Tax Rates and ER Decision

[phil1ben]

I have signed up for the Class of 2015. My decision was further confirmed when I met with my accountant and I saw with hard figures the pain of the most recent increase in tax rates. I am paying income tax at the rate of 39.6 federal, 4.1 State (which is relatively low. i.e. had I remained a NJ resident I would be paying 11.0% State tax), 3.0% Obamacare tax, real estate tax, sales tax, capital gains tax etc...

With all of this, MORE than 50% of my income goes to pay taxes. When you are in the highest bracket most of your deductions phase out so there is not much one can do. Mortgage interest, state and local taxes all phase out.

Simply stated, working and paying tax on W-2 income is not worth it. The founders never contemplated that it would be "One for you and One for me".

The point of my post is that the most recent higher tax rates have strongly effected my decision to retire. I would request that this post does not turn into a discussion of "how lucky I am to be in the 39.6% bracket" but that replies should focus on the effect that the most recently enacted higher tax rates have on one's decision to retire.

 

[Chuckanut]

I don't favor a flat tax, but the current rates (state plus federal) are to high and discourage hard work, expanding a business and innovation, IMHO.

Phil, you have my sympathy. That and $3.70 will get you a latte.

 

[BigNick]

I would request that this post does not turn into a discussion of "how lucky I am to be in the 39.6% bracket" but that replies should focus on the effect that the most recently enacted higher tax rates have on one's decision to retire.

ER is often about realising that you're currently working d*mn hard for someone else. For well-paid people this is often the IRS; for less well-paid people this is typically the shareholders of MegaCorp. Either way, someone else is along for the ride.

 

[FIREd]

For 2013: Federal marginal tax rate: 39.6%. California marginal tax rate: 10.3%. LTCG: 20% Fed + 10.3% CA. Regular payroll taxes plus ACA medicare surtax on wages and investment income. CA disability tax. AMT. No deductions except for 401K contributions. Overall, our effective tax rate is 36% for income and payroll taxes. And that's just with DW working. Still, taxes are not one of the possible reasons why DW would consider quitting her job. But taxes are the number one reason why I won't get a real job any time soon, as my first earned dollar would be taxed at almost 60%. I prefer to concentrate my energy on our investments since investment income is taxed at a much lower rate.

 

[CaliforniaMan]

...

Simply stated, working and paying tax on W-2 income is not worth it. The founders never contemplated that it would be "One for you and One for me".
...

Taxes do play a big part of my decision. Being an independent software consultant for the past 30 years, and having to make quarterly tax payments, you really get to see how much you are giving the government. Income from consulting gives you few deductions.

Around 2002 or I had two years of very low income after the dot com bust. But my tax rate dropped so low, and my expenses were so low (except for buying an new guitar, to keep me busy while not working) the big decline in my income really wasn't that noticeable.

From 2004 on, things have been good, working and saving, but I have to say, I am looking forward to retirement and planning to keep my income at or below the 15% tax level.

I am not opposed to taxes really. I have been to many countries where the tax rates are low or zero, and really they suck (no infrastructure, bribes and corruption take the place of taxes,etc.)

But, I guess I am just getting sick of paying so much tax, and looking forward to living on less. Yes taxes do play a part in how much you want to work.

Oh well. I don't want a free lunch, I just want the government to eat a little less of mine, even if it means my lunch will be a bit smaller. ( need to loose a little weight anyway )

Looking forward to my retirement adventure thing...

 

[haha]

Simply stated, working and paying tax on W-2 income is not worth it. The founders never contemplated that it would be "One for you and One for me".

The founders would puke if they saw any of our modern politico-economic-tax system.

I applaud your decision, non-producers and the demagogues who live by whipping them up see high producers as infinitely pluckable. You at least are saying, not so fast buddy, I'll make myself harder to pluck.

Ha

 

[MichaelB]

The point of my post is that the most recent higher tax rates have strongly effected my decision to retire.

Many of us have traveled this road. It's not just taxes, either. There are other costs of working, and we reach the point where the net $$ we take home aren't worth the life opportunities lost. We were fortunate that even when our income hit those levels our cost of living didn't rise alongside so we were able to keep a high percentage of after tax saving and retire early.

Looking back, I did notice that my dissatisfaction rose sharply after we became financially independent.

