Here are your new income tax brackets for 2020

This week’s article is an FYI for your to start tax planning for next year. Taking a look at this CNBC article, “Here are your new income tax brackets for 2020.” Simply, the article is what it says it is, a breakdown of the new income tax brackets for next year. Here’s what you need to know:

Marginal Tax Brackets

Despite the fact that the phrase “marginal tax brackets” is used quite often, many do not necessarily know what it means. Marginal tax brackets are used in the US to incrementally increase your tax rate as your income increases. Here is an example:

Say that Sally earns $50,000/year and is an unmarried individual.

  • The first $9,875 are taxed at 10%, meaning that she would owe $987.50 on that amount.
  • Then between $9,876 to $40,125 is taxed at 12%, meaning she would owe $3,630 on that amount.
  • Finally, between $50,000-40,126 is taxed at 22%, meaning she would owe $2,172.5 on that amount.
  • Her total federal tax bill would be: $987.5 + $3,630 + $2,172.5 = $6,790
  • Her effective tax rate would then be: 13.58%

So, without further ado, here are the tax rates for 2020:

Basic Tax Planning

You may be thinking, “Now that I know my tax rate, what am I supposed to do with it now? I won’t have to file my 2020 taxes until April of 2021.” On this point, you are correct, but what helps you make the difference on the amount you pay for your 2020 taxes happens now.

The way that your income tax works at the federal and state level is that your adjusted gross income (AGI) is taxed at your marginal tax rates as I’ve described above. The way to calculate your AGI is to take the total, or gross, amount that you’ve earned and subtract qualified deductions from this number. Here is a list of qualified deductions currently in place (more details on each in this article):

  • 401K, SEP and Traditional IRA contributions
  • Health Savings Account (HSA) and Health Reimbursement Account (HRA) Contributions
  • Student Loan Interest
  • Educator Expenses
  • Casualty and Theft Loss
  • Charitable Contributions
  • Medical and Dental Expenses
  • State and Local Taxes
  • Mortgage Interest

The top 4 items of this list are items that can be deducted in addition to the and still use the greater of the standard or itemized deduction. Everything else would need to be a significant cost in order to exceed the standard deductions, which for 2019 are:

  • Single taxpayers: $12,000
  • Head of household taxpayers: $18,000
  • Married filing jointly tax returns: $24,000

Of the items in the list above, what I will focus on today are items that you have control over; being your retirement account and HSA/HRA contributions.

Retirement Accounts

In general, retirement account contributions are tax deductible. For example, say that our friend, Sally, actually earned $95,000/yr (nice pay bump for Sally). This would put her last $9,475 in the 24% tax bracket. This gives Sally an opportunity to 1) put herself in a good position for retirement and 2) save herself some money in taxes. She would do this by saving at least $9,475 into her 401K/403B/457/SEP IRA and/or her Traditional IRA. This would then lower her effective tax rate for the year.

As with everything else, there are limits to what can be contributed to these pre-tax retirement accounts. For the year 2020, those limits are:

  • 401K/403B/457: $19,500 (or $25,000 if over 50 years of age)
  • Traditional IRA: $6,000 (or $7,000 if over 50 years of age)

This tax rule creates an added benefit for contributions to retirement accounts. This means that if you were to contribute the maximum amount to retirement accounts, you may be able to deduct $25,500 (or $32,000 if over 50) from your AGI for tax year 2020.

My general recommendation to my clients is that everyone add in at least up to their employer match to their employer sponsored retirement plans (401K/403B/457). For example, if you put in 8%, your employer may put in up to 4%. In this case, I would highly recommend adding in 8% to your employer sponsored plan just to ensure that you receive this “free money” from them. As for going above and beyond that amount, I usually only recommend that once extremely high interest debts are paid and an emergency fund is established.

*This advice is specifically generic. For a detailed look at your savings goals, budgets and retirement accounts, please look into further research or personal financial coaching.*

In addition to this account, Individual Retirement Accounts (IRAs) are also an option to which you can contribute. These accounts are separate from your employer, which can be a selling point in and of itself as your ability to contribute is not linked to where you work. Additionally, there is a much wider array that you can look at, allowing you to shop for the lowest fees. Currently Vanguard, Fidelity and Charles Schwab are all battling for a race to the bottom in their low fee index fund investments so, I would recommend any of these as a good place to start.

Your IRA contributions, if for a Traditional account only, are also tax deductible, meaning they will reduce your overall AGI. Roth IRA contributions are made after taxes are taken out and are therefore, not tax deductible.

HSAs and HRAs

I go into detail on various health savings/reimbursement accounts in my 2 part series on healthcare savings, so please take a look at those posts to familiarize yourself. What is really necessary to note for these accounts is that your contributions are tax deductible. For 2020, the HSA contribution limits are:

  • For individuals: $3,550
  • For families: $7,100

These limits include your employer’s contributions. As an example, my employer will contribute up to $500 if I complete some health initiatives like a bio metric screening and survey about my lifestyle. This comes off the top of what can be contributed, leaving me only eligible to contribute another $6,600 since my wife is also on my healthcare plan.

In general, my recommendation for these accounts is to contribute at least as much your family normally spends in a calendar year on healthcare. A stretch goal would be to save enough to cover your plan’s deductible for the year, even if you are a generally healthy family. Ideally, you could contribute as much as your out of pocket maximum, but unfortunately most out of pocket maximums for high deductible plans exceed the allowable contribution amounts. Having enough in your account to cover your plan’s deductible is a great place to be and will allow you to rest easy knowing that in most cases, you’re covered.

Important note: while HSA and HRA contributions are tax deductible, FSA or flexible spending accounts, are NOT as they are “use it or lose it” accounts.

Wrap It Up!

Taking into account what your household plans to earn next year, you can take a look and see if making that extra contribution to a retirement or health savings plan will bring you into a lower tax bracket. This can help you save money on your taxes AND be better prepared for retirement and/or a health emergency.

As always, feel free to reach out to me for extra coaching on this topic. Happy tax planning!

Do you plan out your income taxes with your tax deductible contributions for the year? Have any quick questions on the subject? Let me know in the comments below!