Bob’s Journal 9/4

Stealth Taxes Make the Top Marginal Tax Bracket 45.5% for Some Taxpayers

Congress is relying more on Stealth Taxes, as I’ve warned taxpayers for years. That makes the tax code more confusing and causes taxpayers to fall into expensive traps.

The One Big Beautiful Bill Act (OBBB) created several new Stealth Taxes, which I detailed in recent issues of “Retirement Watch” and in the “Spotlight Series.”

One onerous effect of a Stealth Tax is that, while the taxpayer stays in the same bracket in the in the tax rate tables, the taxpayer’s marginal tax rate increases.

The marginal tax rate is the tax rate on the last dollar of income earned. In the tax rate tables, the highest marginal tax rate is 37%.

But Stealth Taxes increase the tax bill by reducing tax breaks or adding other taxes. As the taxpayer’s income rises to trigger or increase Stealth Taxes, the total tax bill rises independent of the rate in the tax rate tables.

One example from the OBBB is the limit on the deduction for state and local taxes (SALT).

The OBBB raised the limit on SALT deductions from $10,000 to $40,000. But the limit is reduced for taxpayers with higher incomes, beginning with modified adjusted gross income (MAGI) above $500,000.

A recent analysis from attorney Bruce Brumberg, published in “Steve Leimberg’s Income Tax Planning Newsletter,” found that the real top marginal tax rate for a married couple with $500,000 of MAGI and at least $40,000 in state and local taxes eligible or the SALT deduction is 32%.

But as income rises, the SALT deduction is reduced so the real marginal tax rate increases. The marginal tax rate for the couple peaks at 45.5% when MAGI is $550,000. When MAGI is above $550,000, the marginal tax rate declines, but never below 35%.

The same analysis can be done with the other Stealth Taxes, such as the inclusion of Social Security benefits in gross income, the Medicare premium surtax (or IRMAA), the 3.8% net investment income tax, the new senior tax deduction, the new limits on charitable contribution deductions and the limit on total itemized expense deductions.

Those Stealth Taxes are triggered at much lower income levels than the SALT deduction.

When planning transactions, taxpayers need to be aware of where they stand in their current income tax bracket. Most people don’t want to take action that will push them into a higher income tax bracket.

But taxpayers also need to know where they stand in the brackets for each of the Stealth Taxes. Taking additional taxable income for the year could increase Stealth Taxes even if it doesn’t push the taxpayer into the next higher income tax bracket.

It’s important to know these numbers when considering a conversion of a traditional IRA to a Roth IRA. It’s also an important consideration when deciding the source of additional cash flow. Some years you might want to take fully taxable income from a traditional IRA. Other years, a tax-free distribution from a Roth IRA or health savings account might be advisable. Or it might be beneficial to take long-term capital gains in a taxable account.

Overlooked Price Increases Can Hurt Retirees

Inflation is a major danger to the financial security of retirees, and the price increases that don’t make headlines can covertly hurt retirees the most.

In 2021 and 2022, prices increased almost across the board, generating the highest inflation rates in more than 40 years.

Headline inflation has declined since then, but prices for select goods and services continue to spiral higher.

Homeowner’s insurance premiums were rising before the general inflation of 2021 and 2022, and premiums have continued to rise faster than the major inflation indexes.

From 2018 to 2013, homeowner’s insurance premiums in the United States increased 33.8% on average. Premiums increased almost 60% in Texas and Colorado.

But not every state saw sharp premium increases. Vermont and Alaska saw increases of around 6%. States with increases of 12% or less were West Virginia, South Carolina and Maine.

The causes of the premium increases aren’t a secret.

Home values have increased, and that leads to higher insurance costs. Likewise, construction and repairs costs have increased in most areas.

The major cause in some states seems to be an increase in weather or natural disaster events that cause widespread and expensive damage to homes.

Electricity prices also have been increasing faster than general price inflation.

IN 2023, residential electricity rates across the country increased 6.3% over 12 months, the highest annual increase since 2000 and about double general consumer inflation.

That’s a big change. Between 2013 and 2023, residential electricity prices increased at about the same rate as general consumer inflation.

But analysts now anticipate residential electricity prices will increase faster than general inflation for a while.

Demand for electricity is surging, caused primarily by the large amount of power needed by data centers for artificial intelligence and other technology.

Another factor is that power companies must repair and maintain their infrastructure. The cost of copper wires, cable and other equipment is increasing faster than general consumer inflation.

In the first edition of my book, “The New Rules of Retirement” (Wiley: 2004), I said that inflation is the most overlooked factor in most retirement plans.

Retirees need to be aware that retirement is likely to last 20 years on average and longer than 30 years for a sizeable minority of people.

Even modest inflation of 2% or so can diminish purchasing power substantially over that time.

Inflation needs to be an important element of every retirement plan. There are several ways to plan for inflation.

The investment plan can be structured so that income and cash flow are likely to increase over time to compensate for rising prices.

There can be flexibility in the spending plan so that some expenses can be reduced or deferred to accommodate cost increases in other items.

The retiree also can also keep a financial cushion in anticipation of inflation. The spending in the early years of retirement might be a bit less than it appears the retiree can afford.

It’s important for retirees and pre-retirees to anticipate that the prices of everything they buy during retirement will increase and have a strategy to implement in case prices rise faster than expected.

