Don't Fear the Taxman: Understanding Tax Brackets for a Smoother Retirement

Today we're diving into a topic that's super important, but often misunderstood tax brackets. Now, don't click away. Understanding tax brackets can actually save you money, especially if you're planning for retirement. But first, let me introduce myself. My name is Warren Berger. I'm the owner of Luminary Financial Advisors located in Cocoa Beach, Florida, and serving people across the country. We help people create and implement tax efficient retirement plans. So what exactly is a tax bracket? In the simplest terms, a tax bracket is a range of income that is taxed at a specific rate. In the US we have a progressive tax system, which means the more you earn, the higher your tax rate could be, but, and this is a big, but it's not as straightforward as it sounds. So how do they work? Let's say you're a single filer for 2023 and you made $50,000 this year.

You might think you'd be taxed at a single rate, but that's not how it works. Your income is actually divided into chunks and each chunk is taxed at a different rate. Here's a simplified example using hypothetical rates. The first $10,000 is taxed at 10%. The next 20,000 is taxed at 12%, and the remaining 20,000 is taxed at 22%. So you pay a thousand dollars on the first chunk, $2,400 on the second, and $4,400 on the last chunk. Add those together and your total tax would be $7,800. Now, you might've heard the terms marginal tax rate and effective tax rate. Your marginal tax rate is the rate you pay on your last dollar of income. In our example, that would be 22%, but you're not paying 22% on all $50,000, just the last 20,000. Your effective tax rate is your total tax divided by your total income.

So $7,800 divided by $50,000 equals 15.6%. That's a more accurate reflection of your overall tax burden. Understanding your tax bracket isn't just about knowing what you owe. It's also about finding opportunities to save. Tax planning is all about making the most of the rules to minimize your tax liability. Here are some ways to do that. Number one, using tax deferred accounts. Contributing to tax deferred accounts like a 401K or an IRA can lower your taxable income for the year. For example, if you're right on the edge of moving into a higher tax bracket, contributing more to your 401K could keep you in a lower bracket, saving you money both now and in the future. Number two, tax loss harvesting. If you have investments, consider tax loss harvesting. This involves selling off underperforming investments to offset the gains you've made

Elsewhere. By doing this strategically, you can reduce your overall taxable income and possibly keep yourself in a lower tax bracket. Number three, Roth conversions. If you're in a lower tax bracket now, but expect to be in a higher one in the future, consider converting some of your traditional I R A funds to a Roth I R A. You'll pay taxes now at a lower rate instead of later when your rate could be higher. Let's go through just a couple of real world examples. Example one, say you're a single filer with a taxable income of $85,000. You're just $5,000 away from moving into a higher tax bracket. By contributing an extra $5,000 to your 401K, you could stay in the lower bracket and also set yourself up for a better retirement. It's a win-win Example number two, you have a year where you know your income will be lower than usual.

Maybe because you took a sabbatical, you're in between jobs or you just recently retired. This could be a great time to convert some of your traditional IRA to a tax-free Roth IRA. You'll pay taxes at a lower rate and enjoy tax-free withdrawals in retirement. So there you have it. Tax brackets aren't just numbers on a chart. They're a tool you can use to plan your financial future more efficiently. By understanding how they work and how different income streams and deductions fit in, you can actually make smarter decisions that pay off in the long run. I hope this has been helpful. If you'd like to get some help with your personal financial situation, I have a link to my personal calendar below. Or you can go to luminary financial advisors.com to set up a complimentary call with me. Whether or not we decide to work together, I'll always make sure you get pointed in the right direction. I also have links below to some checklists and flow charts to help you on your financial journey. And finally, check out the link to our Facebook group called 10 Years to Retirement, where we put out tons of education for people about to head into retirement. Thanks for watching, and I'll see you next time.