Ep 33: Tax-Planning Framework

Ep 33: Tax-Planning Framework

The Smart Take:

It’s common to see articles or to-do lists for year-end tax planning. But these often lack substance and fail to answer why a strategy may or may not make sense for you. Listen to Kevin describe a simplified framework to understand your tax situation and then how to thoughtfully consider what tax-smart strategies make sense for you.

Prefer to read? See below for the transcript of the show.

Randall Munroe’s “What If” Book: https://www.amazon.com/What-Scientific-Hypothetical-Questions-International/dp/0544456866

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The Host:

Kevin Kroskey – AboutContact

Speaker 1:                           Welcome to Retire Smarter with Kevin Kroskey. Find answers to your toughest questions and get educated about the financial world. It’s time to retire smarter.

Walter Storholt:                Well, it’s the Retire Smarter podcast and we’re going to help you do just that on today’s show. Retire a little bit smarter with Kevin Kroskey, president and wealth advisor at True Wealth Design. I’m Walter Storholt, Kevin serves you throughout Northeast Ohio and we’ve got another great show on the docket today. Kevin, what’s going on in your world? I know getting recovered from a little cold, a little transition in the weather got you down a little bit.

Kevin Kroskey:                  Well I don’t know if it’s a transition in the weather or it’s the fact that I have a six-year-old that goes to school. So those germ factories that they go to every day and then they bring it home and pass around the house. But apparently one of the bugs took me down and took down the whole household. So we actually keep passing it around, so hopefully, I’ll be saved on the second go around here, but feeling better today.

Walter Storholt:                Oh man, I’m sorry to hear that. But I guess when we have kids, I have something to look forward to now. Thanks for sharing that. Bringing these little germ machines into the house, right?

Kevin Kroskey:                  Yeah. The first week we took our daughter to, it wasn’t even preschool, but we took her to a Montessori school and socialization and get out there and get learning and what have you. And my wife works out of our house basically as a full-time mom. And the first week we took our daughter to the Montessori school, I mean she came home with cold sores and all kinds of stuff. I mean she had been in this beautiful little bubble for her first couple of years and then, as first-time parents were just freaking out. Like, “What did we do? We took our child out of the bubble.” And she’s okay.

Walter Storholt:                Oh man. So you just got to get them all dirty, two months old. Just go ahead and just start rolling them around in the dirt outside and getting them exposed to all sorts of stuff. So they build those antibodies up early, early on.

Kevin Kroskey:                  Get our dogs to get their saliva on them.

Walter Storholt:                Yeah, there you go. That’ll get them in good shape real fast. Too funny. Well, we had planned to spend a little bit of time on our December episodes diving in to talking about some retirement care communities and some other kind of peripheral retirement planning type discussions, but you’ve been getting a lot of people coming into the office, Kevin, with lots and lots of questions about taxes and since it is the end of the year and I know that this just really gets you going, talking about taxes and how to really build the most efficient tax plans for people. We decided to devote this month to continue that conversation about how to focus on these tax issues, bringing up some of the nuances that you kind of talked about in our previous episodes, which by the way, if you haven’t checked out some of the most recent episodes, be sure to do that. Go check out the one that was just two episodes ago called The Details In A Tax-Smart Retirement Distribution Plan. It’s episode 31, go check that one out and listen to it as well.

Walter Storholt:                We’re going to go into some of the details that we didn’t get into on that show for today. So I know that you’re a rare breed Kevin, you get excited about taxes but you do it so that your clients don’t have to worry about getting excited about a topic that most people don’t want to dive deep into.

Kevin Kroskey:                  The way that we got into this, little quick backstory, so started the business in 2007 and we just had questions that came up from clients. What’s going to happen to my withholding if you go ahead and put a lot more money into my 401k like you’re telling me to do for tax reasons? Or, hey, we’re going to go ahead and sell this holding over here or clients come in and started working with us and they were back in 2007 getting pummeled with capital gain distributions from tax-inefficient mutual funds because the market had run up pretty strongly from about 2003 through 2007 after the tech bubble burst. And then a lot of these funds were, the tax bill kept getting larger and larger. So clients didn’t know why.

