Author Topic: How to avoid bump in tax bracket due to temp work  (Read 6101 times)

mickmey

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How to avoid bump in tax bracket due to temp work
« on: January 10, 2014, 10:21:09 AM »
Hello.  I have a somewhat complex, but temporary, fiscal situation in our family.

Situation: my husband is an active duty army officer.  I am a SAHM in the army reserve (so, I work one weekend a month, a few weeks a year).  We own the home we live in plus two prior residences as rental properties.  We have two kids, contribute about 10% annually to charity and typically take a loss on each of our rental properties due to required depreciation and the fact that the houses are probably poor rental properties (they were bought as homes, not as investments).  We plan on consolidating our rental houses into better choices when we know where we'll retire. 

SO, we were in the 15% bracket last year due to an AGI in the high $80K reduced to mid $40K due to itemized deductions and exemptions.

This year I have the opportunity to work for up to 179 days, and as a newly promoted lieutenant colonel, it's a good chunk of change for a single-income family.  Problem is, it should bump our AGI to about $140-150K with taxable income reduced to $100K or so due to itemization and exemptions.  Solidly in the 25% range. 

Our Goals: pay off our three home mortgages (plus a land lot for retirement home) by May 2020 (hubby's retirement date from active duty).  Use rental income from three homes plus hubby's pension to live employment-free lifestyle.  Our plan is pretty sound, and this six months of extra money is a great boost to the achievement of that plan.

Problem: My working increases our tax burden from about $7K to $17K (by my very rough calculations…exact numbers aren't as important as the more than doubling figure).  It's still worth it, BUT…

Should we invest in the Thrift Savings Plan (military 401K) to get our AGI with deductions below the $73,800 to put us in the 15% bracket (putting our tax burden somewhere in the $9-10K range)?

Is there another way?

We have a somewhat different attitude towards investment because we're both in pension-earning careers.  He'll earn his at 43 and I'll earn mine at 60.  So, generally speaking, our attitude is that we don't need any more money that we can't touch till we're 60 (IRA, 401K, TSP).  We'll be set by then and any extra money will not change things for us.  But, at the same time, if it helps save $8-9K in taxes, it may be worth it. 

One point to note: TSP allows you to take payments spread over life expectancy without paying the IRS Early Withdrawal Penalty Tax (but you can change it to lump sum after 59 ½ and still avoid the penalty).  So, hubby and I could begin withdrawing at 43 with payments based on life expectancy and then switch to lump sum at 59 ½ with no penalty. 

Either way it shouldn't affect our "get out of employment" card by too many months.  We just want to keep the most money for ourselves in a place that makes sense.

Thank you in advance!!

beanlady

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Re: How to avoid bump in tax bracket due to temp work
« Reply #1 on: January 10, 2014, 10:25:03 AM »
Look at the actual tax tables. I don't have them in front of me but think you might be overestimating the increase in taxes. It is only the portion of your income that falls above a cutoff that is taxed at a higher rate.

mickmey

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Re: How to avoid bump in tax bracket due to temp work
« Reply #2 on: January 10, 2014, 10:27:39 AM »
Thank you.  I was basing it off a bank rate 1040 tax calculator.  It was shockingly severe.

seattlecyclone

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Re: How to avoid bump in tax bracket due to temp work
« Reply #3 on: January 10, 2014, 11:01:11 AM »
Don't be too worried about being slightly over the cutoff for a new tax bracket. The higher rate only applies to income above the cutoff. If Alice earns $1 less than the cutoff for the 25% tax bracket, and Bob earns $1 more than the cutoff for the 25% tax bracket, Bob will pay a whole 40 cents more than Alice on his taxes (15% of the dollar below the line and 25% of the dollar above the line).

