Author Topic: The Shockingly Simple Math Behind Early Retirement  (Read 1399 times)

apricity22

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The Shockingly Simple Math Behind Early Retirement
« on: August 07, 2017, 10:56:48 AM »
Hi All,

I found the MMM blog towards the beginning of this year (2017) and have been bouncing around to various articles as well as reading through them chronologically to make sure I don't miss anything (I'm only to about mid-2012 presently). Anyway, one article that has been on my mind is the "The Shockingly Simple Math Behind Early Retirement". I've included the url for this article and the url to another blog that discusses the same concept below.

My question regards how taxes during retirement are accounted for. To demonstrate I will use a simple example:

$100k take home pay (gross income minus taxes, as defined in the blog post)
$75k saved per year (75% savings rate)
$25k living expenses per year x 25 (4% SWR) = $625k
Saving $75k per year at an interest rate of 5% will yield $625k after 7 years just as the table in the article shows. However, when I start drawing $25k per year from my accounts to spend I will need to pay tax on that in the form of income tax and/or capital gains tax which does not appear to be accounted for in the calculations presented in these articles. What am I missing?

http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/
http://the-military-guide.com/2011/01/03/how-many-years-does-it-take-to-become-financially-independent-2/

kenaces

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #1 on: August 07, 2017, 11:08:05 AM »
The article is simplification to make the point that savings rate is THE KEY factor in reaching FI quickly imo.

A more details plan requires one to think about taxes and make tax-smart investment decisions.  As an example based on your numbers if one retires at 25K of income:
~ they will not be paying taxes on LT-gains and dividends
~ they may have some of their money in Roth IRA = no taxes on withdrawal
~ they may have some of their 625K in a paid off home
~ they may have other income from side hustle, SS.....
~ money in HSA that they can withdrawal from for medical cost tax free

2Birds1Stone

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #2 on: August 07, 2017, 11:24:41 AM »
As Kenaces pointed out, someone drawing 25K/yr from a portfolio will barely crack into the 15% tax bracket. Most of your withdrawals will be tax free or very low tax.

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Frankies Girl

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #3 on: August 07, 2017, 11:36:58 AM »
What they said. I'm already FIREd, and it works. Staying below the 15% bracket means zero cap gains/dividend tax. We take a bit more than $25K for yearly expenses, and we still pay zero tax.

I owe nothing. I've got one account I still have a tiny bit of federal tax withheld (as a cushion to my health insurance subsidy calculations through the ACA), but I get every single penny back at tax time.

We're lucky in that we live in a LCOL area, have a nice house with a low rate on a small mortgage and lots of fun stuff to do that costs very little if not free. We eat out lots, we buy nice food, we wear nice clothes and we have lots of nice things (actually too much as we're in the middle of a junk purge).
I frequently have no idea what I'm talking about. Like now.

FIREd as of: March 6th, 2015!

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MDM

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Re: The Shockingly Simple Math Behind Early Retirement
« Reply #4 on: August 07, 2017, 11:25:12 PM »
As Kenaces pointed out, someone drawing 25K/yr from a portfolio will barely crack into the 15% tax bracket. Most of your withdrawals will be tax free or very low tax.
+1

In round numbers, assuming $18K/yr goes into a 401k, $5500/yr into a Roth IRA, and $51,500/yr into a taxable account*, when the total stash reaches $625K there will be
$425K in taxable
$150K in traditional
$50K   in Roth

*Requires gross income ~$131,700 for a single person with no state tax and $25K/yr non-tax expenses.

Drawing proportionally from each of those (doable without penalty if one is 59.5 or older) to fund $25K spending the federal income tax is $0 because the amount coming from traditional accounts is less than 1 standard deduction and personal exemption.

Or, one could convert $10,400/yr from traditional to Roth for $0 tax and withdraw $25K from traditional, also for $0 tax even with a $0 basis, as long as all the gains are long term.

For those with annual spending higher than $25K, taxes will become an issue at some point, but for a one line equation the the simple math isn't too bad.