The Tax Man Cometh…

by kungfugirl on November 10, 2011

The Tax Man Cometh...

The year is 2040.

Hovercraft zoom by rapidly and weave crazily in between the numerous skyscrapers. You’re on your hover-skateboard, even cooler than Marty McFly’s, and you’re skating for your LIFE.

Someone is chasing you. Someone wants something from you. Someone is out to get something from you…something he believes is rightfully HIS.

With a quick glance over your shoulder, you dart frantically down a small side alley, thinking you’ve finally escaped him.

Whew. Safe for the moment.

…or maybe not…

OH NO! Here he comes!!! It’s not the evil Han, it’s not the grim reaper, it’s even worse…..it’s:

The TAX MAN.

Using his insidious robotic bots to track you, he easily follows you down the deserted alley. Filled with bloodthirsty lust and a need for money that cannot be quenched by any other means, he will stop at NOTHING until he gets what he has come for….YOU.

Or rather, your money, to be precise.

It’s game over for you….you are trapped, scared, caught.

What are you going to DO???


Well, unfortunately, if you are our friend in the story above and are already age 70 1/2, there is not much you can do…you owe Uncle Sam his “fair share” (ha) of your income, and there is little you can do to reduce it at this point. I’m so sorry.

Here are the sad tax facts:

1. Any 401(k) income you receive when you retire is taxed as ORDINARY income.

That’s right. If you buy a stock outside of your 401(k) with your regular post-tax dollars, hold it for at least a year, and then sell it for a profit, it is considered capital gains income, which is currently taxed at a maximum rate of 15%, so you must pay 15% of your gain to the IRS.

However, if you buy the same stock inside of your 401(k) and then sell it for a profit, when you take that money OUT of your 401(k) it is considered “ordinary income”, which is currently taxed at a maximum rate of 35% Federal, plus up to 11% State.

OUCH.

Great deal for the government, lousy deal for you.

2. You are required to take out a portion of that 401(k) money as income, each and every year, whether you want to or not, because the piper (Uncle Sam) must get paid.

Yes, even if the stock market pulls a 2008, or you have other income you’re living off of and don’t want to mess with your 401(k), you are still required to sell some each and every year. If it’s at a loss, Uncle Sam doesn’t care…he just wants your money. (I believe in the case of 2008 there was some sort of exception/leniency, but I certainly wouldn’t count on this as part of my retirement “plan”.).

3. You have to plan to be much more “poor” than you probably think in order to have your “ordinary income” tax rate be more than the long-term capital gains tax rate.

Currently, as mentioned above, the long-term capital gains tax rate is 15%. (Note these things are always changing and the tax code now stands at 72,536 pages and counting(!), so I highly recommend consulting with a certified tax professional, someone who loves studying those 72,000 pages (I most certainly do not!) before you make any iron-clad decisions).

But as it stands right now, if you are a single person and make more than $34,500 in taxable income, you will pay 25% income tax on every dollar that you make over this level. By the way, this includes just about every kind of income you can have…..including up to 85% of your Social Security income!

4. Yes, that’s right…up to 85% of your Social Security income is taxable!

You start getting taxed on your Social Security income if all of your retirement income (including so-called tax-exempt interest and other normally “excluded” items) + half of your Social Security income is above a certain threshold.

And what is that magic threshold? Well, it’s barely poverty….$25,000 if you’re single, and $32,000 if you’re married filing jointly. If you hit those levels with the little formula above, then at least 50% of your Social Security income is taxable, and that percentage increases to 85% as your income rises.

5. Taxes will most probably definitely be higher in the future, when you retire.

When you look at the U.S. debt levels (even though right now everyone is focused on Europe), you can bet that your taxes are only going to go in one direction (straight UP). You will most certainly be paying higher taxes on this money in the future than you would have to pay today.

“So what you’re saying, Kung Fu Girl, is that,

I have to take required distributions from my 401(k) once I turn 70 1/2, whether I want to or not, even if I don’t need to or if the market has tanked that year?”

Yes.

“And the money that I make from my 401(k) stock investments is not taxed at the normal capital gains rate, but at my most-probably-higher ordinary income rate?”

Yes.

“And up to 85% of my Social Security income (should I be so lucky to receive any…) is also taxed?”

Yes.

“OK, but what about my current-year tax deduction? Won’t I have more disposable income to spend in the year I put money INTO my 401(k), because my taxes are reduced that year?”

Yes.

But I have a question for you….will you invest that money wisely, or spend it on crap?

Only you know…

My last question for you (thank God, I know you’re about to die from taxation boredom so I’ll spare you, I promise) is:

Does procrastinating your taxes really pay off?

I’m not so sure. In general, procrastination is never a good thing, and I suspect that procrastinating paying your taxes is no different.

It is highly dependent on your own personal situation and plans, of course, but it certainly isn’t the “no-brainer” that the mass-market financial pundits would have you believe. Yes, if you get an employer match (free money) that changes things. Sure, if you plan to retire in a very low tax bracket you could make out ahead. Yes, if you are on the borderline between tax brackets and the 401(k) deduction knocks your current-year taxable income down to the next lower bracket, that could be great.

But ask yourself….is living on income less than $34,501 per year what you want for your retirement?

Certainly now, for the current generation of Seniors, it may work out OK….many of them do have paid-for houses and low property taxes depending on the state where they live, but will that work for you? Will that make you happy and fulfilled?

Once again, only you know.

Well, to get back to our little story and end on a happy note, no matter what you decide for yourself, I hope that in the year 2040 you are happily retired and zipping all over the place in your very own George Jetson hovercraft, and happily teleporting your entire family to exotic destinations as often as you’d like! That’s what I want to do!

More tomorrow, when we’ll finally beat this horse dead (I promise! Never to be heard from again…)…

To your financial success,
– Kung Fu Girl

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About the Author:

Susan Fujii, aka , is an SEC Accredited Investor who believes that anyone can learn to be financially independent.

Susan has authored 199 posts on Kung Fu Finance, and you can connect with her on .

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