Tax Planning for Federal EmployeesA NARFE Federal Benefits Institute Webinar
Presented by Mark Keen, CFP®Federal Benefits Expert
Closed Captioning (CC) is available on the recorded version of this webinar.
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Agenda
Income Tax Basics
Traditional vs. Roth
Tax-Smart TSP Contributions
Make the Most of Tax-Advantaged Plans
Other Tax Savings Options
Resources
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Income Tax Basics
U.S. Tax System
• Progressive tax system
▪ Tax rate increases as taxable income increases
• Seven tax brackets
▪ Ranging from 10-37 percent
• Not all income is taxed equally
▪ Ordinary income
▪ Investment income
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Income Tax Basics
Marginal Tax Rates
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2021 Income Tax Brackets
MarginalTax Rate Single
MarriedFiling Jointly
10% $0 to $9,950 $0 to $19,900
12% $9,951 to $40,525 $19,901 to $81,050
22% $40,526 to $86,375 $81,051 to $172,750
24% $86,376 to $164,925 $172,751 to $329,850
32% $164,926 to $209,425 $329,851 to $418,850
35% $209,426 to $523,600 $418,851 to $628,300
37% $523,601 or more $628,301 or more
Income Tax Basics
Important Tax Rates to Know
• Marginal rate
▪ Rate paid on an additional dollar of income
• Effective rate
▪ Actual percentage of taxes you pay on all your taxable income
• Effective marginal rate
▪ True tax rate paid on next dollar of income
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Income Tax Basics
Marginal Rate
• Based on taxable ordinary income
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Gross income
- above-the-line deductions
= Adjusted gross income (AGI)
- below-the-line deductions
= Taxable income
Income Tax Basics
Marginal Rate
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Gross income $150,000
Above the line deductions $0
Adjusted gross income $150,000
- Standard deduction - $25,100
= Taxable income = $124,900
Married couple, age 45, filing jointly
Income Tax Basics
Marginal Rate vs. Effective Rate
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2021 Income Tax Brackets
MarginalTax Rate
MarriedFiling Jointly
10% $0 to $19,900 12% $19,901 to $81,05022% $81,051 to $172,75024% $172,751 to $329,85032% $329,851 to $418,85035% $418,851 to $628,30037% $628,301 or more
Tax Calculation
$124kIncome Tax Rate Tax
$19,900 10% $1,990$61,150 12% $7,338$43,850 22% $9,647
$18,975
Income Tax Basics
Marginal Rate vs. Effective Rate
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Federal tax liability $18,975
Marginal rate 22%
Effective rate 15.2%
Married couple, age 45, filing jointly
Gross income $150,000
Above-the-line deductions $0
Adjusted gross income $150,000
- Standard deduction - $25,100
= Taxable income = $124,900
Above-the-Line deductions
• Adjusted gross income (AGI) = “the line”
• Deductions to arrive at AGI
Below-the-Line deductions
• Deductions taken after AGI calculation
• Taxpayers take the higher of
▪ Standard deduction
▪ Itemized deductions
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Income Tax Basics
Above-the-Line Deductions
• Common examples
▪ IRA deduction
▪ Health savings account deduction
▪ Student loan interest deduction
▪ Self-employment deductions
▪ Alimony deduction*
▪ Moving expenses for Armed Forces
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* Deduction of alimony payments is only permitted for divorces finalized prior to 2018
Income Tax Basics
Below-the-Line Deductions
Standard deduction
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Itemized deductions• Common deductions
▪ Medical expenses
▪ State and local taxes
▪ Property taxes
▪ Mortgage interest
▪ Charitable contributions
Filing Status 2021 Tax Year
Single or married filing separately
$12,550
Married filing jointly or qualifying widower
$25,100
Head of household $18,800
Add’l for >65 or BlindSingle = $1,700MFJ = $1,350
Income Tax Basics
Income Tax Basics
Marginal Rate vs. Effective Marginal Rate:
It’s Not Always as It Appears
• May differ from marginal rate▪ Additional income may trigger taxes on capital gains and dividends
▪ Additional income may trigger stealth taxes
▪ Net Investment Income tax
▪ Medicare Part B premiums
▪ Phase-out of Lifetime Learning Credit
▪ Phase-out of student loan interest deduction
▪ Phase-out of American Opportunity Credit
▪ Phase-out of Child Tax Credit
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Income Tax Basics
Not All Income Is Treated Equally
• Interest income
▪ Ordinary income
• Dividends
▪ Nonqualified – ordinary income
▪ Qualified – 0, 15 or 20 percent
• Capital gains
▪ Short-term – ordinary income
▪ Long-term – 0, 15 or 20 percent
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Traditional Versus Roth
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Traditional TSP Roth TSP
Maximum Contribution limit(2021)
$19,500 (under age 50)$26,000 (above 50)Reduced by Roth TSP Contribution
$19,500 (under age 50)$26,000 (above 50)Reduced by Traditional TSP Contribution
Contribution Income Limit None None
Federal Tax treatment of contributions1
• Made with pre-tax dollars• Taxable upon distribution
• Made with after-tax dollars• Never taxable upon distribution
Federal Tax treatment of earnings1 Taxable upon distribution Tax-free with qualified withdrawal2
Required minimum distributions Yes – typically required beginning at age 72
Yes3 – typically required beginning at age 72
1 Rules vary by state2 Roth account has been open for at least 5 years and distribution occurred after age 59 ½3 While the Roth TSP is subject to required minimum distributions, Roth IRAs are not
$10,000
$2,200Tax liability (22%)
After-tax balance $7,800
$0
$7,800
$20,000
$4,400
$15,600
$0
$15,600=
$15,600
Contribution
Tax liability (22%)
After-tax balance
Balance after 10 years
Traditional TSP Roth TSP
Return = 7.2%
All things equal. No economic difference!
