Succinctly stated, your marginal tax rate is the amount of tax you pay on your last earned dollar and your effective tax rate essentially represents the average tax percentage you pay on all of your earned income.

Why do these two differ? Because the United States employs a progressive tax system, i.e., a system that requires tax payers to fork over more money as their income increases. Although the progressive tax system has its detractors, e.g., fans of the flat-tax, Fair Tax, or Value Added Tax systems, many find it to be inherently fair as those who earn more, pay more in taxes. Stated less abstractly, our progressive tax system currently has seven (7) tax brackets ranging from a low of 10% to a high of 37%.

So why might the concept of a marginal tax rate be of import? By way of example, it becomes important when deciding whether to contribute to a Roth account or a regular tax-deferred account. If you expect to be in a higher marginal tax rate in retirement, then you may decide to utilize the Roth option. However, if you are currently in a high tax bracket (and you may be in a lower tax bracket in retirement), then you may want to utilize a regular tax-deferred account as your tax savings will occur in the year of your contribution, i.e., at the higher marginal tax rate.

If you have questions about your marginal or effective tax rate, feel free to contact Intelligent Investing at www.mynmfp.com/new-clients.

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