RE Income Effective Tax Rates - Higher Spenders

[DawgMan]

Ok, I know the answer starts with it depends or varies, but I am trying to get a “general” fix on what my effective income tax rate will be once I RE in 2 years. I am planning on a higher withdrawal rate +/- $300K. I get that there can be extreme swings depending upon your where your RE income comes from (I.e 100% from Roth or munis to 100% IRA). Excluding state taxes which obviously vary by state, I would be curios to hear from those of you that are generating $150K + in RE income a few stats...

- Income?
- Effective tax rate (with or without your state rate... please note rate if uses)?
- approximate % split of income generating assets (I.e. IRA 60%, Roth, 20%, pension 20%)?
- Any special deductions beyond standard?
- Other strategies you use to minimize taxes?

Right now, I have underwritten an effective tax rate of 25% (inc state) and project to be about 50/50 taxable and tax differed accounts when I launch. Thoughts?

 

[pb4uski]

Why not just do a pro forma tax return as if you were retired? Eliminate your wage/salary earnings since you won't be working. Presumably your taxable account income would be similar... then add in income relating to any tax-deferred withdrawals and make any other relevant adjustments for changes once you are retired.

In my case, it was pretty much a matter of getting rid of my earnings and adding in a little capital gains since we were selling shares for spending money... but the rest of our return was pretty much the same.

 

[LOL!]

Yes, do a tax return with your personal situation.

For someone wanting to spend $300,000 a year, I suspect you have a large taxable account, so that means you could have a high amount of return of capital which is, of course, not taxed at all and does not appear on your Form 1040.

Example: Sell $300,000 of Vanguard Total Stock Market Index Fund with a realized long-term gain of $100,000. The $100,000 appears on your tax return, but the other $200,000 is yours to spend as you please. If you have no other income and are married filing jointly, I suspect your tax is $0.00. But that cannot be true since such a large taxable portfolio will have plenty of dividends which will add to your AGI, taxable income, and taxes.

I might add that folks who have too much income probably didn't fill out their own tax returns while they were working, so they may be less well-versed in what tax returns are really like.

 

[Stormy Kromer]

I use a general assumption of 20% on my total income. I live in MN which has a high state income tax rate. It is surprisingly close.

2017 will be my first full year of retirement. About 25% of my income is farmland rental, the rest is interest from in installment sale and long term capital gains. What a huge difference that makes not having self employment income.

During my working years I figured 40% when you combine Federal, State and Self Employment tax.

 

[LOL!]

40% might be your marginal income tax bracket, but an effective rate over 20% is HUGE.

 

[audreyh1]

Are you going to be drawing on taxable or tax-deferred accounts. Makes a big difference.

If taxable, you must already know what kind of taxable income is being generated via distributions, interest, etc. because you must be paying taxes on it now. lf tax-deferred, you’re pulling in a big chunk of ordinary income which will replace your salary, but are no longer paying the SS or Medicare parts of FICA.

I agree with those who say to do a tax return with your numbers. No one else here will have your mix and withdrawal so I doubt you’ll get useful info. Taxes vary widely depending on mix of assets and personal situations.

 

[audreyh1]

For someone wanting to spend $300,000 a year, I suspect you have a large taxable account, so that means you could have a high amount of return of capital which is, of course, not taxed at all and does not appear on your Form 1040.

Example: Sell $300,000 of Vanguard Total Stock Market Index Fund with a realized long-term gain of $100,000. The $100,000 appears on your tax return, but the other $200,000 is yours to spend as you please. If you have no other income and are married filing jointly, I suspect your tax is $0.00. But that cannot be true since such a large taxable portfolio will have plenty of dividends which will add to your AGI, taxable income, and taxes.

If this is the case, it’s possible to get the income without realizing capital gains if distributions, interest, etc. paid out exceed withdrawal and rebalancing needs.

More importantly, the OP will already be receiving and paying taxes on this investment income while working, so he should know the answer.

We live off taxable investments and I rarely have to sell anything as distributions cover our annual withdrawal needs and drive our taxes,

 

[68bucks]

When we RE this year we will be taking our income from tax deferred accounts. I expect starting next year, our first full year, we will pull about $200K in income on an age 55 rule distribution. I have been worried about how to deal with minimizing the taxes. I really don't see many options for us to use to reduce our AGI. I expect the $200K will exceed our needs so we will either reduce the rate in later years or use excess money to work on eliminating the mortgage. The age 55 distributions will come from a company stock plan that will pay out over 10 years so I can take the distribution for the years I will need it. The $200K should be about 50% of the actual annual distribution with the rest rolling over to an IRA. I have been weighing whether we should hire a tax professional or if it's too cut and dried and would not really benefit us.

 

[pb4uski]

When we RE this year we will be taking our income from tax deferred accounts. I expect starting next year, our first full year, we will pull about $200K in income on an age 55 rule distribution. I have been worried about how to deal with minimizing the taxes. I really don't see many options for us to use to reduce our AGI. ....