$7,800
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Traditional Versus Roth
Traditional vs. Roth TSP: Constant Tax Rates
$15,000$15,600
$4,400$5,000
$20,000
Tax Liability (22%)Tax liability (25%)
$10,000
$25,000Tax liability (22%)
$75,000
$0
$15,600=
$15,600
Contribution
After-tax balance
Balance after 10 years
Traditional TSP Roth TSP
Return = 7.2%
<
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Increasing tax rates = Roth is more valuable!
Traditional Versus Roth
Traditional vs. Roth TSP: Increasing Tax Rates
$7,800
$15,600$17,600
$4,400$2,400
$20,000
Tax Liability (22%)Tax liability (12%)
$10,000
$25,000Tax liability (22%)
$75,000
$0
$15,600=
$15,600
Contribution
After-tax balance
Balance after 10 years
Traditional TSP Roth TSP
Return = 7.2%
>
20Decreasing tax rates = Traditional is more valuable!
Traditional Versus Roth
Traditional vs. Roth TSP: Decreasing Tax Rates
$7,800
Not a One-Time DecisionThings to take into consideration
• Income-related deductions and credits
• Required minimum distributions (RMDs)
• Medicare income-related monthly adjusted amount (IRMAA)
• Tax Cuts and Jobs Act
• Future state of domicile
• Change in tax filing status
• Estate planning objectives
• Large distribution
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Traditional Versus Roth
Don’t Underestimate the Impact of RMDs• Janice, 45 years old
• $150,000 salary*
• $350,000 TSP
• Contributes maximum each year ($19,500 & $26,000 at age 50)*
• 5 percent agency contributions*
• Retiring at 65
• No distributions before age 72
• 6 percent hypothetical annual return
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$0.00
$1,000,000.00
$2,000,000.00
$3,000,000.00
$4,000,000.00
$5,000,000.00
6566676869707172737475767778798081828384858687888990919293
Projected TSP Balance
$0.00
$50,000.00
$100,000.00
$150,000.00
$200,000.00
$250,000.00
$300,000.00
$350,000.00
$400,000.00
6566676869707172737475767778798081828384858687888990919293
Projected RMDs
* Salary, employee contributions and agency contributions all increased by 2% annually. The above example is for illustrative purposes only and not indicative of any investment. Values are based on a hypothetical 6% return. References to future returns are not promises or even estimates of actual returns an investor may achieve.
Traditional Versus Roth
Medicare Income-Related Monthly Adjustment Amount (IRMAA)
2021 Part B Premium (Based on 2019 MAGI*)
IndividualMarried Filing
JointlyMarried Filing
Separately2021 Premium
$88,000 or less $176,000 or less $88,000 or less $148.50
$88,001 to $111,000 $176,001 to $222,000 Not applicable $207.90
$111,001 to $138,000 $222,001 to $276,000 Not applicable $297.00
$138,001 to $165,000 $276,001 to $330,000 Not applicable $386.10
$165,001 to$499,999
$330,001 to $749,999 $88,001 to $411,999 $475.20
$500,000 or above $750,000 and above $412,000 and above $504.90
* Includes AGI plus tax-free interest. Does not include qualified Roth distributions.
Traditional Versus Roth
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Tax Cuts and Jobs Act Rates Sunset After 2025
Top tax rate not reflective of additional 3.8% Medicare surtax on unearned/investment income for individuals/married couples with MAGI at or exceeding $200,000/$250,000. Marginal tax brackets under TCJA will sunset after 2025. Note that capital gains and qualified dividends are aligned to income thresholds and not marginal brackets under the new law. In the future, tax brackets will be adjusted for inflation using chained-CPI (also known as C-CPI-U); this is a permanent feature under TCJA.
