September 28, 2014

Your Tax Rate is Likely to Be Lower After You Retire

Most people have lower incomes when they're retired compared to when they're working.  With lower incomes comes lower tax rates.  So it ought to follow that your tax rate is likely to be lower when you're retired.   Thats often the case.  

A married couple has a combined income of $60,000 from wages of $40,000 and $20,000 currently.   Their expected social security checks will be $1200 and $800 monthly for total of $2000 or $24,000 a year.   They've done a good job saving 10% of their pay and have amassed a total retirement nestegg in IRAs and 401ks of $600,000.    They plan to withdraw 4% of that annually for $24,000 of income.   This gives them a combined retirement income of $48,000 a year between their SS checks and retirement accounts.   That replaces 80% of their pre-retirement income.    They paid their house off a few years ago so their basic living expenses aren't too high now.

While the couple is working they would have a taxable income of about $33,700.   Thats after taking out 10% they saved in IRA/401k's and then the standard deduction and exemptions.    That $33,700 income puts them in the 15% tax bracket with $4,148 due to the IRS.

After retirement they would have lower household income.   Half of their income is from SS and little of it will be taxed.   Given their total income of $48,000 then only $2,000 of their SS check counts towards taxable income.   They'd get a higher standard deduction of $14,600 due to being 65 years or older.   Their final taxable income is just $3,500 and they'd be in the 10% bracket.    They'd only owe the IRS $350.

Of course this is just one random example.   But in this relatively typical looking couple their tax bracket went down from 15% to 10%.   Most people will see better tax situation in retirement due to social security tax treatment and the higher standard deduction for people over age 65.  

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