You may decide that it makes sense to put some money in an IRA to minimize your income that is subject to the 25% rate. Then in a future year when your combined earnings are lower, you can roll over part of the money from your traditional IRA to a Roth IRA. That way you can shift some of your income from a high-earning year to a low-earning year and pay less tax overall.

dragoncar

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Re: How to avoid bump in tax bracket due to temp work
« Reply #4 on: January 10, 2014, 11:24:30 AM »
Don't be too worried about being slightly over the cutoff for a new tax bracket. The higher rate only applies to income above the cutoff. If Alice earns $1 less than the cutoff for the 25% tax bracket, and Bob earns $1 more than the cutoff for the 25% tax bracket, Bob will pay a whole 40 cents more than Alice on his taxes (15% of the dollar below the line and 25% of the dollar above the line).

You may decide that it makes sense to put some money in an IRA to minimize your income that is subject to the 25% rate. Then in a future year when your combined earnings are lower, you can roll over part of the money from your traditional IRA to a Roth IRA. That way you can shift some of your income from a high-earning year to a low-earning year and pay less tax overall.

I think she took that into account, and the numbers look pretty correct to me.  That said, yes, I would max out all sheltered tax accounts at gross income over $140

MKinVA

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Re: How to avoid bump in tax bracket due to temp work
« Reply #5 on: January 10, 2014, 11:47:54 AM »
How about a college savings plan for those kids?

mickmey

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Re: How to avoid bump in tax bracket due to temp work
« Reply #6 on: January 10, 2014, 12:19:48 PM »
How about a college savings plan for those kids?

We've considered that, but I have to admit we're a little hard on our kids in that regard (they're only 3 and 15 months! Ha!).  Neither of us had money for school, both chose public universities over private ones to keep costs low and took ROTC scholarships.  I had no debt after school.  Hubby did but got it knocked out early. 

On the other hand, we also have the advantage of being able to transfer our post-9/11 GI Bill to our kids (which pays for three years plus expenses).  Also, as a Texas vet, right now I can transfer my Hazelwood Act Benefit to my children.  So, there's lots of potential college money to go around.

What if we set up a plan and they don't need it?

seattlecyclone

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Re: How to avoid bump in tax bracket due to temp work
« Reply #7 on: January 10, 2014, 12:44:54 PM »
What if we set up a plan and they don't need it?

Withdrawals from your child's 529 plan are tax-free as long as they pay for college expenses for your child. This includes tuition, mandatory fees, and room and board. If the kid earns a scholarship that pays for most (or all) of their tuition, you can still take out enough from the 529 to pay for their living expenses. That money will not be taxed.

If they end up with so many scholarships that it looks like they'll still have money in the account when they graduate, you are allowed to withdraw up to the amount of the scholarship each year without paying the 10% penalty tax. You will have to pay regular income tax on any investment gains on the amount you withdraw this way, though.

The 529 plan money can also be used to pay for graduate studies, or can even be re-designated for a grandchild or other family member if your own kids don't manage to use it up.

Catbert

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Re: How to avoid bump in tax bracket due to temp work
« Reply #8 on: January 10, 2014, 12:57:51 PM »
I would contribute the max to TSP.  Assuming military TSP works the same as civilian you will have the option to roll to a traditional IRA when you separate from service.  You could then slowing convert to Roth IRA.

If this is a one shot thing, you could accelerate deduction in this year e.g., 20% to charity this year, 0% next year.   

Even paying 10K taxes on 50K income isn't too shabby!

Note:  Once your MAGI is over 100K you starting losing the ability to write off losses on your rental properties.  You will eventually get them back (following year if you income drops) or when you sell.  Not sure if there are other write-offs that you'll lose.

mickmey

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Re: How to avoid bump in tax bracket due to temp work
« Reply #9 on: January 10, 2014, 05:04:15 PM »
I would contribute the max to TSP.  Assuming military TSP works the same as civilian you will have the option to roll to a traditional IRA when you separate from service.  You could then slowing convert to Roth IRA.