Not much you can do other than grin and bear it.

 

[Travelwanted]

My portfolio spits out about 220k per year in primarily qualified dividends and muni bond payments. Assuming I don't sell anything, I would owe $900 in federal taxes per year.

 

[DawgMan]

Assuming I don't sell anything, I would owe $900 in federal taxes per year.

Like the sound of that!

 

[Travelwanted]

DawgMan - you can make a dummy account at h&R block, taxact, etc and put in your numbers to determine what your tax liability will be. Obviously there are MANY factors that affect YOUR tax rate (pre/post tax, interest, stcg vs ltcg, dividends - qualified or unqualified).

 

[skipro33]

If I were in the OP's situation, I would probably try to find a CPA that specializes in tax and ask him/her for an analysis. Might cost an hour or two of their time, but the guessing would be pretty much eliminated and a solid explanation of the background for the decisions would be provided. The CPA probably has developed computer models for various scenarios, making the what-if's easy to play with.

 

[Helen]

DawgMan - you can make a dummy account at h&R block, taxact, etc and put in your numbers to determine what your tax liability will be. Obviously there are MANY factors that affect YOUR tax rate (pre/post tax, interest, stcg vs ltcg, dividends - qualified or unqualified).

But when will the software be updated to reflect the new tax laws?

 

[DawgMan]

If I were in the OP's situation, I would probably try to find a CPA that specializes in tax and ask him/her for an analysis. Might cost an hour or two of their time, but the guessing would be pretty much eliminated and a solid explanation of the background for the decisions would be provided. The CPA probably has developed computer models for various scenarios, making the what-if's easy to play with.

This is essentially what I will be doing when I meet with my CPA in a couple of months. I am still in accumulation mode for another 2 yrs so have been primarily looking at numbers from 30K feet. I believe I have used pretty conservative assumptions (25% effective tax rate for RE income), but realize every % saved is either less total $$ needed in my stash or more income $$ for me in RE. I will be 55 when I launch so will need to bridge to 59 1/2. I need to play around with the impact of RMDs, 72T, and any other cocktails I can mix up to both minimize taxes now and in the future. My income is too high now to take advantage of Roth conversions and I suspect it may not be the best strategy once I am in RE, but still need to look at that. So while I realize my situation is somewhat unique for me, for encouragement, I was curious to hear what others were doing/paying and/or specific strategies they used in RE to keep their effective tax rate down. Right now, Travelwanted is my hero at a .41% effective tax rate!

 

[RunningBum]

Right now, Travelwanted is my hero at a .41% effective tax rate!

At what sacrifice for returns? What rate is he getting on those muni bonds? Optimize your after tax returns, don't just try to get the lowest tax rate.

Beyond taking all the tax breaks like an HSA if you have an eligible plan, gifting appreciated assets rather than cash, etc., I think the best you can do is to try to have a smooth tax rate over your entire retirement. It doesn't do much good to pay a lower tax rate now only to soar into a much higher one with SS and RMDs start.

 

[audreyh1]

I looked at the TurboTax generated history for 2011 through 2016 and we had IRS reported income above $250K each of those years.

Federal effective tax rates: income/taxes paid ranged from 13.3% to 16.1% with the average at 14.4%*. We are MFJ.

No state taxes.

Our income was by far mostly capital gains rate income (qualified dividends, cap gains distributions, realized gains) and we were well within the 15% tax bracket on our ordinary income, so some of our cap gains income was taxed at 0%. No Roth conversions or IRA withdrawals. We paid some AMT each of those years. We were also subject to the Net Investment Income Tax for income >$250K since 2013.

I don't believe the top line income included tax-free municipal bond income as for some reason Turbotax does not include that in their history/summary.

*updated. Left out NIIT the first go around.

 

[Travelwanted]

At what sacrifice for returns? What rate is he getting on those muni bonds? Optimize your after tax returns, don't just try to get the lowest tax rate.

Beyond taking all the tax breaks like an HSA if you have an eligible plan, gifting appreciated assets rather than cash, etc., I think the best you can do is to try to have a smooth tax rate over your entire retirement. It doesn't do much good to pay a lower tax rate now only to soar into a much higher one with SS and RMDs start.

Thanks for your concern, although your post did sound a bit condescending. I agree with you about optimizing after tax returns.

I am not fully retired yet so those are numbers without ordinary income. I just plugged them in the other day to see where I would be as I am strongly considering fully retiring this year.

FWIW, I was up 18.4% last year. I don't feel like I sacrificed anything. I'm 67% stocks, 33% bonds. My bonds are mostly in VG int term tax exempt bond fund. I have a bit of high yield and long term as well.

The bonds are federally exempt and the rest was nearly all qualified dividends. Thus after deductions it showed I would owe $900.

