Archives for January 2026

A rule of thumb that’s becoming increasingly popular is to do Roth conversions in retirement to the top of the 12% bracket and no higher.

Any rule of thumb is going to have some situations in which it doesn’t work well, but I think this rule of thumb is particularly bad.

Firstly, there are some households for which any conversions are likely to be unhelpful, due to their charitable plans (i.e., they plan to make extensive use of qualified charitable distributions, and they have charities named as the beneficiaries of their tax-deferred accounts). When that’s the case, any current conversions are largely money down the drain. Much of the dollars in question would face a 0% tax rate later, so why pay even a 12% tax rate right now?

And on the other side, there are a variety of factors that would make conversions beyond 12% likely to be beneficial (e.g., super large tax-deferred accounts, such that we’re likely to see a high tax rate on RMDs, or beneficiaries with very high income levels of their own, such that they’d likely pay very high tax rates on inherited tax-deferred accounts).

But the most fatal flaw with the rule of thumb in question is that, for many retiree households, the “up to the top of the 12% bracket” range often includes stuff that will make the tax rate paid on the conversion meaningfully higher than 12%. The most common such things are the unique tax treatment of Social Security benefits (i.e., each dollar of conversion income also causes some Social Security benefits to become taxable) and the phaseout of Affordable Care Act subsidies (i.e., conversion income is causing the premium tax credit to shrink/disappear and potentially causing the loss of cost sharing reductions).

For many retirees (in particular, households where somebody is buying insurance on the exchange or somebody is already receiving Social Security), their marginal tax rate in much of the 12% bracket actually exceeds 20%. And if that’s advantageous, then conversions into the 22% bracket are often likely a good idea as well (because in many cases, much of the 22% bracket doesn’t have those additional tax rate effects).

The following is an excerpt from my book Taxes Made Simple: Income Taxes Explained in 100 Pages or Less.

Many taxpayers in the U.S. have come to expect a sizable refund check every tax season. To some people who don’t prepare their own tax returns, it’s a mystery how the refund is calculated.

The idea is really quite simple. After calculating your taxable income, you use the information in the tax tables to determine your total income tax for the year. This amount is then compared to the amount that you actually paid throughout the year (in the form of withholdings from your paychecks). If the amount you paid is more than your tax, you are entitled to a refund for the difference. If the amount you paid is less than your tax, it’s time to get out the checkbook.

Withholding: Why It’s Done

If you work as an employee, you’re certainly aware that a large portion of your wages/salary doesn’t actually show up in your paycheck every two weeks. Instead, it gets “withheld.”

The reason for this withholding is that the federal government wants to be absolutely sure that its gets its money. The government knows that many people have a tendency to spend literally all of the income they receive (if not more). As a result, the government set up the system so that it would get its share before taxpayers would have a chance to spend it.

The amount of your pay that gets withheld is based upon an estimate of how much tax you’ll be responsible for paying over the course of the year. (This is why you are required to fill out Form W-4, providing your employer with some tax-related information, when you start a new job.)

Withholding: How It’s Calculated

At this point you may be thinking, “OK. Well I’m in the __% tax bracket, and it’s obvious that my employer is withholding way more than that!”

You’re probably right. That’s because your employer isn’t just withholding for federal income tax. They’re also withholding for Social Security tax, Medicare tax, and (likely) state income tax.

The Social Security tax is calculated as 6.2% of your earnings, and the Medicare tax is calculated as 1.45% of your earnings. Before you’ve even begun to pay your income taxes, 7.65% of your income has been withheld.

Your refund is determined by comparing your total income tax to the amount that was withheld for federal income tax. Assuming that the amount withheld for federal income tax was greater than your income tax for the year, you will receive a refund for the difference.

EXAMPLE: Nick’s total taxable income (after subtracting deductions) is $32,000. He is single. Using the 2026 tax table for single taxpayers, we can determine that his federal income tax is $3,592.

Over the course of the year, Nick’s employer withheld a total of $8,500 from his pay, of which $4,000 went toward federal income tax. His refund will be $408 (i.e., $4,000 minus $3,592).

Simple Summary

• Every year, your refund is calculated as the amount withheld for federal income tax, minus your total federal income tax for the year.
• A large portion of the money being withheld from each of your paychecks does not actually go toward federal income tax. Instead, it goes to pay the Social Security tax, the Medicare tax, and possibly state income tax.

To date, there are more than 1,000 articles published on this blog on a variety of topics — many of them answers to reader questions. A large portion of the email questions I receive deal with either tax brackets or withholding. As far as I can tell, these questions stem from the fact that many (most?) taxpayers do not understand:

1. How tax brackets work, and
2. How the amount withheld for taxes from one’s paychecks can be different from the amount of tax one actually has to pay.

Let’s take a crack at each of those, shall we?

How Do Tax Brackets Work?

Based on the 2026 tax brackets, we can see that for an unmarried taxpayer, the 10% tax bracket goes from $0-$12,400 of taxable income. For example, if John’s taxable income is $12,400, his income tax will be $1,240. Nothing tricky there.

But what if John’s taxable income increases by $1 to $12,401 (thereby putting him in the 12% tax bracket)? How much extra income tax will John pay?

Answer: He’ll pay an additional $0.12 of income tax. That is, only his final dollar of income (the dollar that’s in the 12% tax bracket) will be taxed at 12%. His first $12,400 of income will still be taxed at 10%.

Important conclusion #1: Getting a raise at work that puts you into a higher tax bracket will not reduce your after-tax take-home pay. (Possible exception: The raise could make you ineligible for certain deductions or credits, the loss of which could outweigh the increase in income.)

Important conclusion #2: If you’re trying to get an estimate of how much income tax you’ll owe for a given year, do not simply multiply your income by your marginal tax bracket — doing so would overestimate your tax (by a very wide margin in many cases).

How Does Withholding Work?

From every paycheck, your employer withholds some of your salary/wages to go toward taxes. The Federal government requires this because they understand that many people spend every dime that makes it into their bank account (plus some). By making withholding mandatory, the government gets its money before taxpayers have a chance to spend it.

It’s important to note that the amount of tax that’s withheld over the course of a year goes to more than just Federal income taxes. It also covers:

• Social Security tax (6.2% of your earnings, up to $184,500 for 2026),
• Medicare tax (1.45% of earnings), and
• State/local income tax (if applicable).

In addition, the amount that’s withheld over the course of the year for Federal income tax will not actually equal the amount that you’re responsible for paying that year. This is the result of the fact that your employer doesn’t have all of the information necessary to precisely calculate the tax that you’re responsible for paying. (For example, they don’t know what deductions you’ll claim or how much your spouse earns.)

The fact that the amount that’s withheld does not equal the amount you’re responsible for paying is why tax season is basically a massive “settling up,” during which taxpayers either receive a refund (for the amount by which their withholding exceeded their tax) or write a check to the U.S. Treasury (for the amount by which their tax exceeded their withholding).