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We Don’t Pay Much In Taxes?

We like to complain about high taxes. We all do. The thought of the government taking “our” money drives us crazy. With the election right around the corner, we may be thinking about the effects on our pay checks due to a new president.

Most of what I read about income tax rates deals with the ultra-rich and the highest tax brackets. For example, I’ve read about top tax brackets in the 1940’s and 1950’s where the top earners had a 90% tax on the income in that highest bracket. To be clear, to reach that bracket, they would have needed to earn about $20 million per year. While interesting, it doesn’t apply to most Americans.

But what if we went back in time? Would we be paying more or less in taxes assuming our income was adjusted for inflation? I spent some time researching the details.

I have bad news for many of you: Your tax rate is among the lowest rate ever!

If you earn $100,000 today, you pay an effective tax rate of about 17%. But looking back between the 1940s and the 2000s, that effective tax rate was around 25%. You would have to go all the way back to the 1930’s to find an effective tax rate lower than what you pay now. Before 1940, there were many cases where the tax rate was between 2-5%.

See for yourself:
This calculator can highlight how much your income would have been taxed over the last 100 years

Get Ahead With Tax Planning Strategies for Next Year

Are you hunting for last minute ideas and strategies to reduce your tax bill? If so, consider spending that time preparing to reduce your tax bill for next year. It will be a lot more productive to take steps now that could reduce the tax bill for 2016 than to trying to hunt for some donation receipt. Here are a few strategies to consider going forward:

Get a handle on your income tax brackets: If you convert a portion of your IRA into a Roth, or you periodically cash in savings bonds, or if you have a taxable investment account or you can control when you recognize income, it’s critical that you understand your income tax bracket thresholds and plan throughout the year. Recognizing income (through a conversion or sale) can bump you up into a higher tax bracket and you end up paying more in taxes. Sometimes that tax can be steep and costly, affecting your income taxes, your social security taxation, and even your Medicare premiums!

Tax Loss Harvesting: If you have a taxable account, you are well aware of how frustrating it is to own an investment with a huge unrealized gain and don’t want to sell it because of the tax it will generate. The solution is to sell it in coordination with one or several investments that have underperformed. The gain and loss can offset each other. 2015 was a particularly great year to do tax loss harvesting, but we won’t be that lucky in the future.

Gifting Strategies: If you’re charitably inclined, consider giving gifts of appreciated stock. You get a tax deduction AND avoid paying capital gains on the stock. If you’re over 70.5, you can make direct charitable contributions from your IRA which can offset your annual Required Minimum Distribution.

Important Changes to Social Security

Big changes to Social Security usually take years to plan, develop and roll out. But not this time. Congress has suddenly shut down two popular claiming strategies that have been growing in popularity over the last few years. File & suspend and restricted application claiming strategies will disappear in the next 6 months.

I’m not surprised that these strategies have been cancelled. They exploited a loophole in Social Security and in some cases allowed retirees to collect more than the social security system could handle. What’s most surprising is how quickly these changes will occur. See the chart below to see how it affects you.

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Interested in learning more?

How to Reduce the Pain of a Required Minimum Distribution

When the government enacted legislation that allowed individuals to fund a Traditional IRA with tax-deferred income, those legislators also wanted to ensure that the taxes would eventually be paid. The concept was to defer income taxes until the time the money may be needed for retirement.

To ensure that the deferred taxes would eventually be paid back during the saver’s lifetime, a Required Minimum Distribution (RMD) of the balance commences when the individual turns 70 ½. The first year’s RMD is approximately 4% of the total of all tax-deferred IRA balances. Following that, the RMD percentage increases each year during retirement. The penalty for not withdrawing the RMD can result in a substantial penalty of 50% of the shortfall.

Below are a few strategies to consider that could help to reduce the pain of an RMD:

Plan Ahead

Individuals who will continue to accumulate substantial income from pensions and other sources can consider withdrawing portions of their IRA soon after age 59 ½, but only to the extent that the withdrawals do not force a higher tax bracket.

Defer Social Security

In some cases, deferring Social Security until 70 while using your IRA if needed up to that time can yield dual benefits. The RMD reduces while maximizing the Social Security benefits that increase each year that starting payments are deferred.

Conversion to Roth IRA

Converting portions of your existing traditional IRA into Roth IRAs before age 70.5 will allow the balance to continue to grow tax-free. Though taxes must be paid at the time of the conversion, subsequent withdrawals from the Roth IRA will be non-taxable.

Charitable Donations

Donating an amount equal to the RMD to qualified charities will offset the calculation of the taxable income.

Reinvesting into an Investment Account

One of the more popular strategies is to take the RMD, pay the taxes and reinvest the rest into a brokerage account.  Investors can keep their money working for them.

Contact us if you’re interested in discussing any of these strategies.