Pay as little taxes as you can?

[Seattle]

Friends...

I am planning my FIRE strategy and I have been investigating the best ways to invest to meet my goals, but at the same time, be as tax efficient as I possibly can be.

I live in a state with no income tax, so that helps.

I wondered if it was possible to literally find an investing strategy that would allow me to pay literally zero taxes and I ran across this Forbes article that I thought was fascinating and I wanted the forum's thoughts on this strategy and see if anybody actually went this direction and how did it work for you.

How Retirees Pay Zero Taxes - Forbes

The article is alittle dated back to Jun 2013, so some of the Obama magic might have changed some of the tax code to prevent this, but still was interesting enough that I wanted to forward it out there and get some thoughts on it.

For me - I am planning for a $200K per year to cover living expenses in retirement, so being able to pay very little in taxes would allow me to retire that much sooner...

Thoughts?

 

[nash031]

Here's the thing about investing specifically for this: tax laws can change at the stroke of a pen or a day's vote. It makes sense to limit your taxes any way you can on a year-to-year basis, including tax-deferred and tax-free accounts, tax loss harvesting, tax-intelligent asset allocation, doubling up on deductions one year, claiming the standard the next... but I think it's a little naive to plan a 40-year retirement based on tax loopholes. It makes more sense to me to select your investments based on acceptable market risk, overcoming inflation, and then being tax- and fee-smart.

 

[jimnjana]

at 200k per year much of the zero tax strategies won't apply.

 

[flyingaway]

It is possible to spend $200,000 a year and pay little taxes, like the article pointed out, provided most of your money is in Roth IRA or taxable accounts, which are considered as the money that you have already paid taxes, excluding the dividends and capital gains, which have favorable tax rates.

 

[Midpack]

at 200k per year much of the zero tax strategies won't apply.

From the article:

To illustrate, let’s invent a retired couple who live outside Boston. They own a $2 million home, have $7 million stashed away at their broker and haul in $200,000 a year in dividends, interest, Social Security and distributions from publicly traded partnerships. They have $30,000 in deductions, including $20,000 for property tax and $5,000 for a donation.

 

[flyingaway]

at 200k per year much of the zero tax strategies won't apply.

It is still possible if at least half of $200k is from Roth IRA or taxable accounts.

 

[bad_LNIP]

Move overseas. The feie covers up to 200k in income

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[MichaelB]

Move overseas. The feie covers up to 200k in income

The FEIE excludes up to $100K (for each taxpayer) of earned income and does not affect investment income or interest payments.

 

[bad_LNIP]

For a married couple the feie max is over 200k. Form an investment company and collect a management fee. Qualified dividends are tax free up to 91k or so too.

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[MichaelB]

For a married couple the feie max is over 200k.

Yes, although it is important for poeple to understand that there is a limit of $100K for each spouse.

 

[2017ish]

As noted by nash031, laws change. Plus, at least in my mind, even though I spend a lot of time playing "what ifs" with the Code, the goal isn't to minimize taxes--it is to maximize what is available to spend. For example, if you have all assets in "standard" accounts at retirement, you could invest solely in AMT-compliant municipal bond funds and pay no income tax--but you'd be better off long-term to have a mix of investments (including equity).

So too, if at retirement you moved from your no income tax state to California, especially if you bought a house in Palo Alto, you'd drastically reduce your federal income taxes because of the state/local tax (and interest) deductions--but your wallet would nonetheless be lighter in the end. Note that the Forbes article looks at a Boston couple with high deduction for state/local taxes and interest--are they financially better off than if they were retired in a low/no tax state?

Best approach, IMHO, is tax diversification and focus on the bottom line.

Edited to add underlined portion.

 

[jimnjana]

From the article:

okay i confess i didn't read the article. Now that I did, author left out state income tax. Also, I wonder how fictional retiree would have weathered the recent collapse of oil prices. The author didn't specify but I would imagine that many of the partnerships would have been oil gas MLPs. Wonder what kind of real world hit to distributions this retiree would have had, not to mention hit to net worth.

 

[walkinwood]

If you place your assets intelligently (bonds in tax deferred and equitiy in taxable), use index equity funds (or funds with low turnovers), and use taxable accounts to fund your ER, you'll end up with a tax bill much, much lower than you're paying now.

Put the numbers in a tax program and you'll be surprised.

Bob Clyatt made this case in his book Work Less, Live More.

 

[Alan]

Move overseas. The feie covers up to 200k in income

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I think the OP was discussing a FIRE strategy and the article was discussing passive, non-earned income so living and working overseas to get the feie credit is not being FIRE'ed.

 

[Brooks Saddle]

The one point in the article that I didn't understand is delaying IRA distributions until age 70. Perhaps someone can help me understand this.

I read a Prudential white paper that was written a couple of years ago which had a portion on minimizing taxes on social security and taxes overall. Their strategy was to delay social security until age 70 but not IRA distributions. Their advice was to live on IRA distributions until age 70 then elect social security. The RMDs kicked off at that juncture would be less, thus, impacting the point where social security benefits become taxable.

Has anyone else seen that paper?

 

[mickeyd]

The one point in the article that I didn't understand is delaying IRA
distributions until age 70. Perhaps someone can help me understand this.

Since RMD is not activated until age 70 1/2, many folks wish to delay receipt (taxation) of IRA/401(k) proceeds as long as possible. I know that's true for me now that I am 70. I could have withdrawn these proceeds prior to this year, but I had no immediate need for the cash, thus delaying distribution until this year.