Kevin Kroskey:                  And frankly, going through the certified financial planner program, we learned all about taxes and get tested on it, but that theory to take it into practice, a lot of times there’s a gap that’s there and there’s some learning that’s required. And so frankly, I mean I’m a former physics teacher, so I like to solve problems and I’ve always been one to just crack open a book or read something and be able to learn and teach myself. And that’s what I did. So I remember years ago I just bought a license for some tax planning software that’s commonly used in CPA firms and I just started putting in prior-year tax returns for clients and then doing a lot of what if, and then if there wasn’t something that, I would make a guess and say, “I’m going to make this change and here’s what I think is going to happen.” And if that didn’t happen I would do more digging and often filling out the tax forms by hand. So I would learn and yeah, that shows what a crazy, fun guy I am I suppose.

Kevin Kroskey:                  But literally it gave me what, it gave me a lot more confidence too. I learned this stuff and I know a lot about particularly individual income tax. Business income tax is something different and certainly, it’s a lot more vast in a lot of different ways. We’ll talk a little bit about that over the next couple episodes, but it’s just something that I frankly, I thought you had to do, and we’ve talked about this in the past, but your taxes are certainly related to your cashflow. That episode two episodes ago, the one that you mentioned, I went through an example Keystroke I can’t remember the fake name that we use for the client, but he had his own spreadsheet and he was using some assumptions on tax for his spending.

Kevin Kroskey:                  And basically I walked through the example in the podcast episode and showed how he was going to run out of money about five years sooner because he didn’t know really what he was doing tax-wise. And that’s one example, but there are all kinds of others we can get into. And frankly had gotten into during that episode. So your cash flow is really important. When you’re working, you have your take-home pay, if you don’t have any money really outside of your 401k or what have you, that’s what you’re living on. You put money in the 401k, you got some pre-tax deductions, you get some tax withholding, payroll tax withholding, and then you get your take-home pay. And if you spend it all then well, we know how much you spend, we may not know where it went exactly, but we know how much you spent.

Kevin Kroskey:                  And then when you get into retirement, your spending’s going to change. Here in Ohio, we have the unfortunate event of paying local income taxes that’s really only on earned income. So those go away, so security’s taxed differently, you actually have a lot more flexibility now in retirement because you have maybe IRA money, maybe Roth IRA money, money down at the bank that’s already been taxed. And so you have a lot more control over what actually is going to hit your tax return and how you’re going to recreate that cashflow. And so, as you have this tax-smart distribution plan and have a lot of flexibility, certainly knowing the tax consequences of things it fits into the cashflow, into the planning, into how soon you could retire or how long your money’s going to last or how much you can afford to spend.

Kevin Kroskey:                  It just all goes hand in hand. So literally, when I go down to the business, I just saw how it fit together and I said, “Hey, I have some theoretical knowledge, I don’t have the practical knowledge so I better get it.” And so that’s what we did. And then just over those years, we developed pretty good expertise in it and all the way to actually preparing client tax returns these days. So I saw an industry study just a couple of weeks ago. We have these benchmarking studies and what have you, what are different firms doing? And the stat that I saw was only 7% of firms are actually doing tax work for their clients. So that’s a very small minority, I would say. And I would say even if when you look inside of that 7%-

Walter Storholt:                Seven? You got to say that 7%?

Kevin Kroskey:                  7%.

Walter Storholt:                That’s it?

Kevin Kroskey:                  7%, yes. Yeah. It’s anytime, even if we hire a certified financial planner that has experience coming from say, another firm, rest assured we know that we’re going to have to go ahead and train them on tax because they just didn’t get it somewhere else. Even if they talk about it a little bit, they don’t really know how to go ahead and synthesize this stuff and how to forecast it and really incorporate it into a tax-smart retirement plan. So that kind of sets the stage for what we’re going to go through in this episode. And next, we’ll talk about some of the stuff to be mindful about, talk about some of the basics about how this works.

Kevin Kroskey:                  But then in the next episode we’ll just go through, we’ve had some interesting cases recently. I’m just going to talk through one of those cases. And there’s some different competing objectives that the client has, some different opportunities that they have. And so how do we actually think through that in a smart way to go ahead and make the client’s plan work, but also prioritize, say tax planning move A over tax planning move B, and why did we do those sorts of things.

