Playing the Marginal Tax Bracket Game

December 1st, 1999

When we look at the results of a freshly tailored financial plan, prepared by our firm, we are struck by the power that is placed in the hands of our clients. This power is the vision of a possible future and the tools to implement the financial structures that all but assure the client of realizing that future. Among the many benefits enjoyed by a successful planning engagement, is the benefit of understanding how income and estate taxes will affect your future. When our clients are presented with their financial plan, they have a tool by which they can make tax-wise decisions regarding investments, retirement distributions, gifting, and wealth transfer to beneficiaries. Arguably one of the most important tax planning features of our financial plan is the projection of marginal income tax brackets throughout the retirement years of our clients.

We often see examples, in our client’s financial plans, of situations where our client’s marginal income tax bracket fluctuates significantly during their retirement years. The marginal income tax bracket refers to the federal income tax rate at which every additional dollar of income will be taxed. For example, for a married couple with taxable income between $41,201 and $99,600, the marginal income tax bracket is 28%. This means that every dollar of income earned within this range will be taxed at 28%. If your taxable income were to fall below $41,201, you would be taxed at a rate of 15% on each additional dollar of income. In our financial plan, we can spot those years and suggest a strategy to our clients that accelerates income into those years, in favor of a deceleration of income in years in which their marginal income tax rate would jump into a higher tax bracket of 31% or more. Viewing your retirement distributions over a long period of time is particularly important in tax planning. We often see clients who have reached the age of 70 and who have been making required minimum distributions from retirement accounts when they do not need the income. Proper financial planning would have led to different distribution options after age 59-1/2 but before 70-1/2. The law says that we must take distributions. But, if we talk to people early enough about tax planning, we have often given them clever options with which to save taxes.

For example, if our client has a detailed financial plan that identifies opportunities to withdraw their retirement plan balances in earlier years, when their marginal income tax bracket is lower, it may be wise to withdraw funds in earlier tax years with lower tax rates in affect. With the reduction in the retirement account balance comes a smaller required minimum distribution at age 70 and a lower overall tax liability.

Tax planning is different from tax preparation. Our clients will pay a lower lifetime tax bill when we help them play the marginal income tax bracket game.