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Benefits of minimizing income
Old 07-31-2020, 06:00 AM   #1
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Benefits of minimizing income

In planning early retirement, I recently realized a potential benefit I hadn't taken into account: benefits in the tax code/elsewhere that come along with minimizing income. For example, the earned income tax credit.

My wife and I plan to keep working after early retirement enough to generate a small income. What I realized recently is that my family of 4 would get an EITC refund of over $5K if we only have $25k in income coming in (and generated no more than $3k of investment income). Having this extra income without needing to tap our savings in early years would enable earlier retirement than we planned. But our living expenses are more than $25K Income+$5K EITC+$3K investment. So how can I supplement that spending (withdrawal from savings) without raising our reportable income when nearly all of our savings is invested?

From research I've done, one option seems to be withdrawing my Roth contributions early (tax free since taxes were previously paid, and also penalty free) But I have mixed feelings on that; for one, it's our most tax advantaged account. And two, we don't have a lot in Roth accounts. My question is - does anyone know of similar but alternate strategies to tap into savings without generating taxable income so that one could still take advantage of the EITC and other benefits that come with minimal reported income? Our investments are long term buy-and-hold equities with no dividends, so we can control when we want to sell and claim shares and generate reportable income on those.
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Old 07-31-2020, 06:16 AM   #2
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WADR, it seems likely that you're looking at small potatoes in the whole scheme of things unless you don't have any tax-deferred savings.

Since you're talking about retiring early with a family of 4, I assume that you are pretty young. Also, most early retirees have substantial tax-deferred savings from their early years. Those early years of minimal income are a great time to do low tax cost Roth conversions.

A married couple that had no other income could do as much as $105,050 of Roth conversions in 2020 and would pay $9,241 in tax, a reasonable 8.8%... vs $23,111 if they don't and take the money out in RMDs later in life and are in the 22% tax bracket.

That's $13,870 in savings.

Now if you don't have any substantial tax-deferred savings then it may work and be easy to do unless you own highly appreciated securities in your taxable account. For example, if your taxable accounts were in things that yu can sell with negligible tax implications they you could probably limit your income as you want to.
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Old 07-31-2020, 06:21 AM   #3
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I guess if you owned you home you could sell it and rent, use the profit from the sale to supplement your living expenses for the next X years while not increasing your income.

I actually had similar plans...keep income super low and reap all the benefits, then I discovered you could gamble in the stock market and how fun that was..
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Old 07-31-2020, 06:54 AM   #4
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One "trick" is to sell assets from taxable. You only have capital gains taxable income on the gain. So you might sell $50K worth of an index fund for spending money, but only have $5000 in taxes on that sale.

Another option is to alternate years. You could take extra income one year, forgoing the EITC, to set yourself up for a lower income year the next year. So you might get the EITC every other year.

However, you also may have put more income in a higher tax bracket in the non-EITC years, which may totally negate the credit in the other years. Be sure to take an overall approach to your finances, not narrowly focusing on a piece of the picture like tax credits.
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Old 07-31-2020, 07:01 AM   #5
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You might also want to look at your health insurance options assuming you're retiring before medicare. The market-exchange ACA plans require a minimum to join, or be covered by Medicaid, or in some states, not at all - there's a gap in the lowest income brackets.
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Old 07-31-2020, 07:57 AM   #6
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To answer the original question (Title of Post) I added "When Retiring Early".

So: "Benefits of minimizing income when retiring early"

Simple answer, and IMHO the main reason to do so is ACA Subsidy qualification. Assuming you have not got your healthcare subsidized by a previous employer, VA, Medicaid or other source.
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Old 07-31-2020, 08:27 AM   #7
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Originally Posted by ShokWaveRider View Post
To answer the original question (Title of Post) I added "When Retiring Early".

So: "Benefits of minimizing income when retiring early"

Simple answer, and IMHO the main reason to do so is ACA Subsidy qualification. Assuming you have not got your healthcare subsidized by a previous employer, VA, Medicaid or other source.
I second this. OP, since 2014, the value of my ACA subsidy has grown, so when I went over the income limit ("cliff") the last few years due to large cap gain distributions, the value of the lost ACA subsidy rose from a few hundred dollars in 2014 to over $2,000 in 2019. After changing my portfolio to reduce my income without reducing my equity holding, my 2020 subsidy will rise even more, to well over $4,000.
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Old 07-31-2020, 08:35 AM   #8
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Quote:
Originally Posted by ShokWaveRider View Post
"Benefits of minimizing income when retiring early"

Simple answer, and IMHO the main reason to do so is ACA Subsidy qualification. Assuming you have not got your healthcare subsidized by a previous employer, VA, Medicaid or other source.
+1

Minimizing taxable (visible) income is key.
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Old 07-31-2020, 09:14 AM   #9
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To be clear though, 400% of FPL for a family of 4 for ACA subsidies would be north of $100k of MAGI whereas OP was talking about managing income to ~$25k to qualify for the EITC. Big difference.
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Old 07-31-2020, 12:39 PM   #10
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This general idea is why I paid off my mortgage before retiring. Without a mortgage payment, I require a lot less cash flow, which means I can live and spend as I want and still have a relatively low AGI which unlocks multiple tax goodies.

