Effective Tax Rates in Retirement

[Midpack]

There was a thread a few weeks ago from a newly minted retiree who was surprised at how low his/her taxes were. I remember being shocked, even felt guilty, the first year I did my return after retiring. Or course I knew my marginal bracket/effective tax rates would be lower, but after decades paying relatively high taxes - the actual numbers came as a shock the first year into retirement. I triple checked that return, convinced I must have missed something - but I hadn't.

Americans in the 15% bracket and below have NOTHING to complain about, especially given the break on dividends & capital gains.

Since I finished my 2015 returns yesterday, and for me a picture/data is worth a thousand words...

 

[hnzw_rui]

Americans in the 15% bracket and below have NOTHING to complain about, especially given the break on dividends & capital gains.

For retirees, yeah. However, there's quite a significant difference between a W-2 wage earner in the 15% bracket (+ 6.2% SS + 1.45% Medicare + SDI) versus someone retired and living mostly off qdiv and ltcg taxed at 0%.

 

[ERD50]

... especially given the break on dividends & capital gains. ...

We've discussed it before, but the 'break' on cap gains often isn't.

If I bought $1,000 of stock 20 years ago, and sold it for $1,100, I'd likely pay $15 tax on it.

If my neighbor bought $1,000 of stock 1.1 years ago, and sold it for $1,100, he'd likely pay $15 tax on it.

n that case, I don't feel like I got a break - my investment lost money to inflation, yet I have to pay the same tax that someone else did who made the money 20x quicker? I should at least be able to take a credit (even if only against other gains) for the loss!

Adjusting gains to inflation would account for this, and is easy with computers.

-ERD50

 

[Gone4Good]

For retirees, yeah. However, there's quite a significant difference between a W-2 wage earner in the 15% bracket (+ 6.2% SS + 1.45% Medicare + SDI) versus someone retired and living mostly off qdiv and ltcg taxed at 0%.

A significant difference indeed.

A married couple earning $100K in wages with no other deductions will pay about $19K in income, SS, and medicare taxes. The same couple who earned $50K in dividends and $50K in ordinary interest will pay about $4K in federal taxes.

 

[Options]

Well I'm impressed you bothered to graph your ETR for the past several years, and simultaneously wish I hadn't been so damn [-]lazy[/-] freaking busy to do so. I do know my future ETR will be no higher than something like 3.5% for the remainder of my life, at a minimum due to planned Roth conversions, minimal LTCG's and tax diversification, even if said diversification was more accidental than anything else (take anything I can get, though). I had read somewhere that people fail to understand a world of difference exists between pre- and post-retirement strategies for minimizing, even eliminating taxes.

I personally feel no guilt at all, as I've been paying for decades. The two main determinants of superior PF returns are fees and taxes. Why wouldn't I want to minimize both?

 

[Gone4Good]

A related point about our wacky tax code that may be of more practical importance to folks here is how rising interest rates (to the extent they ever actually happen) can push people's marginal tax rate up rapidly.

Someone who is currently in the 15% tax bracket and enjoying the 0% rate on qualified dividends may currently enjoy a low single digit effective tax rate. But they could find their marginal rate spiking to 40% if they get pushed into the next higher bracket.

That's because the 1st dollar of income earned in the 25% tax bracket also pushes one dollar of qualified dividends or capital gains out of the 0% tax bracket. So you end up paying 25% on the new dollar earned plus 15% on a dollar of gains that previously got taxed at zero.

In a high interest rate or inflationary environment, people's tax bills could be quite a bit larger than what they're enjoying now.

That's a potential pressure people may not have factored into their withdrawal rate expectations.

 

[big-papa]

There was a thread a few weeks ago from a newly minted retiree who was surprised at how low his/her taxes were. I remember being shocked, even felt guilty, the first year I did my return after retiring. Or course I knew my marginal bracket/effective tax rates would be lower, but after decades paying relatively high taxes - the actual numbers came as a shock the first year into retirement. I triple checked that return, convinced I must have missed something - but I hadn't.

Americans in the 15% bracket and below have NOTHING to complain about, especially given the break on dividends & capital gains.

Since I finished my 2015 returns yesterday, and for me a picture/data is worth a thousand words...

Very cool! Will there be a point where you're withdrawing from tax deferred accounts or will you be able to complete Roth conversions before that happens? Just wondering if there is a tax spike looming once you start RMD's at some point in the future - something that's always on my mind....

 

[Midpack]

Very cool! Will there be a point where you're withdrawing from tax deferred accounts or will you be able to complete Roth conversions before that happens? Just wondering if there is a tax spike looming once you start RMD's at some point in the future - something that's always on my mind....

I'm trying to keep our taxable income steady, but the tax torpedo will do damage when we get closer to 70 yo.

 

[NW-Bound]

Americans in the 15% bracket and below have NOTHING to complain about, especially given the break on dividends & capital gains...

Some even have NOTHING that is taxable, after exemptions, deductions, and break on dividends & cap gains, despite having a low 6-figure income.