If this is a one shot thing, you could accelerate deduction in this year e.g., 20% to charity this year, 0% next year.   

Even paying 10K taxes on 50K income isn't too shabby!

Note:  Once your MAGI is over 100K you starting losing the ability to write off losses on your rental properties.  You will eventually get them back (following year if you income drops) or when you sell.  Not sure if there are other write-offs that you'll lose.

I think you're right about the roll-over.  I have lots more research to do. 

The charity thing is definitely an option. 

And thank you for the heads-up about the rental write-off!  I didn't know that.   

Nords

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Re: How to avoid bump in tax bracket due to temp work
« Reply #10 on: January 18, 2014, 10:39:52 PM »
This year I have the opportunity to work for up to 179 days, and as a newly promoted lieutenant colonel, it's a good chunk of change for a single-income family.  Problem is, it should bump our AGI to about $140-150K with taxable income reduced to $100K or so due to itemization and exemptions.  Solidly in the 25% range. 
Our Goals: pay off our three home mortgages (plus a land lot for retirement home) by May 2020 (hubby's retirement date from active duty).  Use rental income from three homes plus hubby's pension to live employment-free lifestyle.  Our plan is pretty sound, and this six months of extra money is a great boost to the achievement of that plan.
Problem: My working increases our tax burden from about $7K to $17K (by my very rough calculations…exact numbers aren't as important as the more than doubling figure).  It's still worth it, BUT…
Should we invest in the Thrift Savings Plan (military 401K) to get our AGI with deductions below the $73,800 to put us in the 15% bracket (putting our tax burden somewhere in the $9-10K range)?
Is there another way?
We have a somewhat different attitude towards investment because we're both in pension-earning careers.  He'll earn his at 43 and I'll earn mine at 60.  So, generally speaking, our attitude is that we don't need any more money that we can't touch till we're 60 (IRA, 401K, TSP).  We'll be set by then and any extra money will not change things for us.  But, at the same time, if it helps save $8-9K in taxes, it may be worth it. 
Welcome to the club!  Good problems to have.

I'd max out both of your conventional TSPs now.  When he retires (and when you retire) then you can roll your TSP over to a conventional IRA and convert it to a Roth IRA.  Do a little of the conversion every year, up to the top of the 15% tax bracket, until you have everything in a Roth.  Keep in mind that you'll want to finish that conversion before your pension starts, because your two pensions will probably put you solidly in the 25% bracket.

Another option on bunching charitable deductions is to use a charitable gift fund with Fidelity or Vanguard.  It decouples the timing of the tax deduction from the donation to the charity.  You can load the CGF anytime you want and take the tax deduction in that year.  You can distribute the grants to your charities all at once (if that works for you) or on your original annual schedule.  This way you could donate two or three years of contributions to the CGF this year (while your income is high), take the deduction all during this tax year, and then distribute the grants from the CGF over the next 2-3 years.

I agree with your Texas veteran approach to college for your kids.  It's one of the reasons that our daughter switched her residency from Hawaii to Texas this year.

Here's more thoughts, and I apologize if I'm preaching to the choir. 

If you both make it to retirement eligibility then all of your savings will only have to bridge the years between his active-duty pension and your Reserve pension.  It's quite possible that by the time you're 60 years old, your two pensions will exceed your spending.  Every dual-military couple I know has this "issue", so when you're straightening out your real estate make sure that you also have a landlord exit strategy.

When you both get pensions, you need to decide whether you want each other's SBP.  My spouse and I elected not to take out SBP on each other because we'd rather have the 6.5% now to spend on each other.  If one of us dies now, the survivor has more than enough assets to do just fine without SBP.  If you're concerned about the safety margin, another option would be to take out term life policies on each other to expire at age 60 (when your pension starts) or age 70 (when you'll be taking Social Security).  That's generally cheaper than 30 years of SBP premiums. 

Your SBP decision may also have to take your kids into account, especially if they have special needs with an insurable interest in SBP.

