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Taxes in FI = Is this right?
Old 02-17-2005, 06:03 PM   #1
 
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Taxes in FI = Is this right?

Assumptions:
Portfolio of $1.8mm. Withdraw 72K (4% of the portfolio)

Taxable gains Taxes
T-Notes: 18,000 2,346
(used federal tax table)
Stock div: 25,200 3,780 (15%)
Stock cap gain 28,800 4,320 (15%)
$72,000 $10,446

Average Tax Rate: 14.5%

Assumptions: I pay nothing but federal taxes (I tried searching the web to see if I was doing this right but I could not find the answer). I owe no state or local taxes on the Treasury note interest. I assume that I only need to pay the 15% tax rate on capital gains and stock dividends (no state + local taxes).

I understand that one can get into an even lower tax rate if their taxable income is under $30-something thousand, but am I right in thinking that the IRS counts capital gains, stock dividends, and T-bond interest as income?

Is there a way to lower my tax rate?

Any comments would be welcome.
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Re: Taxes in FI = Is this right?
Old 02-17-2005, 06:36 PM   #2
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Re: Taxes in FI = Is this right?

>>Is there a way to lower my tax rate?

Is it too late to have more kids?
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Re: Taxes in FI = Is this right?
Old 02-18-2005, 08:46 AM   #3
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Re: Taxes in FI = Is this right?

I think you are missing a few things. First, you forgot the personal exemption ($3100) and standard deduction ($6000?). These are yanked right off your taxable income. Second, cap gain might be LT (15%), ST (marginal income tax rate), or ultra long term (10%?). Third, how about any offsetting cap losses that might be harvested. Fourth, and particular issues that relate to your situation, such as deductions larger than the standard (medical costs, RE taxes, etc.). Fifth, although I doubt its an issue, the possibility of an AMT hit.

If you really want to see what taxes will look like in retirement (or any other scenario, for that matter), buy a copy of turbotax ($15 at Costco for the "deluxe " version) and fill out a hypothetical return.
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Re: Taxes in FI = Is this right?
Old 02-18-2005, 02:40 PM   #4
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Re: Taxes in FI = Is this right?

Quote:
If you really want to see what taxes will look like in retirement (or any other scenario, for that matter), buy a copy of turbotax ($15 at Costco for the "deluxe " version) and fill out a hypothetical return.
That's assuming people know what info to enter and where to enter it and can spot a mistake on the output if the input was wrong. As they say...GIGO.
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Re: Taxes in FI = Is this right?
Old 02-20-2005, 03:57 PM   #5
 
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Re: Taxes in FI = Is this right?

Quote:
Second, cap gain might be LT (15%), ST (marginal income tax rate), or ultra long term (10%?).
The ultra-long term cap gain rate was removed in the last tax bill.

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Re: Taxes in FI = Is this right?
Old 02-21-2005, 06:10 AM   #6
 
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Re: Taxes in FI = Is this right?

Thanks for the replies. That was very helpful. After some additional fiddling (mainly to account for the deductions), the overall tax rate falls to just 12.8%. Amazing!

Of course, this situation will change for the worse/better at some point in the future as laws change. Do any of you model in higher taxes as part of a worst-case scenario?

Also, I heard that some states tax capital gains (on top of the federal rate). I tried to find out which ones but could not. Any suggestions?

Thanks again.
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Re: Taxes in FI = Is this right?
Old 02-21-2005, 06:31 AM   #7
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Re: Taxes in FI = Is this right?

If a state has income tax, they are going to tax it all at probably 5 to 7 percent. Also, the first 6,000 is taxed at 10%, not 15%. (all the advice here assumes you are single).
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Re: Taxes in FI = Is this right?
Old 02-21-2005, 08:55 AM   #8
 
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Re: Taxes in FI = Is this right?

Thanks alot Beachbumz...

When you say the first 6k is taxed at 10%, not 15%, are you indicating that I get $7,950 in gains that aren't federally taxed to begin with (the declaring myself deduction + standard deduction), and then the first $6k in capital gains that I have are taxed at a 10% federal rate, with the rest being taxed at 15%? And all of this occurs irregardless of whether I pay state taxes on capital gains? May I ask what this $6K @ 10% deal is called? Not a deduction, but a ...?

BTW, I am single.

Thanks again.
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Re: Taxes in FI = Is this right?
Old 02-21-2005, 09:08 AM   #9
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Re: Taxes in FI = Is this right?

Simply put, you subtract your personal exemption and standard deduction (or itemized deductions) from your total income. This gives your taxable income. The first tax bracket for single is 10% on the first 6,000 in taxable income. Your dividends and capital gains, of course, are usually taxed at a lower level and capped at 15%. This is unaffected by state taxation. There are plenty of tax estimaters on line for free, check out H&R block and Jackson hewitt sites, etc. You can also go to IRS.gov for information on how dividends and CGs are taxed.

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Re: Taxes in FI = Is this right?
Old 02-28-2005, 05:08 PM   #10
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Re: Taxes in FI = Is this right?

Quote:
Thanks alot Beachbumz...

When you say the first 6k is taxed at 10%, not 15%, are you indicating that I get $7,950 in gains that aren't federally taxed to begin with (the declaring myself deduction + standard deduction), and then the first $6k in capital gains that I have are taxed at a 10% federal rate, with the rest being taxed at 15%? And all of this occurs irregardless of whether I pay state taxes on capital gains? May I ask what this $6K @ 10% deal is called? Not a deduction, but a ...?

BTW, I am single.

Thanks again.
It is just the nature of the progressive tax tables -- you start off paying smaller percentages of your income and move up from there.

btw, you might want to know that there is a special capital gains and dividend tax rate if you are paying income tax at the10% or 15% bracket. You will pay taxes on capgains and divs at just 5%.

One key mistake you are making in your back-of-the-envelope calculations is that you are assuming you are actually paying tax on all your capital gains that you withdraw. (I think it was 28k in your example). Here's the deal: you may need 28k to round out your 72k 4% SWR, but you sell appreciated securities to realize those capital gains. You won't have the full 28k in gains -- if your assets appreciated by 100%, you would have capital gains of just 14k, half the amount you withdraw.

Similarly, with some of your interest earned -- you might earn it in your IRA, maybe even in a Roth. Sure you can't withdraw it from the Roth, but so what: your overall portfolio allocation is 'right', and you just sell some additional appreciated assets to get the money you need for your SWR that year.

Do you pay real estate tax? Contribute to charities? Health insurance can be deductible now, I think for everyone. With a little creativity (all within the letter of the law!) and some management of your taxable income streams to keep Adjusted Gross Income (AGI- the number you actually get taxed on) within the lower brackets, you should be able to get taxes down even lower, possibly down to zero.

(I have been paying less than 1k tax, legally, for the past few years with a bigger portfolio, although admittedly I am married with two kids and have been using up some capital gains tax loss carryforwards)

You have enough money at stake that an accountant should be able to pay for him/herself pretty quickly.
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