I belonged in that group for just 2 years due to a confluence of events (OK, OK there were some planned moves in there too), but it is highly unlikely to happen again. Poor me!

We've discussed it before, but the 'break' on cap gains often isn't...

Adjusting gains to inflation would account for this, and is easy with computers.

Somebody has to pay some income taxes to keep the government workin'.

 

[braumeister]

It probably applies to only a few here, but I just learned this the other day and thought it was a nice little trick.

If you're subject to the tax torpedo (taking RMDs that push up your tax bracket), you can avoid the problem of making estimated tax payments or withholding from SS by simply waiting until December to take your RMD and having a chunk of tax withheld from it. The IRS considers that money to have been withheld throughout the year.

Of course, if you need all that RMD money to live on, it may not be possible, but if not, this is a good thing to know.

 

[grasshopper]

We are always bumping up against the 25% tax bracket, in QD, LTCG, Roth conversions.
Of course no ACA for us.
For the last 3 years.
2013 effective rate .38% actually went a hundred bucks into 25% bracket
2014 effective rate 1.04%
2015 effective rate .86%

In each year we took 50k in LTCG, today our cost basis is higher than the market value. So this year I will do some tax loss harvesting. This was only done to get some LTCG off the table before RMD's start, just in case we want to do the $100k round the world trip. Turned out pretty good for us.

 

[Spudd]

I'm Canadian, so our tax system is slightly different.

However.

2014 - I worked the whole year. 28% effective tax rate.
2015 - I worked January and got paid for half of Feb (vacation days). I cashed in my company stock and got a big capital gain. All in all I made just a little less than half my income in 2014. 8% effective tax rate. Pretty good!

I'm looking forward to 2016.

 

[kaneohe]

................................

Someone who is currently in the 15% tax bracket and enjoying the 0% rate on qualified dividends may currently enjoy a low single digit effective tax rate. But they could find their marginal rate spiking to 40% if they get pushed into the next higher bracket.

That's because the 1st dollar of income earned in the 25% tax bracket also pushes one dollar of qualified dividends or capital gains out of the 0% tax bracket. So you end up paying 25% on the new dollar earned plus 15% on a dollar of gains that previously got taxed at zero.

...................................

Generally this is thought of similarly but the 40% is replaced by 30% and the 2nd 25% is replaced by 15%. The stacked bar chart way of thinking about this places ordinary income at the bottom and QDIV/LTCG on the top. Increased ordinary income in the 15% bracket displaces QDIV/LTCG into the 25% bracket. The ordinary income is taxed at 15% and the QDIV/LTCG at 15% for a total marginal increase of 30%.

 

[Viking]

Also Canadian.

From 2007 through 2014 my average tax rate held fairly constant between 20% and 22%.

2015 looks like it will be ~34% (helped along by a substantial lump sum pension payout that couldn't be sheltered in an RRSP, and an increase in provincial tax rates.)

For 2016, I anticipate a 0% average tax rate. Most retirement savings are in tax deferred accounts, and I don't plan on touching those accounts for another 10 years. so over that time, I'll be drawing down the taxable account that contains what's left of the lump sum referred to above.

for 2017 through 2025, it looks like the average rate will be 5%-6% as we will be splitting my wife's pension income. (She retires December 2016!). This may go up depending on the extent of capital gains, but in Canada, they are only taxed at 50% of the marginal rate, so I anticipate that will only be ~7.5% for me.

For 2026 and later, I expect my average rate will go up as I will start drawing from a RRIF/RRSP and will have another $15k/year (2016 dollars) in CPP and OAS.

 

[calmloki]

Perhaps unlike most here our retirement income looks a whole bunch like our pre-retirement income. Rentals and interest income on various loans means we get taxed right and proper. Since our income tax rate is over 15% any dividends or capital gains we get are taxed at a plenty high rate as well. Not complaining though - after pulling out the premiums for Medicare and drug costs our government still sees fit to deposit $313.20 in my checking account every month! Quite glad I don't have to live on that amount.

 

[jim584672]

I originally was going to delay my pension and SS to have longevity insurance, now I am thinking take them earlier since lower for longer is less taxing. Hmmm...

 

[pb4uski]

We've discussed it before, but the 'break' on cap gains often isn't.

If I bought $1,000 of stock 20 years ago, and sold it for $1,100, I'd likely pay $15 tax on it.

If my neighbor bought $1,000 of stock 1.1 years ago, and sold it for $1,100, he'd likely pay $15 tax on it.

n that case, I don't feel like I got a break - my investment lost money to inflation, yet I have to pay the same tax that someone else did who made the money 20x quicker? I should at least be able to take a credit (even if only against other gains) for the loss!

Adjusting gains to inflation would account for this, and is easy with computers.

-ERD50

It's never going to happen so I hope you get over it quickly.