Kevin Kroskey:                  So it’s just knowledge is one thing, I can’t remember… Bloom’s taxonomy, so I’m going to nerd out again for a moment, and I can’t remember exactly what it is, but it’s just as you go up the pyramid, it’s this higher-order thinking. So episode one, we’ll just start talking about some of this stuff and what goes into it, what are some of the tax moves that you can do, what are some of the things be mindful about? And what I would say is the vast majority of financial advisors that are out there, if they are talking about taxes, that’s all the further that they’re going to go. They’re not really going to go ahead and start doing this stuff and synthesizing this stuff and don’t really know the details that go into it. Because again, it’s such a small portion of the financial advisor population that they’re doing this.

Kevin Kroskey:                  If you’re listening to other podcasts or seeing other articles, more likely than not, you’re going to see some sort of disclaimer of, “This is not tax advice, talk to your tax professional,” something of the sort. But we do that work. So we do it firsthand. So, that’s what we’ll be getting into talking about some of the key things that probably you are hearing from other people. But then we’re going to make the bridge and make the leap and move up Bloom’s taxonomy to go ahead and talk through a case so you can actually see how some of these things are, what opportunities a client has, which ones are maybe better than others when both of them look good and how we prioritize and how that fits into their overall plan.

Walter Storholt:                Well, I can’t wait to hear about the stuff. I love how you drop, casually, we’re going to talk about some stuff today and then what was the other and then all of a sudden you’d say Bloom’s taxonomy. Is that the?

Kevin Kroskey:                  Yes, that’s right.

Walter Storholt:                Yeah, so stuff and then Bloom’s taxonomy. It’s like-

Kevin Kroskey:                  I got the basics covered.

Walter Storholt:                You’re in shorts and a tee-shirt and then you immediately like morph into you wearing a suit, you class it up real fast. So I love it. You know how to talk to all kinds of folks. By the way, quick side note, do you know Randall Munroe? Is that name familiar?

Kevin Kroskey:                  It is not.

Walter Storholt:                So you should check out his book, what if? I just didn’t know the piece about you being a high school physics teacher. I maybe had forgotten it from when we talked about a long time on an episode, but I’d forgotten that detail about you. But given that you’ve got that physics background, you love the details and you like scenarios and stuff like that. And probably I’d imagine a lot of our listeners might get a kick out of this too. Go check out his book, what if? So he’s a cartoonist that does stick figure cartoons and he’s got a website I think. And that was what was well known as XKCD, XKCD. And I didn’t know him from the comics, I just knew him from this book, but it’s taking some of his best comics plus some extras. And he built this book and it’s all answering life’s most ridiculous questions.

Walter Storholt:                So questions that readers or anybody will ask him like, what would happen if you… Literally, he takes the questions literally like, what would happen if you tried to dig all the way through to the other side of the world? And he would literally talk about the physics behind how it would actually happen. What would happen to you as you went through it? Just little things like that. Or if you threw a baseball at the speed of light, what would happen to the batter. And so then he talks about the nuclear fission that would then happen and the impacts on the batter that it would occur in nanoseconds. But he does it also very funny with comics all the way throughout too. So you get a real good kick out of it. Definitely check it out. what if? And he just came out with a new book too that I haven’t read yet, but I think it’s called, how to, which is very similar in its style.

Kevin Kroskey:                  I like his titling. What if? How-to, it’s very easy to remember and much better than the Details of a Tax-Smart Retirement Distribution Program. I can learn something from him.

Walter Storholt:                It’s also all of his titles are in lowercase for everything he does. Everything’s in lowercase, no capitals in his titles or anything. So super basic, super basic. But yeah, anyway, check it out. In fact, I’ll put a link in the description of the show today. We’ll give them some free publicity. If you want to go check it out, I’ll link out to one of those books if you want to go check it out. It was a really good read. I really enjoyed it. So I think somebody with your brain would also get a kick out of it. But let’s get to the stuff first. So let’s keep it simple. Right? Let’s get to this stuff on today’s episode before we get to the taxonomy on the next episode, what kind of stuff are we dealing with?