So the ways to get to a survivable low AGI include (making a list here for completeness; I know several have already been mentioned):

1. Reduce expenses
a. Pay off mortgage
b. Move to LCOL area
c. Pay off other debt, such as car loans and credit cards
2. Live off taxable
3. Live off savings
4. Live off Roth contributions
5. If you're within a year or three of accessing tax-deferred funds, some people have advocated taking a loan.
6. Reverse mortgage

I would point out that there is a lower limit to this...for example if you get your income really low, then the EITC actually gets reduced, not increased. And there are a number of refundable credits which can actually go to waste if your AGI and tax liability are low enough.

So what I generally do is live off my taxable and non-portfolio income, and do Roth conversions each year to what I judge to be the best sweet spot for my situation, taking into consideration the various tax goodies vs. their marginal tax costs and my overall situation.
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Old 07-31-2020, 02:02 PM   #11
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Quote:
Originally Posted by ShokWaveRider View Post
To answer the original question (Title of Post) I added "When Retiring Early".

So: "Benefits of minimizing income when retiring early"

Simple answer, and IMHO the main reason to do so is ACA Subsidy qualification. Assuming you have not got your healthcare subsidized by a previous employer, VA, Medicaid or other source.
Yup, can be huge savings.
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Old 07-31-2020, 03:56 PM   #12
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Originally Posted by RunningBum View Post
One "trick" is to sell assets from taxable. You only have capital gains taxable income on the gain. So you might sell $50K worth of an index fund for spending money, but only have $5000 in taxes on that sale.
Excellent responses - thanks all. On the above, my understanding is that to qualify for EITC, you must have no more than about ~$3K in investment income. So I figured this would preclude me from selling much of my taxable assets, since even a little bit would push me over that $3K limit, unless the particular investment has very little capital gains (which might be the case early on, since some money I will have only recently invested, but probably won't be after a number of years). Do you agree, or am I missing something else with your idea as stated above?
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Old 07-31-2020, 04:07 PM   #13
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Originally Posted by SecondCor521 View Post
This general idea is why I paid off my mortgage before retiring. Without a mortgage payment, I require a lot less cash flow, which means I can live and spend as I want and still have a relatively low AGI which unlocks multiple tax goodies.

So the ways to get to a survivable low AGI include (making a list here for completeness; I know several have already been mentioned):
Thanks, very intriguing - I hadn't considered that (liquidating all debt) to reduce income. The main reason I have veered away from liquidating debt is because I expected that my investment returns would easily offset the low interest rates of the debt over the long run, so I'd come out ahead. But through the lens of minimizing income to maximize taxable and other benefits, this now has more appeal. I'll have to crunch the numbers.

If anyone else has additional ideas on this subject (minimizing income), I'd love to hear them - please chime in.

Here's my contribution - I think this would work to maintain EITC as well as in general: tax loss harvesting. By using the specific shares method when selling a stock investment instead of standard FIFO (first in first out), we can choose to only sell those investments that are at a loss or break-even. If at a loss, I think we can use that to offset capital gains elsewhere. If break-even, there are no capital gains and thus no contribution to income. This would probably only work in early years since the older that the "shares" get, the more capital gains they will accrue (or so we hope)
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Old 07-31-2020, 04:18 PM   #14
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Originally Posted by retiresomeday24 View Post
Thanks, very intriguing - I hadn't considered that (liquidating all debt) to reduce income. The main reason I have veered away from liquidating debt is because I expected that my investment returns would easily offset the low interest rates of the debt over the long run, so I'd come out ahead. But through the lens of minimizing income to maximize taxable and other benefits, this now has more appeal. I'll have to crunch the numbers.
Definitely crunch the numbers.

I understand the mortgage vs investment arbitrage argument, and agree with it over long periods of time and at relatively low interest rates like the past several years.

On the other hand, tax goodies generally are risk free, tax free, and surprisingly large, especially the ACA, EITC, and FAFSA aid.

Finally, although there is current discussion in Congress about modifying the qualifications for EITC, I have found it surprisingly hard to get (actually impossible so far for me). There are a large number of what I think are challenging criteria to qualify. If you're thinking about going down that route, I'd strongly recommend very careful evaluation of the EITC rules and your projected financial situation first. It'd be a bummer to head that way and then find out that you don't qualify.
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