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My sister finds herself forcibly retired just a little earlier than planned, but it brings a severance package of a little over $150K. This year, she and her husband would otherwise have an AGI of about $300K, so marginal fed tax of 33%. Next year, she will not be working, and her husband will likely retire after 4-5 months. She has the option of taking that lump sum either in December or January. It seemed to me at first that deferring until January would be a no-brainer since their AGI will be more like $100K in 2017, a 28% marginal rate. But is it? 

Since she has passed her social security max in 2016, deferring would mean paying $7812 next year versus $0 this year. On the other hand, one of her 35 highest grossing years would go from $15K (35 years ago) to $150K, meaning a very slight uptick in SS benefits.If she takes it in 2017, she could shelter $6500 in an IRA, whereas this year she's already maxed 401(k). (We doubt she'd be able to make a 401(k) contribution in 2017 from the severance but don't know for sure).

I'm thinking that a marginal rate of 28% vs. 33% would save only about the same as the social security tax would cost. But we'd be delaying a $50K tax payment by a year, which is worth about $1k.What else should I be considering?

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Any deductions that do not apply for high earners if you get it all this year? What about the alternate income tax?

ETA: alternative minimum tax (AMT)

Also, Inthink there is an extra 2% Medicare tax for earnings over 200k. Not sure on the numbers or percentage but their is some sort of surcharge.

ETA: ok, so it's a 0.9% surcharge for over 250k for married couples - https://www.irs.gov/businesses/small-businesses-self-employed/questions-and-answers-for-the-additional-medicare-tax

Don't forget that she's probably got $450 x 26 worth of UI benefits coming her way, and don't use the word "retire" again. An EDD worker will construe it in the worst way.

Is there progressivity to the CA income tax that will alter your math?

Her state marginal rate maxes out at a pretty low level, so no impact there. Forgot about the UI, and the 0.9%.  I will help her do the math and optimize this, but still welcome other things I'm forgetting. Obviously some good points so far.

Will her husband's income for 4-5 months max out all the brackets through 28%?

Otherwise, you'd be comparing 33% to one of those lower brackets, not 28%. Otherwise, great points you made on your own about SS and factoring in 35 highest grossing years

I don't know the composition of the AGI that you cited but their incomes with the severance would subject them to the 3.8% net investment tax so add that to the list as well.

You'd really have to run these scenarios through a tax program like Turbo Tax to get the exact answer since you aren't giving us enough informtion but I bet deferring to next year will be the winner.

​UI - seriously?  I realize this is FWF and "all the politicians" are taking advantage of "loopholes/legal ways to pull money back out of "the system"" but publicpersona will your sister legitimately be looking for new work during that 6-12 months?  If so then UI may be another thing to consider; However, if she was planning to retire around the same time as her husband doesn't the $150k severance effectively let her retire early with no loss?  Focus on the other items (take in 2016 or 2017) and tell her to enjoy this opportunity and maybe do something to make the world a slightly better place (versus enhancing her wealth by some very insignificant percentage by trying to "take all I can" from "the system").

There are obviously a few pro's to taking in 2016, but 2017 would be best.

inixsys said:   "the system").

That system as you call it is funded by the employer that put the sister in the mess she's in. By not taking it, she's rewarding that behavior.

Not sure where you are getting the marginal tax fed rate of 33% - I believe that around 300K, it should be around 35%. It kind of depends upon the deductions.

With my deductions, my program spits out a tax rate of 25.4% around 225K income, then I switch over to AMT and rate jumps to 32.5%. At around 250K, rate jumps to 35%. And at 500K, tax rate drops down to 28%.  [The 25.4% rate might sound fishy - but it is the effective federal rate assuming that I can deduct the state taxes. Once I cross into AMT, I can no longer do that].

The best thing you can do is to enter the numbers in a tax software and let the software spit out the numbers for the 2 years. It would be approximate since we don't know the exact tax rates etc., but it is better than going by published tables since the taxes have one adjustment or the other. And obviously account for the FICA/medicare/investment income etc.


any heathcare related deductions?
tax loss harvesting or losses in taxable investing . May be go through list of possible deductions .

Thanks for suggestions so far. Good points. I agree that running what ifs in tax software would be the best thing. They do get hit with AMT each year.

I suppose the takeaway is that deferring to 2017 makes sense if it achieves at least $7812 difference in tax (to compensate for Soc Sec tax). Other than the Soc Sec tax, I've thought of no down side to deferring to a year where their AGI will be at least cut in half, and probably more.

Any 401k or IRAs they are looking to roll into a Roth? That could raise the net taxes for the rollover in 2017

MilleniumBuc said:   Any 401k or IRAs they are looking to roll into a Roth? That could raise the net taxes for the rollover in 2017
No conversions in the plan. She has already maxed out 401(k) for 2016, and the thinking is that she might could contribute the max to 401(k) in 2017 if deferred. But at minimum, she could put $6500 in an IRA in 2017.
It also occurred to me that we are assuming tax rates in 2017 will remain the same as 2016. The way things are going, that may not be the case.

set up a business and take a net operating loss

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