Traditional Versus Roth
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Tax-Smart TSP Contributions
26* $13,850 contributed to Traditional TSP & $12,150 contributed to Roth TSP** $81,050 is the top of the 12% tax bracket. The next dollar of ordinary income will be taxed at the 22% marginal rate.
Wages- Traditional TSP ContributionAdjusted Gross Income
- Standard Deduction= Taxable Income
Federal Tax LiabilityMarginal Rate
Income Taxed at 22%Income Taxed at 12%Income Taxed at 10%
$26,000
Traditional
Contribution $ 120,000 $ 26,000 $ 94,000 $ 25,100 $ 68,900
$ 7,870 12%
$ -$ 49,000$ 19,900
$26,000
Roth
Contribution $ 120,000 $ -$ 120,000 $ 25,100 $ 94,900
$ 12,375 22%
$ 13,850 $ 61,150$ 19,900
Split
Trad. & Roth
Contribution $ 120,000 $ 13,850* $ 106,150 $ 25,100 $ 81,050
$ 9,328 12%**
$ -$ 61,150$ 19,900
Difference $ -$ (12,150*)$ 7,950 $ -$ 12,150 $ -$ 1,458
$ -$ 12,150 $ -
Traditional TSP vs Roth TSP: Not a Choice of One or the Other
Make the Most of Tax-Advantaged Plans
The TSP Isn’t the Only Tax-Advantaged Plan
Other tax-advantaged plans include
• Individual Retirement Arrangements (IRAs)
▪ Traditional IRA
▪ Roth IRA
• Health Savings Accounts
▪ Requires high-deductible health plan
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1. Must have a qualifying high-deductible health plan to make contributions. Funds in the HSA may be withdrawn tax free for qualified expenses unless a credit or deduction for medical expenses is clamed. After age 65 funds also may be withdrawn for any reason and taxed as ordinary income without penalty. Some health insurance premiums may be qualified expenses such as COBRA coverage, coverage while receiving state or federal unemployment compensation, Medicare Part B and D premiums and qualified long-term care (LTC) insurance premiums up to certain limits but excludes Medicap/Medicare supplement policies and most hybrid products that combine LTC with annuities and the life insurance. See IRS Publications 969 and 502. This is not intended to be individual tax advice, consult your tax professional.The above example is for illustrative purposes only and not indicative of any investment. Does not include account fees. Present value of illustrated HSA after 15 years is $170,452. Estimated savings from tax deductions at a 37% marginal rate are $55,016. Assumes cash or income used for health care expenses is not withdrawn from an account with a tax liability. The example assumes the HSA is fully invested, if $2,000 was held in a cash account, the illustrated cumulative HAS account value would be $224,780. 2021 family contribution limit is $7,200 adjusted for inflation of 2.0% for 30 years with catch-up contributions of $1,000 per person (adjusted for inflation) starting at age 55 in 2026. Individual 2021 contribution limit is $3,600. $229,406 is enough to fund about 13 years of projected average qualified Medicare-related health care expenses for a couple.
2021 Contribution LimitsIndividual: $3,600 Family: $7,200
Make the Most of Tax-Advantaged Plans
Make the Most of Tax-Advantaged Plans
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Thrift Savings Plan Traditional IRA Roth IRA
Contribution limit $19,500 (under age 50)$26,000 (above 50)
$6,000 (under age 50)1
$7,000 (above 50) 1
Reduced by Roth IRA Contribution
$6,000 (under age 50) 1
$7,000 (above 50) 1
Reduced by Traditional IRA Contribution
Contribution income limit
No No income limits to contribute
• Single: $124k - $139k• MFJ: $198k - $208k
Tax deductibility income limit
Traditional: NoRoth: Contributions not deductible
MFJ:Covered spouse: $105k -$125k2
Non-covered spouse: $198k - $208k2
Single:Covered: $65k - $75k2
Contributions not deductible
Required minimum distributions
Yes – both Traditional and Roth TSP subject to RMDs
Yes No
1 Must have earned income to contribute to IRAs2 Covered refers to a participant in an employer’s retirement plan. If single and not covered or married and neither spouse is a participant in an employer’s retirement plan, a traditional IRA contribution is deductible regardless of income.
Other Tax Saving Options
Backdoor Roth IRA Strategy
• When income is too high to contribute to a Roth IRA
▪ Step 1. Nondeductible contribution to traditional IRA
▪ Step 2. Convert nondeductible contribution to Roth IRA• Tax-free conversion*
• Be aware of pro-rata rule
• Isolate basis if IRA contains pretax funds
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* Conversion is nontaxable if the amount converted consists entirely of nondeductible contributions. Any pre-tax money converted will be subject to tax.