Kevin Kroskey:                  We’re going to go to the stuff. So we’ll just start with the thing that we all know and love is 1040, the tax return that we file every year. And the one that I’m going to refer to through the podcast is what the return looked like in 2017; in 2018 it got this makeover. And my understanding is that the IRS is going back to what it looked like in 17.  Personally did not like the 18 return. It was confusing and things were hidden and put on different schedules. So we’re going back to our simple two pages for our tax return. And when you look on that first page, certainly it’s kind of name, rank, serial number at the top part of that. But then you get to your gross income.

Kevin Kroskey:                  So gross income from all sources, whether wages from working, you could have rental property income, you could have lottery winnings, you could federal return if you get a state income tax refund, you have to pick it up as income as well. But all that is your gross income, income from all sources. It could also be you have a trust account with investments in it kicks off different distributions of taxable income, be it dividends qualified or non-qualified interest, what have you. So that’s the top part of it and that’s the first part of the equation here. And I guess a quick side note, when you’re working and you have your gross income, let’s say that your salary is $100,000. You are putting money into your 401k plan on a pretax basis. So that pretax contribution to your 401k, it’s not going to show up on the first page of your tax returns, it’s not going to show up on your tax return at all quite frankly, it’s going to show up on your W2 but not on your tax return.

Kevin Kroskey:                  And that’s because it’s just subtracted out pretax before you do get paid. Now you can trust that with a deductible IRA contribution if you can do that, and that’s actually going to be an adjustment to your income on the first page of the tax return, which we’ll get to in a moment. So gross income, income from all sources and then you get down to the bottom of this page one and get into those adjustments. So, the adjustments to the income, it could be a self-employed health insurance deduction. Whenever you’re working and you have this money being deducted pretax, similar to the 401k, the 401k is deducted before federal and most state income taxes, not all state income taxes, but most, but it is not deducted before payroll taxes.

Kevin Kroskey:                  And so I don’t want to overly complicate things here, but the 401k is before income tax, not payroll tax. If you have health insurance as an employee that you’re contributing to, you are taking those, actually, your employer is taking those deductions both before income as well as payroll taxes. So a little bit of a difference. But if you’re not an employee and you’re self-employed, well the IRS makes up for the loss of this pretax deduction and pre payroll tax deduction here by putting it as an adjustment. Some other things, again, IRA deduction at least if there were, say alimony payments, there’s been a change here more recently where those are no longer deductible. But if you had an agreement, say pre-2018, those payments were deductible, there’s some other adjustments you could have as well. So you have gross income, you subtract out any adjustments and then you get to your AGI or adjusted gross income.

Kevin Kroskey:                  And the AGI is important because there’s a lot of things in the tax code that are based on this. There’s fewer more today, post tax reform, but there’s still a lot of things that are based on it. One of the things that come into play for a lot of our clients in retirement is something called IRMAA, and this isn’t the hurricane that ripped through Florida a couple of years ago and engulfed the entire state causing billions of dollars of damage. This is the income-related Medicare adjustments, so it’s called IRMAA for short, but basically, once you’re 63, IRMAA can go ahead and cause your Medicare premiums for part B and part D to be higher. So we’ll talk about that a little bit. But again, that is actually based on your adjusted gross income.

Kevin Kroskey:                  So AGI, if you can lower it, that tends to be a good thing for tax planning, but you don’t pay tax on your gross income, you don’t pay tax on your adjusted gross income, you actually pay tax on your taxable income, which is next. But before we get to taxable income, there’s also something else. And Walter, I know you talk with a lot of financial people such as myself. Let me see how much you’ve learned over the years.

Walter Storholt:                Oh boy.

Kevin Kroskey:                  What’s between adjusted gross income and taxable income?

Walter Storholt:                You broke up a little bit there.

Kevin Kroskey:                  7%, I know a lot of those guys maybe just talking about this stuff. Let’s see.

Walter Storholt:                7%. Yeah, I’m going to blame it on them for not teaching me rather than my ow knowledge.

Kevin Kroskey:                  There you go. So you told me last time, every time we’re done talking, you feel a little bit smarter. So this is your big takeaway.

Walter Storholt:                This is my moment today. Yes, let’s do it.