 

[Scuba]

2017 will be our first year of ER, but I got a pretty large employer payout in 2017 so our taxes won't be typical of our retirement income. I think whether or not it's worth hiring someone to help you analyze this depends on your own comfort level of modeling various options, plus the complexity of your options. Like you, we couldn't contribute to Roths when we were working and apparently 2017 our tax rate will still be pretty high so our CPA didn't recommend it.

I am thinking of getting an analysis done to help us decide about various future income streams we have options to take at certain points or delay. The consequences of a bad decision could be far more than a fee to model this for us.

 

[DawgMan]

I looked at the TurboTax generated history for 2011 through 2016 and we had IRS reported income above $250K each of those years.

Federal effective tax rates: income/taxes paid ranged from 12.0% to 14.8% with the average at 13.5%. We are MFJ.

No state taxes.

Our income was by far mostly capital gains income and we were well within the 15% tax bracket on our ordinary income, so some of our cap gains income was taxed at 0%. No Roth conversions or IRA withdrawals. We paid some AMT each of those years. We were also subject to the net investment income tax for income >$250K.

I don't believe the top line income included municipal bond income as for some reason Turbotax does not include that in their history/summary.

Good info!

I am a total return investor based on my AA so anticipate doing something similar to what you have posted in the past... take my 1 yr income and drop it into a separate account and rebalance. As stated, the goal will be to smooth out the tax implications over my projected RE. Just need to run the different scenarios to see how they play out taking into account possible RMDs.

 

[RunningBum]

Thanks for your concern, although your post did sound a bit condescending. I agree with you about optimizing after tax returns.

I am not fully retired yet so those are numbers without ordinary income. I just plugged them in the other day to see where I would be as I am strongly considering fully retiring this year.

FWIW, I was up 18.4% last year. I don't feel like I sacrificed anything. I'm 67% stocks, 33% bonds. My bonds are mostly in VG int term tax exempt bond fund. I have a bit of high yield and long term as well.

The bonds are federally exempt and the rest was nearly all qualified dividends. Thus after deductions it showed I would owe $900.

It wasn't meant to be directed at you. I have no idea of your situation, and whether you are in a high tax bracket where tax exempt works well for you. It was more directed at the OP, a message that striving to minimize taxes is misguided. Generally, if your tax rate is extremely low, tax exempt funds aren't usually worthwhile because you generally get less return than a non-exempt fund.

 

[audreyh1]

Good info!

I am a total return investor based on my AA so anticipate doing something similar to what you have posted in the past... take my 1 yr income and drop it into a separate account and rebalance. As stated, the goal will be to smooth out the tax implications over my projected RE. Just need to run the different scenarios to see how they play out taking into account possible RMDs.

Sorry - I updated my post with higher effective tax rates. My initial run left out the NIIT!

 

[Travelwanted]

It wasn't meant to be directed at you. I have no idea of your situation, and whether you are in a high tax bracket where tax exempt works well for you. It was more directed at the OP, a message that striving to minimize taxes is misguided. Generally, if your tax rate is extremely low, tax exempt funds aren't usually worthwhile because you generally get less return than a non-exempt fund.

Haha...no worries. Again we agree. But, fortunately I am a high bracket so for now it makes sense.

Yes, my big question will be whether to stay in tax exempt funds next year once my ordinary income drops to 0.

I think the saying is "don't the the tax tail wag the dog".

 

[DawgMan]

It wasn't meant to be directed at you. I have no idea of your situation, and whether you are in a high tax bracket where tax exempt works well for you. It was more directed at the OP, a message that striving to minimize taxes is misguided. Generally, if your tax rate is extremely low, tax exempt funds aren't usually worthwhile because you generally get less return than a non-exempt fund.

Wait... so I am now the shmo?! (however you spell "shmow").

Yes, I am not chasing tax avoidance first... just second, after I have maxed out the booty!

 

[Danmar]

I looked at the TurboTax generated history for 2011 through 2016 and we had IRS reported income above $250K each of those years.

Federal effective tax rates: income/taxes paid ranged from 13.3% to 16.1% with the average at 14.4%*. We are MFJ.

No state taxes.

Our income was by far mostly capital gains rate income (qualified dividends, cap gains distributions, realized gains) and we were well within the 15% tax bracket on our ordinary income, so some of our cap gains income was taxed at 0%. No Roth conversions or IRA withdrawals. We paid some AMT each of those years. We were also subject to the Net Investment Income Tax for income >$250K since 2013.

I don't believe the top line income included tax-free municipal bond income as for some reason Turbotax does not include that in their history/summary.

*updated. Left out NIIT the first go around.

I am quite envious at how little tax you pay. In Canada we pay at the max marg rate at your income level. As such we pay (at the margin) about 32% on div income, 24% on cap gains (return of capital not taxed), and about 48% on regular pension income. This is combined federal and provincial. On top of that there are federal VAT’s of 5% as well as provincial VAT’s ranging up to about 8%-9%. Capital gains tax owing at death as well.

Boy you Americans have it good. Other than health care of course. But for high earners it would be much less to pay for insurance than to pay our taxes. And yet......