Cool and breezy Yucatan greetings to my dozens of readers around the globe. These days we’re enjoying the mild November weather here in Merida. After a blazing hot summer (and fall), it’s a relief to have daily highs of “only” 85 to 90 degrees. After a great trip in October to FinCon 2017 in Dallas, I’m excited that it’s finally November. Why? Come on, think about it. Thanksgiving? No. Autumn leaves and pumpkins? Nope. The 2018 IRS updates necessary for our Free Money! tax planning? Yeap, you nailed it!
Every October Forbes publishes an article with all of the IRS tax updates for the upcoming year. (Read it here.) I usually find the Forbes article the day it’s published, but this year I missed it. How did I miss such an important post? Okay, I’ll admit it: I was focused on the Trump administration’s proposed tax-law changes. Specifically, the talk of reducing retirement plan contributions to $2,400 a year really shook me up. (Okay Donald, you got me on that one. You gotta admit that he really is the King of Misdirection.) As I fretted and worried, the Forbes article slipped right past me.
Why is this annual Forbes article so important? Simple, it always contains the essential information for our Free Money! calculations. As soon as I know the new standard deduction, personal exemption, and tax credit information, I can crank out our tax plan for the upcoming year. As always, there are two parts to our tax plan: 1.) the Free Money amount and 2.) the 10% Money amount.
Our 2018 Free Money
If this is your first visit to my blog, you’re probably skeptical about any claim of “free money.” The free money I’m talking about is the tax-free income allowed under basic IRS tax law. (Be forewarned, I’m not a lawyer, CPA, or tax expert of any sort.) In our case, we’re a family of three who will automatically qualify for some great tax breaks in 2018. First, we’ll be able to grab $13,000 of free money by using the MFJ (married filing jointly) filing status for our standard deduction. Next, we’ll claim three personal exemptions ($4,150 each) to increase our free money by $12,450. Right off the bat, the IRS allows us $25,450 of tax-free income…thanks guys!
Wait, the IRS largesse doesn’t stop there. Because we are happily burdened with the obligation of raising our son, the Feds provide us with a child tax credit of $1,000. Put simply, this means that our first $1k of federal income tax is wiped clean by Mr. IRS. How much extra income are we allowed to earn? Easy, $1,000 divided by .10 (10 percent) yields $10,000! (This always confuses readers. Just remember that your first tax bracket is taxed at 10 percent.) In 2018, we’ll be able to earn $35,450 of income and pay $0 in federal income tax. Deal, put it there pal! Okay table fans, here are the Free Money! numbers in table form:
It’s hard to believe that a family of three who earns almost $3k a month is considered too poor to pay federal income tax. In many parts of the U.S. $3k is a good chunk of change, especially if you live frugally and have a mortgage-free home. If we need more than $35,450, we’ll still have one other low-tax income option…
Our 10% Money for 2018
Do you remember how that $1k child-tax credit allowed us to pull $10k of income? Well, there’s a little more tax-efficient money to be had: the remainder of the money at 10% income-tax bracket. Since we’ll be filing MFJ in 2018, our 10% tax bracket will end at $19,050. However, we “ate up” $10k of that bracket when our $1k child-tax credit reduced our first $1k of income tax. The math for the remainder of the 10% bracket is straight forward:
$19,050 – $10,000 = $9,050
Since this money is still in the 10% bracket, we’ll only owe $905 of federal income tax ($9,050 * .10). Here’s what our Free Money + 10% Money will look like in 2018:
So there you have it, we can net $43,595 of income after paying our low federal income tax of $905. That is an effective tax rate of 2.03%…not too shabby, right? In most of the places we frequent that’s a decent amount of money.
Our 2018 Income Options
Now that we know these two numbers, we can make informed decisions as we take distributions from our 72t IRAs and 457 accounts. If we take out more than $44,500 from those accounts, we will be stepping into the 15% tax bracket. I’d rather walk over a bed of hot coals than wander into that tax bracket!
No matter how much money we take from our accounts, we will not be clueless when tax time comes in April of 2019. It amazes me when people are “shocked” about how much they owe in taxes. Uh, that’s why you take five minutes a year to calculate these numbers. (If you still don’t understand how to calculate these numbers, don’t despair because I made a special page just for you…it’s later in the post. Shhh, keep that a secret between just the two of us.)
Before we take any income in 2018, we already know how much we’ll have on a monthly, weekly, and daily basis. This is a useful way to look at our possible income scenarios for the upcoming year. Check out our possible income numbers for 2018:
Maybe it’s just me, but both sets of numbers look considerable to me. Either income amount would work for us here in Merida, Mexico. Both options would also work in the rural places we lived previously.
The Big Takeaway
Doing a little tax preparation once a year can help you control your tax bill and possibly save you thousands of dollars annually. Please try to flip your thinking and realize that YOU (not the IRS) control your tax bill. Once you know your Free Money! and 10% Money amounts, you can then take steps to reduce your income (401k/403b/457 plans, IRA, HSA, etc.) to your individual tax-paying pain threshold. Some people shoot for $0 while others don’t mind paying a lot in taxes.
The point is that you should decide, more or less, how much you’ll pay in taxes in 2018. Remember that on Monday, April 15th, 2019, you will already know how much you owe in federal income tax. Unless you have an unexpected windfall (high five!), your Free Money tax planning should keep you within your income-tax pain threshold. (In our case, the 15% rate!)
Okay class, you now have a homework assignment. Actually, it’s a lot easier than last year’s tax-planning homework. I want you to go to this link and find your Free Money! and 10% Money amounts for 2018. See if your numbers add up. If you can’t figure out the math behind your numbers, please let me know in the comment section and we’ll take it from there.
One last thing: it’s likely that the U.S. will have a new tax system in 2018. If and when that happens, this tax info will become obsolete. Don’t worry I’m already working on a post related to the Trump administration’s new tax plan.
|Health Savings Account: We use Elements Financial to access commission-free, low-cost Vanguard ETFs at TD Ameritrade.