Consider your tax bracket when setting up your (401k) investments

Knowing your tipping point when it comes to your tax brackets may save (earn) you a bunch of money and tell you if you should be investing more of a percentage of your income. What I mean is this, if you are on the border of being in a higher tax bracket, investing more money into your 401k or IRA or whatever plan you use, could actually put you in that lower tax bracket, saving you a bunch of money in taxes while increasing your investments – that make you money.

Let’s make an example; We’ll put a pal of mine in the spotlight whom we’ll call John. John is a single guy who makes $90,000 a year, and he invests 6% of his pay pre-tax into his 401k plan. His net taxable income would be (assuming he has no other deductions for simplicity that would lower his taxable income) $90,000 – $5,400 (90,000 X .06 = 5,400), or $84,600. In the tax tables below, you would see John falls into the 28% tax bracket, as his income is between $78,850 but not over $164,550. John would pay $16,056.25 plus 28% of the excess over $78,850, in this case that would be $94,000-$84,600 = $9,400 X .28 or $2,632. So, he would pay $16,056.25 + $2,632 = $18,688.25 in taxes for a net take home pay of $94,000-$18,688.25= $75,311.75.

What if John would have put aside 12.5%? $90,000 – $11,250 (90,000 X .125 = 11,250), or $78,750. In the tax tables below, you would see John now falls into the 25% tax bracket, as his income is over $32,550 but not over $78,850. John would pay $4,481.25 plus 25% of the excess over 32,550, in this case that would be $78,750-$32,550 = $46,200 X .25 or $11,550. So, he would pay $4,481.25 + $11,550 = $16,031.25 in taxes for a net take home pay of $78,750-$16,031.25 = $62,781.75.

By investing a little more than double what he was previously, John dropped himself a tax bracket and avoided $2,657 in taxes ($18,688.25 – $16,031.25 = $2,657). Not to mention, his investments went from $5,400 to $11,250. If his company matched that money, instead of having $10,800, he would have $22,500 invested and working for him. If he was 30, and left that alone til he was 60, he would have made over $393,000 (assuming company match of 100%, investment total of 22,500), compared to a little over $188,000 if all he had invested was $10,800 (this number is based off of 5,400 and a 100% company match, investment total 10,800).

Table 1.–Federal Individual Income Tax Rates for 2008

If taxable income is: Then income tax equals:

Single Individuals

Not over $8,025………………………………………………………… 10% of the taxable income
Over $8,025 but not over $32,550……………………………….. $802.50 plus 15% of the excess over $8,025
Over $32,550 but not over $78,850……………………………… $4,481.25 plus 25% of the excess over $32,550
Over $78,850 but not over $164,550……………………………. $16,056.25 plus 28% of the excess over $78,850
Over $164,550 but not over $357,700 …………………………. $40,052.25 plus 33% of the excess over $164,550
Over $357,700 …………………………………………………………..
$103,791.75 plus 35% of the excess over
$357,700

Heads of Households

Not over $11,450………………………………………………………. 10% of the taxable income
Over $11,450 but not over $43,650……………………………… $1,145 plus 15% of the excess over $11,450
Over $43,650 but not over $112,650……………………………. $5,975 plus 25% of the excess over $43,650
Over $112,650 but not over $182,400………………………….. $23,225 plus 28% of the excess over $112,650
Over $182,400 but not over $357,700………………………….. $42,755 plus 33% of the excess over $182,400
Over $357,700 ………………………………………………………….. $100,604 plus 35% of the excess over $357,700

Married Individuals Filing Joint Returns and Surviving Spouses

Not over $16,050………………………………………………………. 10% of the taxable income
Over $16,050 but not over $65,100……………………………… $1,605 plus 15% of the excess over $16,050
Over $65,100 but not over $131,450……………………………. $8,962.50 plus 25% of the excess over $65,100
Over $131,450 but not over $200,300………………………….. $25,550 plus 28% of the excess over $131,450
Over $200,300 but not over $357,700………………………….. $44,828 plus 33% of the excess over $200,300
Over $357,700 ………………………………………………………….. $96,770 plus 35% of the excess over $357,700
6

Married Individuals Filing Separate Returns

Not over $8,025………………………………………………………… 10% of the taxable income
Over $8,025 but not over $32,550……………………………….. $802.50 plus 15% of the excess over $8,025
Over $32,550 but not over $65,725……………………………… $4,481.25 plus 25% of the excess over $32,550
Over $65,725 but not over $100,150……………………………. $12,775 plus 28% of the excess over $65,725
Over $100,150 but not over $178,850………………………….. $22,414 plus 33% of the excess over $100,150
Over $178,850 ………………………………………………………….. $48,385 plus 35% of the excess over $178,850

Notes:
An individual’s marginal tax rate may be reduced by the allowance of a deduction equal
to a percentage of income from certain domestic manufacturing activities.7
Alternative minimum tax liability
An alternative minimum tax is imposed on an individual, estate, or trust in an amount by
which the tentative minimum tax exceeds the regular income tax for the taxable year. The
tentative minimum tax is the sum of (1) 26 percent of so much of the taxable excess as does not
exceed $175,000 ($87,500 in the case of a married individual filing a separate return) and (2) 28
percent of the remaining taxable excess. The taxable excess is so much of the alternative
minimum taxable income (“AMTI”) as exceeds the exemption amount. The maximum tax rates
on net capital gain and dividends used in computing the regular tax are also used in computing
the tentative minimum tax. AMTI is the taxpayer’s taxable income increased by the taxpayer’s
“tax preference items” and adjusted by redetermining the tax treatment of certain items in a
manner that negates the deferral of income resulting from the regular tax treatment of those
items.
The exemption amounts are: (1) $45,000 ($66,250 in taxable years beginning in 2007) in
the case of married individuals filing a joint return and surviving spouses; (2) $33,750 ($44,350
in taxable years beginning in 2007) in the case of other unmarried individuals; (3) $22,500
($33,125 in taxable years beginning in 2007) in the case of married individuals filing separate
returns; and (4) $22,500 in the case of an estate or trust. The exemption amounts are phased out
by an amount equal to 25 percent of the amount by which the individual’s AMTI exceeds
(1) $150,000 in the case of married individuals filing a joint return and surviving spouses,
(2) $112,500 in the case of other unmarried individuals, and (3) $75,000 in the case of married
individuals filing separate returns or an estate or a trust. These amounts are not indexed for
inflation.

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