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Financial Planning > Tax Planning > Tax Deductions

When shifting assets, consider the power of 28

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For those who have read my bookThe Power of Zero,” it’s easy to guess my favorite tax bracket in retirement: zero percent. Why? Because if tax rates double as some experts are predicting, two times zero is still zero!

However, when tasked with guessing my second favorite tax bracket, very few succeed.

As you may have surmised from this article’s title, my second favorite tax bracket is 28 percent. To understand why, we have to refer back to a key concept from “The Power of Zero”: In a rising tax rate environment, you want to have carefully prescribed amounts of money in your taxable and tax-deferred buckets. In your taxable bucket, you want to have about 6 months’ worth of basic living expenses. In your tax-deferred bucket, you want your balance to be low enough that Required Minimum Distributions at 70 ½ get offset by standard deductions and personal exemptions.  Everything above and beyond these thresholds should, by definition, flow into the tax-free bucket. 

Most of the potential clients with whom I meet have the lion’s share of their assets in their taxable and tax-deferred bucket, and little if any in their tax-free bucket. So in order to protect their assets from the impact of future tax increases, it becomes necessary to reposition their assets to tax-free. I call this asset shifting. It isn’t unusual for my clients to shift anywhere from $50,000 to $150,000 per year from tax-deferred to tax-free buckets over a 10-year period. 

When a tax-free retirement strategy calls for large asset shifts, the 28 percent tax bracket can be your best friend. Remember, you pay a tax any time you shift money from tax-deferred to tax-free. That taxable income gets piled right on top of all your other income, and gets taxed at your highest marginal tax bracket.

Here’s the potential rub: If you are currently in the 15 percent tax bracket, and that asset shift pushes you into the 25 percent tax bracket (starting at $75,301), this can be a huge source of heartburn. Technically, you’ve only added 10 percent to your tax rate. However, you’ve nearly doubled your tax liability!

See also:

Life insurance as long-term care: Doing double duty

The top 10 IUL myths and how to debunk them

But consider this: If you’re currently in the 25 percent tax bracket, and your asset shift pushes you into the 28 percent tax bracket (starting at $151,901), then your tax liability has risen by a mere 3 percent. At the same time, you’ve given yourself an extra $80,000 of shifting room before reaching the next tax bracket (the 33 percent tax bracket begins at $231,451).

In other words, for an extra 3 percent premium, you’re able to shift an additional $80,000 per year. In the case of many of our clients, that’s all the flexibility they need to get their tax-deferred assets repositioned to tax-free before tax rates go up for good.  

Once your potential client realizes that the 28 percent tax bracket is only slightly more expensive than the 25 percent tax bracket, that person will be more inclined to make large asset shifts. Of course, much of this shift will go to Roth Conversions, but if they’re over 59 ½, some of it can go towards a Life Insurance Retirement Plan (LIRP). The LIRP can enable them to grow their money safely and productively while providing a death benefit that, in many cases, doubles as long-term care insurance.

In short, if your client believes that tax rates are going up, he or she has a disproportionate share of assets in the first two buckets and is currently in the 25 percent tax bracket, make sure to do some educating around the power and flexibility of the 28 percent tax bracket.

See also:


The Roth 401(k) vs the IUL

What most retirement gurus get wrong


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