Roth Conversions and the Virginia Age Deduction Phase-Out

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Modern public policy has painted a bullseye on the pockets of the wealthy and productive. There is an unhealthy assumption that the wealthy don’t deserve their money, spend the wealth they have extravagantly on themselves, and are greedy and uncharitable. In reality, most of these targeted individuals are everyday millionaires next door. They come from hardworking families. They are frugal. They don’t buy expensive shoes or designer suits. Instead, they take their lunch in a brown paper bag and repair their shoes with duct tape. Yet they are very generous and represent most of the charitable giving. Sadly, the public policy target ends up hurting these people anyway.

On both the federal and state level there are several taxes, phase-outs, and surcharges that target individuals of various higher income levels. Each individual tax seems small, but over the course of the tax schedules the sums total into an exorbitant bill.

Most of these taxes are keyed off of federal AGI or MAGI (just meaning a modified version of federal AGI). On the federal level, a few are the Qualified Dividends and Capital Gains Tax (15% – 20%), IRMAA Medicare Premium Surcharge ($642 – $3,535.20), Net Investment Income Tax (3.80%), and Additional Medicare Tax (0.90%).

At the Virginia state level, one that brings concern to older tax payers is the phase-out of their Age Deduction. Here are the state rules on the subject:

Age Deduction for Taxpayers Age 65 and Over

If you or your spouse were born on or before Jan. 1, 1953, you may qualify to claim an age deduction of up to $12,000 each. The age deduction you may claim will depend upon your birth date, filing status, and income. If you were born:

  • On or before Jan. 1, 1939: You may claim an age deduction of $12,000. If you are married, each spouse born on or before Jan. 1, 1939 may claim a $12,000 age deduction. For individuals born after Jan. 1, 1939, the age deduction is based on the criteria below.
  • On or between Jan. 2, 1939, and Jan. 1, 1953: Your age deduction is based on your income. A taxpayer’s income, for purposes of determining an income-based age deduction, is the taxpayer’s adjusted federal adjusted gross income or AFAGI. A taxpayer’s AFAGI is the taxpayer’s federal adjusted gross income, modified for any fixed-date conformity adjustments, and reduced by any taxable Social Security and Tier 1 Railroad Benefits.

This deduction shall be reduced by $1 for every $1 that the taxpayer’s adjusted federal adjusted gross income exceeds $50,000 for single taxpayers or $75,000 for married taxpayers. For married taxpayers filing separately, the deduction will be reduced by $1 for every $1 the total combined adjusted federal adjusted gross income of both spouses exceeds $75,000. You may not claim the age deduction if you claim the Disability Income subtraction.

For details on how to compute, see the Age Deduction Calculator.

This means if you are a married couple over age 65 and born after 1938, then each $1 your AGI goes over $75,000 reduces your $24,000 deduction ($12,000 per spouse) by $1, effectively increasing your Virginia taxable income by $2 until you run out of deduction.

Some younger than age 65 will not even notice this difference. an AGI of $74,000 for a person less than age 65 is still $74,000 in income after the age deduction. However, for a couple both over age 65, their age deductions lower their Virginia AGI to $50,000, effectively decreasing their taxes by $1,380 (5.75% of $24,000).

However, federal AGIs between $75,000 and $99,000 of couples over age 65 begin to lose this age-based special treatment and lose the tax savings they had at lower income levels.

In most cases, you don’t have a lot of control over your AGI. You earn what you earn and unless you are motivated to work less and earn less, you’ll be taxed what you’ll be taxed. That being said, there are many AGI lowering strategies that can be pursued, but they come at a cost.

Decreasing AGI is, for many people, a red herring. There are many extremely valuable AGI-increasing tax strategies which should be considered instead. These include intentionally realizing gains, Roth contributions, and Roth conversions. All of these strategies offer long term tax savings, especially when implemented each year, for the average tax payer.

By the end of your life, having done a Roth conversion this year can be worth hundreds of thousands of dollars in today’s values. Yet some people get hung up on the loss of a $1,380 state tax deduction or the addition of a $130 additional medicare tax. These types of surcharges are small enough to be like rounding errors in the math behind the value of a conversion. Don’t miss out on the long term value of AGI-increasing strategies just because modern public policy has spite for the wealthy.

Photo by Michelle Tsang on Unsplash

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Chief Operating Officer, CFP®, APMA®

Megan Russell has worked with Marotta Wealth Management most of her life. She loves to find ways to make the complexities of financial planning accessible to everyone. She is the author of over 800 financial articles and is known for her expertise on tax planning.