Analysis: What Went Wrong at the Federal Reserve

President Donald J. Trump is pressuring the Federal Reserve to reduce interest rates. But economists continue to ask why it took the Fed so long to raise interest rates and tighten monetary policy to stifle the pandemic-era inflation.

A recent paper by three Fed economists and published by the Fed itself sought to uncover what happened and the lessons learned by the Fed’s staff.

The paper states clearly that the Fed board and its staff significantly underestimated both the level and the persistence of the inflation surge that followed the reopening of the economy during the pandemic.

The economists concluded that the lack of similar historic episodes made it difficult for the Fed staff to prepare a quantitative analysis as events were unfolding.

The Fed staff anticipated inflation to increase beginning in 2021 due to supply shocks and bottlenecks and other factors. But it didn’t anticipate that demand would surge as much as it did or that it would persist at high levels.

Changes that occurred in consumer purchasing patterns and in the labor force also were not anticipated.

The paper said that in response, the Fed staff made various changes to their forecasting procedures.

The paper concludes that the innovations the Fed staff made in its forecasting methods will leave it better equipped to forecast the effects of any such events in the future. But it points out that large shocks such as the pandemic are hard to forecast.

The paper is an interesting summary of what the staff knew at different stages, the forecasts it made at different times and why the forecasts were wrong. It highlights economic changes the Fed staff missed at different points during the period.

But the paper doesn’t leave a lot of confidence that similar missteps won’t recur.

The Data

The Consumer Sentiment Index from the University of Michigan declined to 58.2 at the end of August. The index was 58.6 in mid-August and 61.7 at the end of July, which was a five-month high.

A four-month streak of increases in the index ended in August. Major causes of the decline in sentiment were higher inflation expectations and a belief that the conditions for buying durable goods were the worst in one year.

Personal income increased 0.4% in July after rising 0.3% in June.

Personal consumption expenditures (PCE) rose 0.5% in July and 0.4% in June.

A measure of inflation, the PCE Price Index, increased 0.2% in July, down from a 0.3% jump in June. The 12-month increase in the PCE Price Index was 2.6% through both July and June.

The core PCE Price Index, which excludes food and energy prices and is the Fed’s preferred measure of inflation, increased 0.3% in both July and June.

The 12-month rise in the core PCE Price Index was 2.9% through July, a gain from 2.8% through June.

Pending home sales declined 0.4% in July following a 0.8% decline in June. Over 12 months, pending home sales increased 0.7% through July after being down 2.8% through June.

The Kansas City Fed Manufacturing Index was zero in August, an improvement from -3 in July.

Gross domestic product (GDP) increased at an annualized rate of 3.3% in the second quarter, according to the second estimate. That’s an improvement from a 3.0% increase in the first estimate and a 0.5% decline in the first quarter.

A major reason for the increased growth from the first quarter to the second quarter was a surge in business investment, especially related to artificial intelligence.

Also, real consumer spending increased at an estimated 1.6% annual rate in the second quarter compared to a 0.5% increase in the first quarter.

Factory orders declined 1.3% in July after falling 4.8% in June. Most of the drop in orders during both months was due to transportation orders.

After excluding transportation, factory orders increased 0.6% in July and 0.4% in June.

The number of job openings in the United States declined to 7.181 million in July from 7.357 million in June. There were only small changes in the number of hires, separations and quits.

New unemployment claims decreased by 5,000 to 229,000 in the latest week.

Continuing claims, which lag a week behind new claims, declined to 1.954 million from 1.961 million.

The Markets

The S&P 500 lost 0.76% for the week ended with Tuesday’s close. The Dow Jones Industrial Average fell 0.19%. The Russell 2000 declined 0.16%. The All-Country World Index (excluding U.S. stocks) dropped 1.02%. Emerging market equities retreated 0.78%.

Long-term treasuries lost 0.91% for the week. Investment-grade bonds dropped 0.51%. Treasury Inflation-Protected Securities were unchanged. High-yield bonds fell 0.12%.

In the currency sector, the U.S. dollar gained 0.25%.

Energy-based commodities increased 2.66%. Broader-based commodities rose 2.71%. Gold advanced 4.34%.

Bob’s News & Updates

A recent review on amazon.com of my latest book said, “Carlson is a unique national Asset while alive! Get the book, dude!” Look for “Retirement Watch: The Essential Guide to Retiring in the 2020s” (Regnery Capital: 2023) at amazon.com, barnesandnoble.com, booksamillion.com, and regnery.com.

My previous book, “Where’s My Money: Secrets to Getting the Most out of Your Social Security,” is receiving mostly five-star reviews on Amazon for telling you clearly what your benefit options are in different situations and how to determine the best choice for you. You can find it on amazon.com or Regnery.com.

The number of regular viewers for my Retirement Watch Spotlight Series continues to increase. You should sign up because I make in-depth presentations of key retirement finance topics. You can watch these online seminars from the comfort of your home or office at times you choose. To learn more about my new Spotlight Series, click here.

A recent five-star review of my book, “The New Rules of Retirement” on amazon.com said, “A complete retirement guide! One of the best books on this topic!” Click for more details about the revised edition of “The New Rules of Retirement.”

If you’re interested in my books, check my amazon.com author’s page.

I’m a senior contributor to the Forbes.com blog. You can view my contributor page here.