Why and how to avoid income lumps
Tuesday, June 20th, 2006
Categorized as: Savings Bond taxes
In his column for June 14, Learning to avoid ‘taxable events’, Scott Burns of the Dallas Morning News answers two questions about avoiding lumps of income that will push you into a higher tax bracket.
What causes income lumps is taking lots of money out of tax-deferred accounts, such as Savings Bonds, traditional IRAs, or 401Ks in one year. Burns recommends diversifying your money between tax-deferred and taxable accounts to avoid this.
To create this diversity, you may have to move a little money every year out of the tax-deferred accounts into the taxable accounts.
The majority of Americans don’t face high taxes. A couple filing a joint return, for instance, can have a taxable income of $61,300 this year before they leave the 15 percent tax bracket. Since the same couple would have $6,600 in personal exemptions, a standard deduction of $10,300, and another $2,000 deduction if elderly, a couple can have a gross income of $80,200 before entering the 25 percent tax bracket. (For a single elderly person, the comparable figure is $40,350.)…
A single person with an average Social Security benefit of about $1,000 a month can have other income up to $19,000. Additional income over that amount will cause a portion of Social Security benefits to be added to their income and taxed.
So if you make a large IRA withdrawal for a purchase, redeem a large amount of I Savings Bonds, or make a large withdrawal from a tax-deferred annuity, you’ll pay taxes not only on the taxable amount of the withdrawal, but also on a portion of your Social Security benefits.
The only way to avoid this nasty event is to talk with your accountant and “walk the line” on your income, trying to avoid triggering this additional taxation.
How do you do that?
First, you avoid big lumps of income. That means making withdrawals gradually….