For the last 11 years I've been leisurely converting our two conventional IRAs and two TSPs to Roth IRAs, and not worrying too much about skipping a year when our income goes over the 15% bracket.  This year I realized that our income (and my spouse's Reserve pension) when she reaches age 60 could push us right through the 25% tax bracket into the 28% bracket.  In addition to that, our accounts have experienced considerable growth during that time.  I only have eight years left to finish these conversions, and now I'm not worried about straying up into the 25% tax bracket to get it done. 

mickmey

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Re: How to avoid bump in tax bracket due to temp work
« Reply #11 on: January 20, 2014, 09:28:19 AM »
Wow, Nords!  So much good information.  I had no idea about the CGF.  What a neat concept! 

And we hadn't considered not taking SBP, because I'm *mostly* a SAHM, so I'd need his pension from when he retires (I'll be 44 or so) to when I draw my pension (60).  But, you're right about considering term life.  We'll have to run the numbers.  I totally see us not needing to take SBP on mine. 

As for the landlord exit strategy, what exactly do you mean?  Get out of the land-lording business when income needs are met and roll it into a different investment to pass to kids?

And good to know about the leisurely TSP conversion.  Good luck with finishing yours on time. 

Thank you for the great advice!

Nords

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Re: How to avoid bump in tax bracket due to temp work
« Reply #12 on: January 25, 2014, 09:04:09 PM »
I totally see us not needing to take SBP on mine. 
There's an obscure trick on Reserve SBP that will provide you years of coverage for just two years of premiums. 

When you "retire awaiting pay" from the Reserves, your spouse has several SBP options.  (It's his decision, not yours.)  One of them is to elect "gray area" benefits if you die before you collect your pension.  You pay no premiums during this time because you're not collecting a pension yet.  Then, when you turn age 60 and begin collecting your pension, your spouse cancels the SBP.  DoD will charge two years of premiums, but the net effect is complete gray area coverage.  Now all you need to do is consider term insurance for the period when you're between ages 60 and 70.

So consider "Option C":
http://the-military-guide.com/2011/04/14/the-reserve-component-survivor-benefit-plan/
http://the-military-guide.com/2011/04/13/more-sbp-details/

As for the landlord exit strategy, what exactly do you mean?  Get out of the land-lording business when income needs are met and roll it into a different investment to pass to kids?
Yep.  Jason Hull (HullFinancialPlanning.com) says that he's selling his rental properties when he's age 60 and rolling the after-tax profits to some other asset.  One concern is that he's using a great property manager now, and she'll probably be retiring herself at about the time he reaches age 60.  He doesn't want to manage his own properties as his years advance (and our cognition declines), so selling out is less hassle for him.

We ended up with a rental property because it was less hassle to keep (and rent out) than to sell.  Now that we have the time on our hands to reassess that situation, we're still holding on to see if our daughter wants to have it after she's finished with Navy.  Our rental property is also designed for aging in place (not so much our current home), so it's even possible that we'd move back into it someday and sell our residence.  In other words, our exit strategy is "probate".

Of course if your exit strategy is "probate" then you escape a bunch of taxes and give your kids a great boost in the property's cost basis.  Not that you'll be around to appreciate your prescience.

mickmey

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Re: How to avoid bump in tax bracket due to temp work
« Reply #13 on: January 27, 2014, 07:22:12 PM »
Thanks so much.  I wouldn't have known, or even thought, about electing SBP for the "gray area."  What a neat concept.

I really appreciate your advice.

Nords

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Re: How to avoid bump in tax bracket due to temp work
« Reply #14 on: January 27, 2014, 09:16:31 PM »
Thanks so much.  I wouldn't have known, or even thought, about electing SBP for the "gray area."  What a neat concept.
I really appreciate your advice.
Glad to.  Please help spread the word about the book-- I'm seeking reader advice & stories for the next edition!