay tax on cap gains and qualified dividends at a rate of 20%.

AMT

AMT (Alternative Minimum Tax) is a parallel tax calculation that uses a different set of rules. It adds back some items into the tax calculation. If you owe more under the AMT rules than under the regular tax rules, you have to pay the higher amount. Under the AMT rules, if your taxable income is less than the stated exemption amount then AMT does not apply.

For singles, in 2017 that exemption amount is $54,300; for marrieds, it is $84,500.

Tax Rules for High-Income Earners

Let’s take a look at some of the tax rules that now apply to those with higher incomes.

  • Medicare Surtax on Earned Income - This is a tax that works just like current payroll taxes (FICA taxes). It is a .9% tax on earned income that applies to earned income in excess of $200,000 for singles and $250,000 for marrieds.
     
  • Medicare Surtax on Investment Income - This tax is sometimes referred to as “NIIT” or Net Investment Income Tax. It is a 3.8% tax that applies to investment income if your adjusted gross income is in excess of $200,000 for singles and $250,000 for marrieds.
     
  • Phaseout of Itemized Deductions and Exemptions - If you make too much money you will not be able to use all of your itemized deductions and exemptions. Here's how it works: if you are single with adjusted gross income (AGI) of $261,500 a year, or married filing jointly with AGI of $313,800 or more then you’ll lose 2% of your personal exemptions for each $2,500 beyond the threshold limit, and 3% of your itemized deduction to the extent your AGI exceeds the threshold.
     
  • AMT for High Earners - AMT is most likely to affect singles with incomes of about $200,000 - $350,000 and married couples with incomes in the $250,000 to $475,000 range. (You may be more likely to have to pay AMT tax if you have a large family with many dependents that you claim, pay high state taxes, high property taxes, or have large miscellaneous itemized deductions.)

Using Tax Rates While Still Saving

In our example at the top of this article of  a single tax payer, let’s assume the person was not making any contributions to a retirement plan. Suppose they started contributing $2,000 to a Traditional IRA or company 401(k) plan. The first $100 saves them taxes at the 28% rate; so in this example, it reduces their tax bill by $28. The next $1,900 saves them taxes at the 25% rate, so it will save them $475. Their $2,000 deductible IRA contribution reduced their tax bill by $503.

Now suppose this person lost their job part way through the year; now their taxable income was expected to be about $25,000. Maybe they still have money in savings they could move to an IRA, but does it make as much sense now? That same IRA contribution would only save them tax at the 15% rate so it would reduce their tax bill by $300. Perhaps a Roth IRA would make more sense.

If your income varies each year (such as those working on commission) consider using your expected tax bracket to determine which type of account to fund each year. This decision should also be revisited if you are easing into retirement. As you earn less, it may not make sense to continue making deductible contributions. While you are doing your tax planning you should also see if you have investment income that could be repositioned to reduce your overall annual tax bill.

Using Tax Rates While Planning Your Retirement Income

Tax planning gets more complex when you begin planning for retirement income. Each withdrawal you take from a traditional IRA is taxable income, and once you turn 70 1/2 you are required to take withdrawals. To make things more complex, all your combined sources of income affect how much of your Social Security income will be taxed. Getting professional help at this phase can save you money.

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