What is Tax Bracketology? And Why It Matters.

Bracketology isn’t only for March Madness. It is also for April. And in this case I am talking about Tax Bracketology. Actually, it is year-round as tax planning is a year-round sport, not just something to hope for in December. Let’s dive into this 2 1/2-minute read. 

First off, Tax Bracketology is a term I created. Kind of like Rocking Horse Investing. You know, investments moving around a bunch but you never make progress.  

Apologies for digressing there. Back to taxes and what exactly I mean about Tax Bracketology. The short version is filling up tax brackets when your taxes are expected to be at their lowest. It’s that simple.  

Let me share an example from a client. I have a physician who took a good chunk of a year off a few years back. In this case, her income dropped significantly for that year. The plan was for her to head back to practicing medicine the following year. However, we wanted to take advantage of being in a lower bracket. What did we do?

Great question. The primary thing was to convert some tax-deferred assets (old 401a balance) over to Roth dollars.  

Why would we create a tax bill by converting tax-deferred assets into “never-to-be-taxed-again” assets? Well, we had a golden opportunity to take advantage of her being in a much lower tax bracket for a period of time.  

In her case, she was going to be in a tax bracket starting with a 2 for that year. Once back to medicine the following year there would be a jump to a bracket beginning with a 3. So, we converted as much of the tax-deferred we could by filling up the marginal tax brackets that start with a 2.  

I’m not saying I am a genius, but the timing was perfect. The Roth account was then aggressively invested (remember about tax location) and the market had outstanding years in 23 and 24.  

It was more a case of real financial planning and doing serious tax planning too.  

Now, Tax Bracketology doesn’t only apply in cases where you may take a sabbatical. I more frequently see it when a physician retires well before RMDs begin and we can take advantage of lower rates before the RMDs kick in.  

Here is a super simple example and I am just making up numbers here to keep it as clear as possible. This includes tax bracket numbers as I want to keep it basic. Let’s say you have income this year of $150,000 and are in the 22% bracket. However, next year your income is expected to more than double. Well, by us doing some advanced tax planning we realize you have some space to stay within the tax brackets that begin with a 2 before jumping into a bracket commencing with a 3 next year and years beyond. So, we take a look at accelerating some tax bills now because we realize this year is when your taxes will be at the lowest.   

Again, the purpose is to take advantage of any unused capacity within a lower tax bracket. We fill up those brackets when taxes will be at their lowest.  

My last point. This is what advanced tax planning is. It is not just throwing your tax return through a software program and saying: “Here is what your tax bill was last year.” Nope, it is looking forward and taking multiple factors into consideration, such as Medicare premiums (whole other topic). 

When you are ready for some real financial planning and advanced tax planning work you know how to get in touch with me. Then again, you can always keep tipping Uncle Sam.