The Myth of Retiring in a Lower Tax Bracket

Will I Be in a Lower Tax Bracket When I Retire?

Watch as Erin Kennedy and Joe Dowling from Dowling Financial Services discuss the myth of retiring in a lower tax bracket. Contrary to common belief, tax brackets may increase due to current tax rules. Strategies include smart spending from IRAs, considering Roth conversions beyond the 12% tax bracket, and planning for a surviving spouse’s potential higher tax bracket. Retirement planning involves calculating needs, running scenarios to ensure security, and addressing clients’ fears. Proactive planning offers reassurance and lifts the burden of financial decisions, making retirement enjoyable and achievable.

Joe and his team are committed to helping you work towards achieving all your financial goals and you with a “worry-free” retirement. You can speak to Joe and learn more about how he can help you retire comfortably here.

Related Articles:

3 Ways to Prepare Your Investments for Potential Tax Hikes

3 Tips for Avoiding Paying Taxes on Your Social Security Benefits

Four Ways to Maximize Your Retirement Income and Minimize Your Tax Bill

Transcript:

Erin Kennedy (00:15):

Hello and welcome to Retirement Wealth Academy. I’m your host, Erin Kennedy. Thanks for being with us. This show is dedicated to helping retirees and pre-retirees sort through some of the most complicated topics about retirement, and for the answers we turn to local experts. Today we have with us Joe Dowling. Joe, it’s good to see you.

Joe Dowling (00:31):

Oh, it’s good to be here.

Erin Kennedy (00:33):

I’m glad you’re here because we have a really important topic today. The myth of retiring in a lower tax bracket. A lot of us assume we’re going to be in a lower tax bracket when we retire, but that’s not always the case.

Joe Dowling (00:43):

No, that’s definitely not always the case, especially with the tax rules, the way that they’re written right now because of the Tax Cuts and Jobs Act. We have some of the most favorable tax brackets that we’ve had in many, many years and we know now with the Congress that’s divided, they’re likely not going to act on it. Now we’re planning for these ending in 2025, and what’s going to happen as it stands right now is those tax brackets are actually going to increase. So your 12 is going to go back to 15, your 22 is going to go back to 25, 24 is going to go to 27. A lot of people think, “Well, I’m going to have lower amounts of income”, but also those margins are going to shrink.

(01:21):

The other thing that people don’t think about is if something, God forbid, happens to a spouse, because they go back into a single filing tax bracket. They get a little bit larger of a standard deduction, but it’s one of those things that people don’t really want to think about, but it is the reality because at some point in the future, and we hope it’s not premature, but we know that taxes are going to go up when only one of them is around.

Erin Kennedy (01:44):

Right. No, good point. I have looked at the national debt recently, and I know the government has to come up with that revenue somewhere. What are the strategies then that you’re suggesting to take advantage of today’s historically low tax rate?

Joe Dowling (01:56):

One of the things that we suggest is depending on where a client is, we want to utilize those tax brackets. We want to utilize them for what they need from a spending perspective. If they’re spending under that $115,000 to $120,000 that they’re allowed to have as a married couple filing jointly, we want to make sure that they’re spending it out of their IRA. I don’t want to touch those Roths if they have them, I want to save them for a rainy day. The other thing we want to look at is what is the difference between what they’re spending and what their marginal tax rate is, or how much is left in that marginal tax rate? We may want to utilize that for Roth conversions.

Erin Kennedy (02:33):

I see.

Joe Dowling (02:33):

I’m actually a big advocate that I can justify even doing a Roth conversion higher than that 12% tax bracket. Once we exceed that tax bracket, we go into the next one, now we’re at that 22% tax bracket. Well, if my money doubles in 10 years and I don’t have any additional taxes owed, realistically on $100,000 I paid $22,000 to convert that.

Erin Kennedy (02:58):

Right. Good point.

Joe Dowling (02:59):

Now all of a sudden it grows after 10 years using the rule of 72, you make 7.2% per year for 10 years, well, now that $100,000 grows to 200, but I only pay $22,000 in taxes. My effective rate now becomes 11%, and the more that money grows, the lower that effective rate becomes. I want to spend through the IRAs while they’re alive, while they’re living in this favorable tax rate, and even it’s not the end of the world going from 12 to 15, but we still want to be smart about it, and we want to take advantage of it. We want to avoid things like the IRMAA adjustment when it comes to Medicare, because those are additional penalties. But we just have to look at it holistically and client by client, because everybody has different priorities, especially if you’re planning for somebody that has children and they say, “okay, I’m going to live in this lower tax bracket.” Well, if you truly believe that, do you think that it’s going to be lower for your children? If not doing it for you and your spouse, let’s do it for them.

Erin Kennedy (04:02):

Right. That conversion as a gift to your beneficiaries. Absolutely. I was surprised to learn that only 42% of people have ever calculated what they’ll need to live on in retirement. I’m assuming that should be a first step to designing a plan and I know that’s something you specialize in. There’s no cookie cutter answer to figuring this out.

Joe Dowling (04:18):

Oh, exactly. I tell people every time they come in, it doesn’t matter how much money you have, we’re going to run a retirement plan because even though you know it looks good or you think in the back of your mind that it’s going to look good, we’re visual creatures and we need to see that. I make sure that … that’s usually part of our second meeting is we go through the retirement plan with all the facts that I’ve gathered. We know a little bit about their risk profile. We know what they’re spending. We know how much they have, and that’s really what we’re looking at. I stress test the portfolio to look at it and say, “Okay, well, what if we encounter high rates of inflation?” I did this for years. It wasn’t just over the last couple of years-

Erin Kennedy (04:55):

Good for you.