 

[pb4uski]

Generally this is thought of similarly but the 40% is replaced by 30% and the 2nd 25% is replaced by 15%. The stacked bar chart way of thinking about this places ordinary income at the bottom and QDIV/LTCG on the top. Increased ordinary income in the 15% bracket displaces QDIV/LTCG into the 25% bracket. The ordinary income is taxed at 15% and the QDIV/LTCG at 15% for a total marginal increase of 30%.

Yes, that is my experience as well... 30%, not 40%. But with Roth conversions it is simple to recharacterize any excess to avoid the 30%.

 

[kaneohe]

Yes, that is my experience as well... 30%, not 40%. But with Roth conversions it is simple to recharacterize any excess to avoid the 30%.

It may also be useful to take a more global view. The 30% marginal rate could be of limited extent depending on your other income. Eventually it may go back to 25% once all the QDIV/LTCG has been pushed into the 25% tax bracket. Avoiding the limited extent 30% marginal rate could mean that eventually when RMDs start, they may be so large that you face even higher marginal rates due to AMT/NIIT. Paying taxes now is not appealing; paying even higher taxes later could be even worse. ymmv, of course.

 

[scrabbler1]

This thread and the portion of the thread about the ACA and the tax treatment of health insurance premiums have some opposite conclusions which may cancel each other out. In that thread, I and others complain about how those in employer-sponsored HI plans receive better tax treatment than those of us in the individual market. In this thread, others (and I agree with them) boast about how us early retirees receive better tax treatment from our investment income than those still working.


I prepare the tax forms of my ladyfriend and her income, all wages, is just about the same as my income, all investment income. We each earn about $42k but her income taxes due are at least twice mine at the federal level. (State income taxes due are about the same because our state, NY, taxes investment income and wage income alike.) She also pays FICA taxes, of course. But I pay the entire amount of my HI bill except for the small ACA subsidy and a small slice of the premium I am able to deduct on Schedule A (the amount over $4k which is 10% of my AGI). Her employer pays for most (75%, not sure) of her premiums while her share is paid with pretax dollars making it fully deductible even though she takes the standard deduction.


Given our very similar total incomes, it would be an interesting exercise to see if her (income tax + FICA tax + HI premiums) is more or less or about the same as mine. Have any of you ever done such an exercise?

 

[NW-Bound]

... In this thread, others (and I agree with them) boast about how us early retirees receive better tax treatment from our investment income than those still working...

In my case, my taxes climb back up when I deplete down my after-tax savings and start to tap tax-deferred accounts. My dividends and cap gains off the after-tax savings are not enough to live on, and I have been liquidating principal too.

Soon, the only advantage I have over workers is that my IRA and 401k withdrawals do not get FICA and Medicare tax.

 

[gerntz]

We've discussed it before, but the 'break' on cap gains often isn't.

If I bought $1,000 of stock 20 years ago, and sold it for $1,100, I'd likely pay $15 tax on it.

If my neighbor bought $1,000 of stock 1.1 years ago, and sold it for $1,100, he'd likely pay $15 tax on it.

n that case, I don't feel like I got a break - my investment lost money to inflation, yet I have to pay the same tax that someone else did who made the money 20x quicker? I should at least be able to take a credit (even if only against other gains) for the loss!

Adjusting gains to inflation would account for this, and is easy with computers.

-ERD50

Your outcome is part of making a lousy investment (I have too.). Had you realized it sooner, you'd have been further ahead.

 

[Gone4Good]

Given our very similar total incomes, it would be an interesting exercise to see if her (income tax + FICA tax + HI premiums) is more or less or about the same as mine. Have any of you ever done such an exercise?

If you already prepare her tax forms you have all the info you need to figure that out. All you need is her age and zip code to figure out how much she'd pay for a health insurance plan on the exchange.

And don't forget to factor in the ACA subsidies, too, which can be viewed as a negative tax.

It's important to note, though, that health insurance premiums for most retirees through Medicare are far lower than what young(er) people pay for exchange plans. So we're really talking more about age specific issues than wage and investment income issues.

And also there's still the option to get a High Deductible plan and contribute to an HSA. My HSA contributions for the past five years where higher than my insurance premiums, so I'm basically getting a bigger tax deduction for my health insurance than if I were a company.

Also, if you can manage to get some 1099 income, your health insurance premiums become deductible too.

 

[Senator]

My tax rate will likely exceed 20% of AGI. Much of my income ($70K) will be shielded by depreciation, so perhaps the effective rate is really lower. It is something I will have to recapture at 25% if I sell before I die.

The DGF will have a negative tax rate. She will get money back, even though she will not have to pay any in. Factor in virtually healthcare ($20 a month all inclusive, $0 deductible) , and it's a huge bonus.

This is really a great country.

 

[ERD50]

Originally Posted by ERD50
We've discussed it before, but the 'break' on cap gains often isn't.....

Adjusting gains to inflation would account for this, and is easy with computers.

-ERD50

It's never going to happen so I hope you get over it quickly.

I'm not expecting it to change, just pointing it out.

-ERD50