 

[bad_LNIP]

I think the OP was discussing a FIRE strategy and the article was discussing passive, non-earned income so living and working overseas to get the feie credit is not being FIRE'ed.

Who said anything about working overseas?

Look, you can form an LLC in a different country. LLC hires you and your wife to manage the LLC's investments. The LLC is capitalized from your investments. The LLC pays you a salary. As long as you are overseas for 330+ days, it qualifies for the FEIE.

Do I need to spell out where the LLC's investment income comes from?

This is no different than managing your investments, except there is a name change

 

[LOL!]

Do not forget that return of capital is tax-free, so if you have $8,000,000 in a taxable account and only $4,000,000 is gains, then that's $2,000,000 tax-free in the future already.

Thus if one spends $200,000, then they may only need to have $100,000 or less of taxable income. The Bogleheads forum has an entire thread with links to some tax returns showing all this:
Bogleheads • View topic - How to pay ZERO taxes in retirement with 6-figure expenses

Thus spending $200,000 annually is still well within some of the zero-tax strategies.

 

[Alan]

Who said anything about working overseas?

Look, you can form an LLC in a different country. LLC hires you and your wife to manage the LLC's investments. The LLC is capitalized from your investments. The LLC pays you a salary. As long as you are overseas for 330+ days, it qualifies for the FEIE.

Do I need to spell out where the LLC's investment income comes from?

This is no different than managing your investments, except there is a name change

I'm afraid you will have to spell it out a little more because I still don't understand - sorry.

If you are living overseas then you would be paying taxes overseas on the salary you pay yourself and you file taxes in the US and deduct the earnings you have made overseas. You may have low taxes paid in the USA but you will have paid taxes in the country you are living. What am I missing?

 

[RunningBum]

As noted by nash031, laws change. Plus, at least in my mind, even though I spend a lot of time playing "what ifs" with the Code, the goal isn't to minimize taxes--it is to maximize what is available to spend. For example, if you have all assets in "standard" accounts at retirement, you could invest solely in AMT-compliant municipal bond funds and pay no income tax--but you'd be better off long-term to have a mix of investments (including equity).

This, exactly. The goal shouldn't be to pay the least amount of taxes. The goal should be to get the best overall after-tax return, within your risk comfort zone.

 

[karluk]

I'm afraid you will have to spell it out a little more because I still don't understand - sorry.

If you are living overseas then you would be paying taxes overseas on the salary you pay yourself and you file taxes in the US and deduct the earnings you have made overseas. You may have low taxes paid in the USA but you will have paid taxes in the country you are living. What am I missing?

bad_LNIP has advocated this tax avoidance strategy elsewhere in this forum, most notably in the following thread

http://www.early-retirement.org/forums/f30/thoughts-on-my-game-plan-for-er-73508.html

I consider this type of tax avoidance to be practically begging the IRS for an audit with the likely result of having your tax dodge disallowed and being assessed back taxes and penalties, but bad_LNIP has apparently convinced himself that it's worth a try.

 

[Alan]

bad_LNIP has advocated this tax avoidance strategy elsewhere in this forum, most notably in the following thread

http://www.early-retirement.org/forums/f30/thoughts-on-my-game-plan-for-er-73508.html

I consider this type of tax avoidance to be practically begging the IRS for an audit with the likely result of having your tax dodge disallowed and being assessed back taxes and penalties, but bad_LNIP has apparently convinced himself that it's worth a try.

Thanks for the reference, I guess I must have missed or forgotten that thread.

 

[bad_LNIP]

I've also talked to multiple CPA types including one who took the exclusion for himself while working overseas. All approved.

Why is it begging for an audit? Why does the IRS select my return over others? Why would the exclusion be disallowed? Where have I gone wrong other than suggesting something unconventional but not incorrect per the irs.

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[pb4uski]

Seattle, as others have said it depends a lot on your sources for the $200k/year and how much is principal vs income. At that high a WR it is unlikely that you'll get to zero tax, but it is possible in some situations (high Roth and taxable account balances and little tax-deferred balances).

However, most people have high tax-deferred account balances. For some of us paying zero taxes can be quite suboptimal. I could pay zero taxes right now, but if I did between SS and RMDs once I turn 70 I would be pushed into the 25% tax bracket. In the long run, I am better off paying some taxes now and avoiding the 25% bracket (in favor of the 15% bracket) later in life.

So be careful that a myopic focus on the taxes you pay doesn't cause you to do something suboptimal.

 

[Telly]

......However, most people have high tax-deferred account balances. For some of us paying zero taxes can be quite suboptimal. I could pay zero taxes right now, but if I did between SS and RMDs once I turn 70 I would be pushed into the 25% tax bracket. In the long run, I am better off paying some taxes now and avoiding the 25% bracket (in favor of the 15% bracket) later in life.

So be careful that a myopic focus on the taxes you pay doesn't cause you to do something suboptimal.

Alas, that was me just a few years ago... by making IRA contributions, could set tax rate to zero for some years. But last year, I woke up and started to calculate what the effects of future RMD's would be on us -eek! So have started to do Roth conversions up to the top of 15% bracket, plan on doing this every year till RMDs kick in, and delaying SS for me till 70.

Avoiding taxes today, although it feels great, may not be the best thing to do overall!