The Millstone Times March 2021

Monroe Township News | As We Age Taxes in Retirement

“The difference between death and taxes is death doesn’t get worse every time Congress meets.” - Will Rogers By, Bryan Kudera “Which has a better rate of return, a 401(k) or an IRA?” Some of my followers might get a chuckle out of this question, but as a Certified Financial Planner, it’s a question I’ve heard countless times. Clients become infatuated with one metric when considering financial plan- ning, and that is ROR. However, there are many other factors that impact a plan’s probability of success, such as liquidity and taxation. These last two points are dictated more by the type of account holding the investments, not necessarily the investments themselves. So, if that leading question is something you’ve often been wondering about, remember that a 401(k) and IRA are just types of accounts, like a holding tank, but not actual investments. In respect to liquidity, retirement savers are usually familiar with the Age 59.5 sensitivity as- sociated with most qualified plans, either from their benefits orientation, or a rude awakening when they try to tap their retirement plan only to find out there could be a tax consequence and a 10% premature distribution penalty. This article will focus on taxes, an overlooked, and constantly changing, dynamic that can wreak havoc on the best laid plans. Rate of return deserves its attention, but if Uncle Sam decides to take half of that asset, suddenly it’s not so valuable. 1. Income Taxes

Income taxes have historically been the most severe form of taxation in America. The US uses a progressive tax system, meaning the more money you make, the more taxes you’ll pay. In 2020, there are seven tax brackets, starting at 10% and peaking at 37% 1 . It’s worth noting that the US uses a marginal tax system, this means that only the dollars that eclipse a bracket get taxed at that rate (i.e. A single man makes $518,402, putting him in the 37% tax bracket. Only $1 will be taxed at 37%, everything below $518,401 will be taxed in lower brackets, creating a lower “effective tax rate”.). These brackets are determined by income and filing status: Single, Head of Household, Married Filing Jointly/Qualifying Widow, or Married Filing Separately. In addition to Federal Income Taxes, some states, 43 currently, implement their own State Income Tax. The highest state income tax belongs to California, which tops out at 13.3%, whereas their neighbor, Nevada, has no state income tax. Similarly, my home state of NJ can reach 10.75%, a common reason why many “snowbirds” claim residence in Florida, where there is no state income tax 2 . In addition, some cities carry their own local income tax! Perhaps the worst part about planning for future income taxes, is the constant change. In 1913, the 16th Amendment created federal income tax. The top tax bracket was 7% on all income over $500,000, which would be about $11 million in today’s money. The highest tax rate ever was 94% in 1944, levied on all income over $200,000. The rates have continually changed with almost every new administration up until today, with 37% being the top bracket for 2020, as previously mentioned. 3 2. Capital Gains A capital gain occurs when a capital asset is sold or exchanged at a higher price than its basis. Short-term capital gains, those that occur within one year, are taxes as ordinary income (see above). Long-term capital gains, assets held over one year, can enjoy a lower rate. In 2020, there are three capital gains tax brackets, including 0%, 15% for the majority of Americans, and 20% for high earners (i.e. Filing Single with over $441,450 taxable income). Investors may also be subject to a Net Investment Income Tax (NIIT) of 3.8%, since the passage of Obamacare. 4 Similar to income taxes, the capital gains tax rates have always been changing. Historically, the top capital gains tax rate has trended well below the max- imum marginal income tax rate, except for 1988-1990, in which they were equal.

1 Source: IRS 2 https://taxfoundation.org/state-individual-income-tax-rates-and-brackets-for-2020/ 3 https://bradfordtaxinstitute.com/Free_Resources/Federal-Income-Tax-Rates.aspx

4 https://www.taxpolicycenter.org/briefing-book/how-are-capital-gains-taxed 5 https://www.investopedia.com/ask/answers/090415/dividend-income-taxable.asp 6 https://www.ssa.gov/benefits/retirement/planner/taxes.html

24 The Millstone Times

March 2021