Since 1968 , marginal top rates on taxable income have been as high as 77% and capital gains rates as high as 39.6% . While I don't think tax rates will get this high, it will be higher than the 35% and 15% maximum tax rates that are in effect now for income and capital gains respectively.
For many wage earners and people receiving pensions, there is little to do but accept higher tax rates. With the exception of home mortgages, rental real estate or dependents, there is isn't much the average wage earner can do to reduce taxable income. However, for retirees with mainly non-wage earnings (e.g. dividends, interest, and capital gains) or retirement plan distributions(e.g. 401k or IRA), there may be some opportunities if one can time when the income is taxed.
Since retiring in our forties in 2007, I've been looking at ways to allocate income to minimize future tax payments I'll be making. Here are some of the approaches I will be using:
- Make Roth IRA conversions at a 15% or lower marginal tax rate. Since 1968, the tax rate of the first bracket has ranged between 10-16%. Therefore, I am projecting that my future tax rate on retirement plan distributions will be 15% or higher. It's an easy decision to make the conversion now to enable a 0% tax on withdrawals in the future. The only downside risk is the enactment of a FairTax.
- Start distributions from traditional IRA earlier than 70 1/2. For those that have significant retirement account savings, the required minimum distribution (RMD), which begins at 70 1/2, may force one to take large withdrawal each year and that are nearly 100% taxable. After 59 1/2, distributions from an IRA are penalty free. I plan to use a mix of spending from principal, investment earnings, and IRAs to keep taxes on retirement distributions at a minimum.
- Sell stock with long term capital gains in the next 2 -3 years. In 2008 to 2010, the long term capital gains rate for stock can be as low as 0% and is a maximum of 15%. The low capital gains tax rate is due to expire in 2010. It is likely the maximum long term maximum capital gains tax rate will be higher than 15% after 2010, or even earlier.
If one likes the stock, it can be immediately repurchased, at a higher cost basis.
For those interested, the analysis can be done on a spreadsheet simulating a tax return using income sources and adjustments, itemized deduction and exemptions, credits, and the 2008 tax tables. Otherwise, a qualified financial planner should be able create a individualized plan based a person's own situation.
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This is not financial or tax advice. Please consult a professional advisor.
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