 

[ziggy29]

For multiple reasons -- and let's please not make this too political -- I have little incentive to return to full-time work after my layoff last April. For one thing, DW has a job that provides housing and paid utilities, so our income needs are fairly small. For another, the benefits of the extra income (not just in terms of taxes, ACA or anything else, but household quality of life issues overall) are strongly near the point of diminishing returns.

The closer you get to FI, the smaller your BS bucket gets and the more quickly it can fill to the point of just saying "no" to the corporate rat race.

 

[Rustic23]

I was looking at something similar to this the other day. Since we retired there have been several changes. We live in a house that cost twice as much as when we retired, property taxes are more than doubled, yet, we have almost 40% more disposable income for the year than we did when we were working. I define disposable income as money I can spend on anything we want!

When working, payroll tax, work expense, ie getting back and forth, lunch, clothing and so on, consumed more of our checks than I thought. Our standard of living has gone up not down, and life is infinitely more enjoyable!!

 

[M Paquette]

I don't have my 2013 numbers yet. I expect them to be similar to my 2012 numbers

Federal Income Tax effective rate: 0.0%
California State Income Tax effective rate: 0.51%
Property taxes as a percentage of AGI: 3.53%
California & Local Sales tax paid as a percentage of AGI: 2.96%

Yes, I track everything. Data, right? Data goes in database where it belongs...

So, I paid a total of 7% of the AGI on my Federal tax return for all taxes. Being retired helps. So does some aggressive tax loss harvesting back in the the Great Fluctuation...

 

[jebmke]

I think various people have different reasons for when and where they choose to retire. For me, my decisions have never been financially driven -- either top line or taxes. I guess I am lucky. I was able to leave the work force at a time of my choosing when I was at the top of my game, so to speak.

 

[robnplunder]

I don't favor a flat tax, but the current rates (state plus federal) are to high and discourage hard work, expanding a business and innovation, IMHO.

Phil, you have my sympathy. That and $3.70 will get you a latte.

But I favor a flat tax. With my luck, it will happen when I retire and pay less than 5% tax, living off my asset. Grrrr.

 

[Chuckanut]

Is there any way to turn part of your earned income into capital gains?

 

[Ready]

I feel your pain. I retired last year and am now just calculating the taxes on my final year of earned income. Between the Federal and CA taxes I'm paying over 50% on the final bracket. I have never been so excited to earn no income and qualify for 0% federal taxes on capital gains. It's one of the great fringe benefits of not earning income in ER.

I suspect a lot of talented people who earn a lot have this same epiphany when they consider that half of everything they earn goes to the government. It creates a real disincentive to work if you don't need to. I don't have the solutions for the country...but my solution was to retire and enjoy life, so no complaints here.

 

[RunningBum]

I guess if you are FI, this can help with OMY syndrome. If not, my thought is that you are only impacting yourself by retiring early to avoid paying taxes and risking your future well-being is a sound strategy, unless you are willing to reduce your expenses to RE.

Also, take a look at your real tax rate. Being in the 39.6% bracket does not mean you are paying 39.6 in federal income taxes, it only means your dollars in that tax bracket are that high. And the OP mentioned capital gains tax...those don't add to your tax rate on your earned income, it is a smaller separate tax on separate income, though yes, it can be avoided with lower income.

I'm detecting a lot of emotion in this thread. I don't think emotion is good in financial decisions. I think it does make sense to look practically at what taxes do to your income. You may draw the same conclusion as the OP. One more year of a 6 figure income may not help as much as you are thinking with the high tax rate if you are trying to pad your retirement, so it is valid to examine the trade-off. Or you may just have to accept the reality of the situation (at least until the next election) and deal with it.

Quit working because you can afford to retire early and the tradeoff of working longer to afford nicer things or have a cushion isn't worth it. Don't quit over a hissy fit on tax rates. My 2 cents, tax free.

 

[Fermion]

We are in the class of 2015 also and pay about 33 to 36% tax not counting SS so I feel your pain (although not quite as much.)

Just take comfort in the fact that you can stick it back to them in 2016 by keeping your retirement income low enough to pay 0% cap gains and get a nice fat $10,000 ACA subsidy. It helps think about that during mid April when you file federal.

 

[steelhead]

Is there any way to turn part of your earned income into capital gains?

Save your after-tax income and invest it in capital assets. You'll eventually eliminate the need for earned income and can rely on tax-favored capital income.

Otherwise, become a hedge fund manager with carried interest income.

 

[brewer12345]

Our income is at far more mundane levels and DW's business income is approaching 50% tax rates: 25% fed, 5% state and 15.3% payroll. Thank heaven for the solo 401k. With me as a layabout she will only pay payroll taxes on a much reduced income level as health insurance and health expenses are deductible from self employment income.