Other Tax Saving Options
Isolate IRA Basis for Tax-Free Conversion• What is basis?
▪ Established in a Traditional IRA with after-tax contributions
▪ After-tax contributions are not the same as Roth contributions
▪ TSP does not permit after-tax contributions
• Why not leave basis in Traditional IRA?▪ Earnings on after-tax contributions will be taxed upon
distribution▪ Converting to Roth IRA offers opportunity for tax-free
earnings
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Isolate IRA Basis for Tax-Free Conversion
• IRS Pro-Rata Rule
▪ Prevents IRA owners from distributing or converting only their basis when pretax money exists
▪ Must determine how much basis represents as percentage of IRAs• Must aggregate value of all IRAs (Traditional IRAs, SEP IRAs,
SIMPLE IRAs)
• Employer plans are not included in the pro-rata calculation
▪ Distributions and/or conversions will consist proportionately of basis and pretax money
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Other Tax Saving Options
IRS Pro-Rata Rule Example
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Other Tax Saving Options
Total Value After-tax Contributions
Pre-tax Contributions and Earnings
Traditional IRA 1 $94,000 $0 $94,000
Traditional IRA 2 $6,000 $6,000 $0
Totals $100,000 $6,000 $94,000
Pro-rata calculation 6% 94%
Conversion $6,000 $360 $5,640
Tax-free Taxable
Other Tax Saving Options
Isolate IRA Basis for Tax-Free Conversion
• IRS Pro-Rata Rule
▪ Applies to all distributions and conversions, exceptrollovers to employer-based retirement plans
• Strategy
▪ Isolate your IRA basis by transferring all pretax money from IRA to TSP
▪ Then free to convert IRA basis tax-free to Roth IRA
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Example: Transfer $94,000 in Pretax Money to TSP
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Other Tax Saving Options
Total Value After-tax Contributions
Pre-tax Contributions and Earnings
Traditional IRA 1 $0 $0 $0
Traditional IRA 2 $6,000 $6,000 $0
Totals $100,000 $6,000 $0
Pro-rata calculation 100% 0%
Conversion $6,000 $6,000 $0
Tax-free Taxable
Other Tax Saving Options
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Consistent Charitable Contributions
Bunching Deductions
2021 2022 2023 2024 Total
Other itemized deductions $ 20,000 $ 20,000 $ 20,000 $ 20,000 $ 80,000
Charitable contributions $ 10,000 $ 10,000 $ 10,000 $ 10,000 $ 40,000
Total itemized deductions $ 30,000 $ 30,000 $ 30,000 $ 30,000 $ 120,000
Standard deduction $ 25,100 $ 25,100 $ 25,100 $ 25,100 $ 100,400
Deductions taken $ 30,000 $ 30,000 $ 30,000 $ 30,000 $ 120,000
Marginal tax rate 24% 24% 24% 24% 24%
Tax savings $ 7,200 $ 7,200 $ 7,200 $ 7,200 $ 28,800
Other Tax Saving Options
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Bunched Charitable Contributions
Bunching Deductions
2021 2022 2023 2024 Total
Other itemized deductions $ 20,000 $ 20,000 $ 20,000 $ 20,000 $ 80,000
Charitable contributions $ 40,000 $ 0 $ 0 $ 0 $ 40,000
Total itemized deductions $ 60,000 $ 20,000 $ 20,000 $ 20,000 $ 120,000
Standard deduction $ 25,100 $ 25,100 $ 25,100 $ 25,100 $ 100,400
Deductions taken $ 60,000 $ 25,100 $ 25,100 $ 25,100 $ 135,300
Marginal tax rate 24% 24% 24% 24% 24%
Tax savings $ 14,400 $ 6,024 $ 6,024 $ 6,024 $ 34,472
Resources
IRS Publication 590 A - Contributions to Individual Retirement Arrangements (IRAs)
IRS Publication 590 B - Distributions From Individual Retirement Arrangements (IRAs)
Managing Money NARFE Magazine articles• Five-Year Rule for Tax-Free Roth Distributions (January 2020)• The SECURE Act: A Game Changer (March 2020)• Roth Conversions in the Tax Cuts and Jobs Act Era (May, June, July 2019)• Qualified Charitable Distributions and the TSP (June 2018)
TSP-BK02 Withdrawing From Your TSP Account• For separated and beneficiary participants
TSP-775 Important Tax Information About Your TSP Withdrawal and RMDs
TSP-536 Important Tax Information About Payments From Your TSP Account
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Thank You!
A NARFE Federal Benefits Institute WebinarPresented by Mark Keen, CFP®
[email protected]@narfe.org
Closed Captioning (CC) is available on the recorded version of this webinar.
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