Markeith, let’s warm up with a little “tax brain teaser” about Bill. Sounds like fun, right?
So, after working hard for his adult life, Bill, 65, has finally retired and he’s going to more concerts than ever before.
Bill has $42,275 in taxable income which includes $25,000 of Social Security benefits this year.
As you can see, Bill’s $42,275 of taxable income puts him in the 22% tax bracket because it’s more than $41,775 and less than $89,076.
Toward the end of the year, Bill decides to take an extra $1,000 out of his IRA for a trip to see Willie Nelson play in Austin. How much is he taxed on that extra $1,000?
The logical answer is that for every dollar of IRA money he pulls out, he pays $.22 in federal income taxes. Therefore, if he took out $1,000, he should owe $220 in federal income tax—22% tax. Simple enough, right?
He owes $407 in tax—a 40.7% federal tax rate on that income!
Thanks to the madness that is our tax code, and the unique formula that determines how Social Security benefits are taxed, the real answer is that Bill owes a $407 on that extra income.
Shocking, right? Almost to the point where it can’t possibly be true! I mean, if the top rate for a single person is 37%, and that rate doesn’t begin until he has more than $510,000 of taxable income, how can he pay a higher rate with much less income?
It doesn’t make any sense! But here’s the thing… It doesn’t have to. It is the tax code, after all.
Joining us for this discussion on IRA Challenges is Markeith Gentry who is the station’s Production Assistant and makes sure Mastering Your Money is available to our listeners. Welcome back to Mastering Your Money, Markeith Gentry