Kevin Kroskey:                  All right, so you have your standard deduction, just something the IRS gives to you just for being you, Walter. In fact, because you’re married, it’s actually doubled. So the amount for 2019 is 24,400. if you’re both better than 65, it’s another 1,300 per person or 27,000 so let’s go back through this example. Let’s say you have $100,000 of income hitting your tax return. If you were to have any adjustments, you would subtract those out. Let’s just assume that you don’t, they’re not necessarily all that common. You get down to your adjusted gross income. We’re still at 100,000 and now you go ahead and you take your standard deduction. I’m just going to use round numbers here. These numbers change every year based on inflation, but just to kind of keep the podcasts more accessible, let’s just round it up and call it 25,000. So you have a hundred minus 25, then you get to your taxable income, which is what you pay tax on. And that’s 75,000 you with me?

Walter Storholt:                I’m with you and I’m actually in that camp that was itemizing for many years and then last year it changed and the standard deduction became best option.

Kevin Kroskey:                  You’re right. So the tax cuts and job act was passed very late 2017, it was really applicable for individual income taxpayers in 2018. There are a few things that impacted businesses in 17, but for 18 historically about 30% of the population itemized. And I believe the numbers came in last year, only around 10% of the people itemized and in fact most of the people that are listening to this, probably at some point in time, at least when they were working, were probably itemizing. And the standard deduction was a lot lower and then you had something called personal exemptions that they added on to it. Those exemptions are now gone and there’s just a higher standard deduction.

Kevin Kroskey:                  So only 10% of the people are itemizing. So that’s going to be one of the planning things that we’re going to talk about because if you’re close to itemizing, maybe there’s some things that you can do to get there, but before we do that, let’s talk about what some of those deductions are. So if you, the old schedule, I think, I can’t even remember what they called it in last year. For years it was called schedule A, but maybe it’s schedule one now, but all the different itemized deductions you have. So if we just run through a few of the big ones, if you have mortgage interest, that tends to be a big one that’s on there. That’s changed too. So it’s basically the first $750,000 is deductible.

Kevin Kroskey:                  So, if you have a bigger mortgage than maybe not all of it is deductible. If you’re charitably inclined, that’s a deduction that you have on your federal return as well. Some of the things that went away, if you had unreimbursed business expenses, that’s no longer a deduction. Your real estate taxes, your state, and local taxes as well. Basically the acronym for this are your salt taxes and those are now capped at only $10,000 so here where we are in Ohio, we tend to have reasonably high property taxes. It’s not like we’re New Jersey or something like that, but we have several clients that their property tax bill alone is more than $10,000 per year.

Kevin Kroskey:                  And then maybe they’re paying local taxes, maybe they’re paying state income taxes. And literally we could have, say a two-doctor family, this local tax is two and a quarter. They’re paying about 5% for state and they could be paying $50,000 in those state and local income taxes and say another 10 or so on property tax as well. With tax reform, they’re now capped at only 10,000 and a lot of people thought like, “Wow, hey, we’re really going to get hurt here,” but I can tell you, I don’t know, we probably ended up doing about 60 tax projections for clients in the fourth quarter last year and a similar amount this year. I don’t think we had a single client that ended up being worse off. And that was a big concern for a lot of people in that example that I just gave, but because the brackets were more favorable and the rates were a little bit lower, everybody just ended up working out to the good.

Kevin Kroskey:                  If they were in a different state, higher property taxes, higher income tax state, New Jersey, California, things like that, that definitely could not have been the case. But for literally, I think it was every single one of our clients that we looked at, we were somewhat surprised at first, but nobody was really hurt by that limitation, at least here in the great state of Ohio.

Kevin Kroskey:                  So some other things that could be on there, your medical expenses. Now again, when you’re working, what I had suggested was when you’re working, your employer’s deducting anything that you’re paying, pretax from your pay for your health insurance, you don’t get to go ahead and itemize that because you’re already not paying taxes on that money. It’s not after-tax money. So it’s a pretax deduction so you can’t double count it. However, once you get into retirement, let’s say that you’re 60, you’re retiring and now you go on to Cobra and Cobra, you basically continue your employer’s health insurance for up to 18 months or 36 months if you met a disability qualification. But basically now you’re using after-tax money to go ahead and pay those premiums. So now those could potentially be itemized along with some of these other deductions that you have.