Joe Dowling (04:56):

When we had high rates of inflation, but it was one of those things that we were doing for years, and I’d run it with highly rates of inflation and low rates of return. Because I tell people, “The one thing you want to know, this is one of the biggest decisions you’re going to make in your life. You want to know that you can do it no matter what happens.”

Erin Kennedy (05:12):

Of course.

Joe Dowling (05:13):

If I’m running inflation and growth at 2.6 and 3.6, I’m only beating inflation by 1%. That assumes my money’s in the safest place, and if everything looks good there, we should have no problems at all. Then we can become a little bit more realistic and play with the numbers. It’s a very interactive tool. My clients like that because then we can also set ranges on what they’re spending, because a lot of them will say, “Hey, I really like the fact that I’m leaving behind this much money, but what if I wanted to spend a little bit more of it?”

(05:43):

Well, then we can say, “All right, now, if you spent an extra $10,000 a year or $15,000 a year, what does it actually do to the trajectory? What are you left with?” Clients really enjoy that and after they do that, it gives them an idea, “Okay, well, I can retire early.” For some people it’s like, “Now I know I’m working on my time and I can go any day.” It gives people the comfort that even if they’re not ready, they know that they’re there or they’re getting close. Because another thing that clients want to know is they want to know the truth and I always tell them that I’m not going to sugarcoat it. If it doesn’t look like they can retire, I’m not going to tell them that just because they’re a client.

Erin Kennedy (06:22):

Of course.

Joe Dowling (06:23):

They know that they’re getting true fiduciary advice, they’re getting an honest opinion about whether or not they can retire, because some of them, most of them, are in the highest earning years that they’ve ever had. They don’t want to retire only to return to work in three years doing the same amount of work or the same amount of hours for less money. That’s what we look at is, okay, do you really need to work maybe an extra year or two? Do you need to look at social security at 67? Because everybody has this idea that they need to work until 67 because Social Security says they have to to get their full benefit. I tell everybody we’re goals-based. What is your goal? Is your goal to work until 67 or 70 or is it to retire early? Because if it’s to retire early, then we may collect social security a little bit early.

(07:09):

Those are some of the things that are different for everybody that comes in and that brings up an interesting thing was I had one client tell me, she said, “I’m 59. I’m making more money than I ever have in my life. Why would I retire?” I said to her, I said, “Well, what was the goal of saving? You socked away all of this money, you and your husband, into your 401Ks, into your brokerage accounts, and your goal was what? To save enough money for retirement. I just told you, you can do it.” I said, “Why wouldn’t you?” Plus the job wasn’t as fulfilling as it used to be. She said, “I never thought of it that way”, and she said, “Let’s do this.”

Erin Kennedy (07:46):

But it’s so valuable to have that conversation with somebody, right?

Joe Dowling (07:49):

It is, and it’s extremely fulfilling. Part of what I do, probably the most fulfilling is being able to tell somebody they can do it. Like I said, even if they don’t do it, because some people still be a little bit on edge and they say, “Okay, well, I’m going to work for one more year instead of three.” But they really like to hear it and to know that it’s true because a lot of people have not seen it. Only thing a lot of people have heard about is what they’re investing in and index funds and how cheap they are, and just the typical headlines that we’re all dealing with. That’s a big part of what I try to do for our clients. I tell them, “We’re going to talk about everything.”

(08:25):

A big part of what we do is education based. And you may not understand it all, but after doing it a couple of times a year for many, many years, you’re going to start to learn. Even if there’s still things that you don’t understand, you’re going to hear these headlines. You’re going to turn on the TV or you’re going to open up your iPhone and you’re going to look at little news articles and you’re going to say, “I don’t get it, but I know Joe mentioned it and they’re looking at it and I don’t have to worry about it.”

Erin Kennedy (08:50):

It all comes back to proactive planning, sitting down and crunching those numbers. I can’t imagine though how reassuring it feels when you can lay out somebody’s financial plan and address their number one fear of outliving their money.

Joe Dowling (09:04):

It really is, that’s their number one fear. Like I said, it doesn’t matter how much money people have, they still feel that they have to live on a budget. What I try to tell people is when we’re determining budgets, it’s not that we’re trying to nickel and dime them like they’ve been doing to themselves over the last 30 or 35 years. We’re just trying to get an accurate picture of what they have coming in and what they have going out so that they know they can do this and feel confident, and they enjoy that. It’s one of the things that still comes up every year though, is they say, “Am I spending too much money? Am I going to make it?” Especially over the last couple of years with this volatility-

Erin Kennedy (09:40):

And inflation.

Joe Dowling (09:41):

And inflation, and they’re like, “I’m spending more,” and I said, “Well, let’s get you a little bit more.” That’s what the money’s there for. They’re always kind of tugging and trying to say, “Okay, it feels a little unnatural taking from these accounts because all I’ve done for the last 30 or 40 years is saved.” It is an extremely large decision. It’s stressful, it’s emotional. We try to take that away from them. We try to take that burden away from them and let them know if everything’s going to be okay, that it really is going to be okay. You can almost see the weight lifted off of their shoulders when we do that.

Erin Kennedy (10:15):

Of course. So valuable, again, the proactive planning and having this conversation. Joe, I really appreciate your time today. Thank you very much for being here.

Joe Dowling (10:21):

Absolutely. My pleasure.