Episode 89: How Do I Know Which Tax Bracket I’m In?
Tax time is upon us! Welcome back to our Money Wisdom Question Series, I’m Nick Colantuono, CFP® and today’s question is, “how do you know which tax bracket you’re in and how do you know the rates that you have to pay?”
The Higher the Income, the Higher the Taxes
Well look, tax brackets all come down to income. The more income you have, the higher the tax will be on those higher dollar amounts of income. I will say, the good thing about our tax structure here in the United States is that it’s graduated. So if you have the majority of your money maybe taxed at 12% and you go over that tax bracket, it’s not like those new tax rates, the 22% or the 24% bracket, get retroactively applied all the way back to dollar 1. Only those dollar amounts in those higher brackets get applied the higher bracket.
Income Sources & Deductions
The easiest way to think about taxes is to take all your sources of income, whether it’s earned income, 1099 income, W-2 income, Social Security, any distributions you took from IRAs, anything that either applies to earned income or what is known as ordinary income. What you then do is take all your deductions. Are you single? Are you married? Do you have children? Do you have dependents? Did you make any IRA, 401(k) or retirement plan contributions? Did you pay any real estate taxes? Do you have mortgage interest? The easiest way to think about this is to take all your income, minus all your deductions, and those dollar amounts are going to hit different brackets.
Tax Brackets
The first bracket is 10%, the next bracket is 12%, there’s then a pretty significant jump where you go from the 12% Federal bracket up to a 22% Federal bracket. Beyond that, as you get higher income amounts you go 24%, then 32% and then 35%. Again, this is how you want to do the calculations when trying to figure out “what tax bracket am I in?” Then as a result, “what’s my tax rate?” Keep in mind that different levels of income will have different rates associated with them, so when calculating your overall tax rate, it’s not just about how much income you have, it’s in which bracket does the majority of your income fall?
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Taxes Simplified
Reducing your tax liability is one of the most effective ways to save money in retirement. Working in tandem with a tax planner or financial professional, you can create a custom, tax-efficient financial plan that aligns with your retirement goals.