Kevin Kroskey:                  And this year in 2019 you have to get over 10% of that AGI or that adjusted gross income. So let’s put some numbers on this real quick. Let’s say that AGI is that $100,000 that I mentioned, 10% here Walter, I’ll toss you a softball now, 10% of $100,000 is…

Walter Storholt:                Oh, we’ve got 90 right there. Well, 90,000.

Kevin Kroskey:                  Well 10% of a hundred-

Walter Storholt:                90 left, 90 left, 90 left. I was making it harder than it needed to be. I was subtracting already. And-

Kevin Kroskey:                  You over-thought, yes.

Walter Storholt:                I was overthinking the question there. I knew that one.

Kevin Kroskey:                  Yeah, so 10% of 100,000 is 10,000 so if your medical premiums are over 10,000, which sadly these days is not all that uncommon, if you and your spouse are paying say $15,000 then the amount over 10,000 or the 5,000 would be countable as an itemized deduction. So again, you add all this stuff up, the 10,000 for the salt deductions, if you do have some mortgage interest, again on the first 750, if you are charitably inclined, if you do have some amounts over that 10% of AGI for medical, those are really the itemized deductions that you could have there. So if those amounts get over the 24,400 or 27,000 if you’re 65 and better for both of you, married filing jointly, then there you go. You go ahead and you itemize. But again, only about 10% of the population is doing that.

Kevin Kroskey:                  So this is some of the stuff, this is the basic essential framework of the tax return and how it works. And so now that you have that simple equation, gross income minus adjustments gets you to adjust the gross income minus either your standard deduction and your itemized deduction gets you your taxable income. And the taxable income is what you pay tax on. So very simple, very important framework. Now that we get to taxable income, two other concepts come into play. And one is just some basic bracket management. So what I mean by that is our tax system is progressive in nature. So the first dollars of income are taxed at a lower rate, then the higher income you get, the more you pay and the higher rate that you pay.

Kevin Kroskey:                  And so it’s just how our tax system works. Right? So the people that do very well have to pay a higher rate and pay a bigger share of the total income tax that Uncle Sam collects. And just to give some examples here, again, I don’t want to just start spewing a bunch of numbers, but when you look at, say the first bracket is 10% and I’m going to use round numbers here. These numbers change every year and I can tell you after practicing for a number of years, you just go to your tax card because again, every year you have inflation and then the tax brackets adjust with inflation. But I’m just going to use round numbers. And in terms of round numbers, the first $20,000 of taxable income is taxed at a 10% rate. So you could have $20,000 in fact, what did we just say? You could be married filing joint and you get a $24,000 standard deduction. So you could actually have 20 plus 24 or about 44,000 and you’re still only paying a 10% tax rate.

Kevin Kroskey:                  And again, it’s only the first 24 that’s not tax, remember the deduction that the IRS gives you, it just kind of comes off the top there. So the first 20 is at a 10% rate. Again, this is married filing jointly and then you call it the next 60 or from amounts from 20 to 80,000 is taxed at a 12% rate. So you go from 10 to 12, not a huge jump, only a 2% rate differential there. And again, if you have… And this is something really important for most people to think about because this really does encompass many, many of our clients. But if you have $80,000 of taxable income and you add the standard deduction on top of it, and again, I’m just going to use some round numbers here. Let’s say it’s 25,000 you can have $105,000 of income hitting your tax return in retirement or whenever and you’re not paying any higher rate than 12%.

Kevin Kroskey:                  So a lot of people don’t understand that and they think that, hey, they’re paying a lot more than that. But think about this for a moment. You’re in retirement, you paid off your mortgage, maybe even have all of your money in an IRA because that’s what you should have done. And you got the match on the employer 401k and what have you. And you did that for all those years. You get into retirement, a lot of your expenses are a little bit lower. You’re not having to do some of the things that you did before. And you can have 100, 105,000 dollars of income from your 401k or IRA, all these accounts that have yet to be taxed hitting your tax return.

