How a Reverse Mortgage Can Lower Taxes
Friday, 09 July 2010 08:09
When we (CCG) work with retired people or people who are about to retire, we try to design a plan that is focused on three goals: insure lifetime income, protect against any loss in principle, and reduce taxes.
We are not always able to do all three, and in many cases, our clients are fortunate enough not to have to worry about ever running out of money, but I can assure you that I have never met anyone, regardless of their age, income, or retirement status, who wasn’t interested in reducing their taxes.
Beyond all the hoopla, what makes reducing taxes such a great deal is that every dollar you save in taxes automatically converts into additional disposable income. In other words, reducing your taxes is equivalent to giving yourself a raise.
In order to reduce federal taxes, we must start by identifying the origin or source of income. All income has to be generated from somewhere, and it is the “where” part that results in how income is taxed. Since the IRS does not treat all income the same, understanding the different classifications is the key to legally reducing taxes owed.
We could spend a lot of time talking about the different tax classifications employed by the IRS, but for this article let’s focus on ordinary income and the current federal tax rates that apply to ordinary income.
Before we go any further, I want to make sure that we are all on the same page. It is imperative that anyone dealing in the 62 and older marketplace understands that all federal tax brackets are the same for everyone and that income determines how much, if any, of a person’s Social Security is taxed.
Although tax rates can, and most likely will, change for our propose, I am using the 2010 federal tax rates as illustrated in the following chart. I do not give tax advice and certainly don’t want to give the impression that I am a tax expert. As such, I am not ready to swear that the following table is indisputably accurate, so use it at your own peril. Of course, if you want to be absolutely certain, you can always go to the IRS.org, pull down the instructions for Form 1040, and print out all thirteen pages. Either way, keep in mind that tax rates are based on the taxpayer’s Adjusted Gross Income (AGI). There are however, four different tables depending on the filer’s status, which are Single, Married Filing Jointly, Married filing separately and Head of Household. For the sake of time and space, I am only listing the Married Filing Jointly table.
For married couples filing jointly:
The second constant is how much, if any, of a person’s Social Security will be taxed and at what rate. Here are the basics: for single filers with income over $25,000 and married individuals filing jointly with incomes over $32,000, fifty percent of their Social Security will be taxed. However, it doesn’t stop there, once income for single filers goes over $34,000 and married filing jointly filers exceeds $44,000, the percentage of their Social Security benefits being taxed goes up to 85%.
Fortunately, the IRS doesn’t consider money generated from a reverse mortgage as income, which is something you definitely want to make sure your clients and prospects are aware of. But, there are aspects of this tax issue that far too few people take into consideration. The following scenario is an example of one married couple that is part of a very large group of people who qualify for, but normally won’t consider, a reverse mortgage.
The married individuals are 65 years old, have an annual income, after deductions, of $70,000, and live in a $500,000 home, which they own outright. Their income comes from two sources: $33,000 from Social Security and $37,000 from qualified retirement accounts. It is important to take into consideration that when withdrawn, 100% of the qualified money is taxable as ordinary income, and that amount is counted in their tax return as ordinary income. Which means an addition $28,050 is added to their taxable income. The end result is that they pay federal tax on an adjusted gross income of $66,050. Based on those numbers, their federal tax bill is $9,070 or 12.96% of their gross income.
Now if this couple would take just $1,000 per month in a reverse mortgage, they could reduce the money they are taking from their qualified accounts by $10,000 annually. This simple change would set a number of things in motion that will result in what most people would consider a positive outcome.
The first thing that happens is that the adjusted gross income drops by $22,550. That’s a 34.14% decline to $43,500. Their new tax bill would be $5,687, which would indicate a savings of $3,383 or 37.30%.
But the benefits of that one simple move doesn’t stop with just the tax savings, it also provides them with the opportunity to add, rather than subtract, from their qualified accounts, which will continue to grow tax deferred income.
Of course, like always, I am only giving you an overview from about 10,000 feet, and as such, I want to reiterate that I’m not an accountant, a CPA, or tax advisor, and I don’t give tax advice to clients. I do, however, discuss ideas about how people can use different products to legally reduce their tax burdens.
If you would like to get more in-depth on this topic or any of the others we have introduced over the last few months you might want to consider attending one of my upcoming educational seminars.
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