Golden Years projections include yearly tax calculations. Income taxes are calculated using IRS marginal tax brackets. The federal tax brackets can be “indexed” each year to compensate for the effects of inflation.
No one knows exactly how the tax brackets will change year by year, so we allow the planner to enter the “index rate” that is applied to the tax brackets. This is typically the same rate the assumed inflation rate for the projection, because the actual federal brackets will be adjusted each year for inflation. The index rate will also apply to the dollar amounts used for personal exemptions and standard deductions.
The index rate for federal tax tables and exemptions is located in the Tax Data section on the File Status/Options tab, shown below:
If you set the “index rate” to 0%, the program will use the current tax brackets, personal exemption and standard deduction amounts throughout the projection. Leaving this to 0% would be the most conservative assumption.
2012 Breakpoints – For Married Filing Jointly:
$0 10%
$17,400 15%
$70,700 25%
$142,700 28%
$217,450 33%
$388,350 35%
If the clients have $150,000 of taxable income in today’s dollars, using the current tax breakpoints their tax would be:
First $17,400 * 10% = $1,740
Next $53,300 * 15% = $7,995
Next $72,000 * 25% = $18,000
Last $7,300 * 28% = $2,044
Total Taxes: $29,779
Assuming a 3% inflation, that same $150,000 in today’s dollars would be equal to $201,587 in ten years.
If we leave the index rate to 0%, the tax breakpoints will not change, so taxes due on the $201,587 would be:
First $17,400 * 10% = $1,740
Next $53,300 * 15% = $7,995
Next $72,000 * 25% = $18,000
Last $58,887 * 28% = $16,488
Total Taxes: $44,223
If we index the brackets at 3%, the adjusted breakpoints in ten years would be:If you set the “index rate” to 3%, the program will increase the tax brackets, personal exemptions and standard deduction amounts at 3% each year. This will help compensate for the effects of inflation.
$0 10%
$23,384 15%
$95,015 25%
$191,777 28%
$292,235 33%
$521,910 35%
Again, assuming 3% inflation, the $150,000 in today’s dollars would be equal to $201,587 in ten years. If set the index rate to 3%, the taxes due on the $201,587 would be:
First $23,384 * 10% = $2,338
Next $71,631 * 15% = $10,745
Next $73,378 * 25% = $18,345
Last $33,194* 28% = $9,294
Total Taxes: $40,722