Kevin Kroskey:                  You get 25 grand-ish off the top and then your taxable income, you’re paying either a 10 or 12% tax rate. And in fact, if you actually look at the amount of tax that you’re going to pay, it’s about $9,000 to the federal government. So you have 105 hitting your return, you pay 9,000, you’re paying less than if you think of an effective tax rate, you just take that whole gross income that’s hitting your tax return and you go ahead and divide that into the tax that you paid. It’s something less than 9%, not too shabby. You can have quite a good lifestyle. You get 105, let’s just round it up and let’s say it’s 10,000, 105 minus 10 in tax that you pay. You can spend 95,000 a year or almost $8,000 a month, no mortgage, can have a pretty good lifestyle, wouldn’t you say, Walter?

Walter Storholt:                Yeah. I like how those numbers come together when you put it that way.

Kevin Kroskey:                  So that applies for a lot of our clients. But when you get up out of that 12% bracket, you go from 10 to 12, it’s only a 2% increase. You go over 12, well here you have a much bigger increase and it goes to 22% so quite a big jump. You’re going from 12, it’s a 10% increase all the way up to 22 and so a lot of the planning that we’ll often do is just try to manage around that. Sometimes, a client will be in retirement and most of the money’s in yet to be taxed IRA and we’re pulling money out and we want to fill up that low bracket, but we don’t want to go over it because it’s fairly punitive going from 12 to 22. So maybe we just go ahead and draw down our money at the bank that’s already been taxed, maybe we draw that down a little bit more, maybe we take some money out of a Roth IRA that is tax-free forever and doesn’t show up on her tax return as taxable income. But that threshold going from 12 to 22 is pretty important.

Kevin Kroskey:                  So that’s what we would call bracket management, not a big difference going from 10 to 12, pretty big difference going from 12 to 22. And for married filing jointly, I’m just going to use married couples as an example here, but single, at least up to this point, all the numbers that I’ve used for married filing jointly, just half it, that doesn’t hold true as you get higher up into the tax brackets but that’s been true so far. So 22%, that tax rate goes up to about 170,000 a taxable income. So again, if you have the standard deduction added on to it, 170 plus again, we’re at round numbers 25, we’re at 195. You’re still not paying any higher than a 22% tax rate. And then after 22, you get to 24. And 24 again, 22 to 24 not a big jump, right? Only another 2% increase. And 24 goes all the way up to 321,000 of taxable income.

Kevin Kroskey:                  And this was one of the big changes that happened with tax reform in 2017. If we go back, use back to the future here for a moment and go back to 2017 if you had $80,000 of taxable income. So it was a number that we were just kind of illustrating, 80,000 taxable income, you’re paying a tax rate of 25% on those last dollars, 25% and now you can have taxable income all the way up to about 320,000 of taxable income and you’re only paying a rate of 24%. so not only is the rate lower, again, I don’t know it’s 1% difference from 25 but man, oh man, are the brackets a lot wider.

Kevin Kroskey:                  So when I started with that example before about the two doctors, they’re both making a lot of money, paying a lot of local tax, state tax, have high property taxes, but they’re getting capped at that $10,000 salt deduction. The reason why our clients still ended up better under tax reform is for these reasons, the rates are lower and the brackets, particularly in that range that I just highlighted, are much, much more favorable. So definitely, definitely an important concept to remember. And if you’re in, we have a lot of clients in that range of making a couple hundred thousand dollars a year. I mean those people are really benefiting under this new tax regime that we have in place, at least for the next several years. So very important to remember.

Walter Storholt:                I think a lot of people when they hear taxes talked about really focus on just those percentages, right? That’s the very high level, the political snippets are all really coming down to that percentage number, but a lot more attention really needs to be paid to, you’re a detail guy right? That’s where the details are is then the brackets and how they’re shaped and reworked and formed, where the opportunity really starts to present itself. And it sounds like that’s a nice illustration that you just ran through there of just how that happens in a real-life example.

Kevin Kroskey:                  Yeah, thank you, Walter. And then after 24, you get up to another big jump. It goes from 24 to 32. So anytime you’re around these larger thresholds, I certainly would prefer to pay 24 versus 32 but then after 32 it’s certainly you’re paying a pretty high rate, but it’s kind of squashed together. 32 goes to 35, 35 goes to 37. So the big jumps that you have are going from 12 to 22 and then 24 to 32 and that encompasses a lot of people. Again, in retirement you can live like a king in Northeast Ohio having a hundred grand hitting your tax return per year, paying less than $10,000 in federal tax and then living on eight grand a month. A lot of people can be pretty happy doing that and we have a lot of clients doing just that.