 

[phil1ben]

There used to be a group of friends who met shortly after college graduation for dinner each month. They all met at a diner religiously each month. When the bill came, they all split it evenly. Some years past.

Two members of the group became more successful than the others. Some more time past and it was suggested that those two pay a little more than the others. They had no issue with that and paid as requested. They were all still friends.

Some more time past and it was suggested that they go each month to an expensive steak house and that the two more successful fellows pay the increased cost. Again they agreed because they enjoyed being together each month.

After a few more years someone in the group suggested that the two wealthy fellows should pay for the entire dinner. They did so for a few months. The remainder of the group started ordering additional meals to take home.

Finally the two wealthy guys stopped going to dinner and the group fell apart.

Some of the guys now meet at McDonalds every few months, however, the number is dwindling.

 

[photoguy]

I'm not sure that the tax rate is the correct way to view the issue as opposed to the net take home pay. In desirable fields (which you are probably in if you are in the top tax bracket), employers have to pay more for the same employees. So if CA state tax is 10%, well your base income is probably 10% higher anyway than a low tax state.

Don't have any studies to back this up, but that's my thoughts.

 

[MichaelB]

The thread has been relocated to the FIRE Related Political Topics forum. Please keep in mind the posting guidelines, which can be found in the forum sticky

Threads belong here if the focus is predominantly opinion based, concerning public policy, prominent political figures, or topics about governmental conduct. Posts must be related to the subject of early retirement in more than a tenuous fashion.

 

[RunningBum]

There used to be a group of friends who met shortly after college graduation for dinner each month. They all met at a diner religiously each month. When the bill came, they all split it evenly. Some years past.

Two members of the group became more successful than the others. Some more time past and it was suggested that those two pay a little more than the others. They had no issue with that and paid as requested. They were all still friends.

Some more time past and it was suggested that they go each month to an expensive steak house and that the two more successful fellows pay the increased cost. Again they agreed because they enjoyed being together each month.

After a few more years someone in the group suggested that the two wealthy fellows should pay for the entire dinner. They did so for a few months. The remainder of the group started ordering additional meals to take home.

Finally the two wealthy guys stopped going to dinner and the group fell apart.

Some of the guys now meet at McDonalds every few months, however, the number is dwindling.

So did this mean anything?

replies should focus on the effect that the most recently enacted higher tax rates have on one's decision to retire.

or did you just want to bitch about taxes?

 

[scrabbler1]

I can't say the tax rates had any direct influence over my decision to ER back in 2008. At the time, I was working only part-time so my tax bill was not huge. However, when I first switched from working full-time to part-time back in 2001 I did realize that there was a decent tax benefit to reducing the portion of my earnings which were taxed at the highest combined marginal rates (which for me at the time was nearly 43% using federal, state, and FICA rates). What this meant in practical terms was that even though I reduced my total gross pay by 47% my after-tax net pay dropped by only about 40%, making my revised part-time budget better than I had first anticipated.

When I did ER 5 years ago, I saw that the elimination of FICA taxes and commutation expenses was roughly the same as having to pay for 100% of my health insurance. (That has changed with the ACA now in place.) There was a slight reduction in income taxes initially but in the last 5 years I have been able to adjust the types of income I have to make more of it in categories which are taxed at 0% (QD and LTCG) to the point that for 2013 I will for the first time pay more in state income taxes than in federal income taxes.

 

[pb4uski]

Taxes were only a small factor in my decision to retire. I'll admit to being frustrated with paying more in taxes than most families earn, but OTOH I recognized that it was a nice problem to have.

I can see where once more than half of the fruits of your efforts is being absconded by the government that one can wonder if it is really worth the effort, especially given the sacrifices that high earners make (stress, long hours, constantly on call) but that most in society don't recognize or appreciate (and would be unwilling to make in many cases).

When I was planning for my retirement I took my tax return prior to retiring and then took our my earnings and made other adjustments for changes in retirement, I was pleasantly surprised at how low my tax burden was.

 

[Alan]

We were high income workers before we ER'ed but taxes had nothing to do with why we wanted to ER. In fact I wish we were able to make voluntary FICA contributions to SS to get to 30 years instead of the 23 years I have. This would increase future base payments a little, but more importantly would eliminate WEP which will cost me the full amount (Currently ~$408/month reduction in SS).