Kevin Kroskey:                  But then, if you have a few hundred thousand dollars is hitting your tax return or even several hundred thousand again, those brackets up until about 320 or so of taxable income, very, very wide and very, very favorable and low. And again, I mentioned this several times throughout the podcast series over the last year and a half, but the current law as it stands is come 2026 the tax rates are going to revert back to what they were in 2017. So we have these period of years from now in 2019 through 2025 where what I just described is going to be the law of the land barring any additional legislation that’s passed in the interim. So what’s going to happen, and not only is this going to happen this year, but then we’re going to have some small inflation increase next year. So, these brackets are going to get a little bit more favorable. We can have a little more income and still pay these lower rates and that’s going to keep repeating up until we get to 2026 or some legislation changes the tax laws, whichever comes first.

Walter Storholt:                Yep. It’ll be a big topic of discussion I’m sure as we head through the next political season in 2020 but also just really good from an individual perspective here to realize how things got reworked, how we can take advantage of those things as well. So is that all the stuff Kevin? We’re ready for the next level on the next show?

Kevin Kroskey:                  Yeah, I tell you what, I’ll go through a running list here to whet the appetite a bit. So some of the things that we’ll talk about, bunching strategies, trying to get over the standard deduction for charitable donations, using things like donor-advised fund, maybe a charitable, an IRA rollover or qualified charitable distribution, if you have required distributions coming out, there’s something called the net investment income tax you got to be mindful about once you start getting over about 200,000 of AGI for single or 250 if you’re married. We already talked about IRMAA, and we kind of mentioned some taking money out of Roth IRAs and avoiding higher tax brackets. But the common thing that we’ve talked about over the years and some other people talk about, but again, we’ve been doing this a long time and we’ll talk about this and about prioritizing it, about converting money from your IRA over to a Roth.

Kevin Kroskey:                  But the other thing that is important too, let’s see, do you have some money in say like a joint account or a trust account and you’ve had some growth. We’ve had quite a strong market here in the US, so you have some unrealized gains, more likely than not in these positions. Well if you’re in that low 12% tax bracket, you sell those assets, it comes out as 0% federal tax. So that’s quite appealing. And then there are some credits to be mindful about too. So those are some of the things we’re going to talk about. But we’re going to start really going through a case, something we recently worked through for new client and synthesizing all this stuff and talking about what we could do this or do that, which one’s better and why? And actually start going ahead and moving up Bloom’s taxonomy and connecting the dots here.

Walter Storholt:                That’s what we call a tease, Kevin. That was good. Teased the next episode very well. That’s a lot that we’re going to lock into and walk away from. I may have two or three nuggets to feel smarter about on the next show, so that’s a lot to look forward to. I got a couple of good things today with Bloom’s taxonomy and of course learning a little bit more about the standard and itemized deductions. If you heard something in today’s show that you’d like to talk out a little bit more with Kevin, or if you need some help with your own financial plan, easy to get in touch with him and give you this information at the end of each show, you can give him a call at (855) TWD-PLAN, that’s (855) 893-7526. Or you can go to truewealthdesign.com if you’re ready to talk about getting a full financial or retirement plan in place, you can speak with a certified financial planner on the team by going to truewealthdesign.com and clicking the, “Are we right for you?” button to schedule your 15 minute intro call with an experienced member of the team.

Walter Storholt:                There is more to come in the next edition of the show. We do hope you come back and join us for that one where we continue this conversation about taxes and dive into some of those strategies and synthesizing all this information into a cohesive plan and how do we prioritize the different options that are on the table. We’re going to dive into all of that next time around right back here on Retire Smarter. Kevin, until then, thank you so much. We’ll talk to you soon.

Kevin Kroskey:                  Thank you, Walter.

Walter Storholt:                All right, for Kevin Kroskey, I’m Walter Storholt, we’ll talk to you next time. Be sure to join us and don’t forget to subscribe to Retire Smarter on your favorite podcasting apps as well. Talk to you again soon.

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