Author Topic: Taxes in Early Retirement (GoCurryCracker Links)  (Read 13789 times)

arebelspy

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Taxes in Early Retirement (GoCurryCracker Links)
« on: June 29, 2015, 08:49:33 PM »
A common question when planning for ER is "What will my taxes look like?"

Well, if you've done it right, you can make your tax liability close to $0 in ER.

The blog GoCurryCracker has some great posts on taxes, which I've gathered here for your enjoyment/edification.

First, the concept/theory on how to "Never Pay Taxes Again":
http://www.gocurrycracker.com/never-pay-taxes-again/

Then the "7 minute taxes" on the exact steps to take to calculate what you need to do at the end of the calendar year:
http://www.gocurrycracker.com/7-minute-taxes/

There's information on the "Social Security Tax Torpedo" about how your social security can be taxed if you have other income, and ways to mitigate that:
http://www.gocurrycracker.com/social-security-tax-torpedo/

And finally, the proof is in the pudding.

They have posted their actual 1040 tax returns from 2013:
Quote
All together, our adjusted gross income was $91,752.  How much tax did we pay on such a high figure?  You guessed itÖ $0
http://www.gocurrycracker.com/the-go-curry-cracker-2013-taxes/

And 2014:
Quote
Oops, I did it again.  Another year of nearly $100k [Ed. Note: $95,644] in investment income, but with a very budget friendly income tax bill of $0
http://www.gocurrycracker.com/go-curry-cracker-2014-taxes/

EDIT: Some of GCC's other tax-related posts, per a suggestion:
Quote
Separately, I just realized that the "Roth Sucks" post isn't included in the Go Curry Cracker sticky, so I would also suggest adding it there:

http://www.gocurrycracker.com/roth-sucks/

...and maybe also his overview on the impact of utilizing tax-advantaged accounts:

http://www.gocurrycracker.com/turbocharge-savings/
« Last Edit: September 28, 2015, 09:43:20 AM by arebelspy »
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Jeremy

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #1 on: June 30, 2015, 08:38:47 AM »
I have a feeling I'm going to like this new category ;)

arebelspy

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #2 on: June 30, 2015, 09:06:00 AM »
I have a feeling I'm going to like this new category ;)



When you hit a lot of home runs like those blog posts, you can expect a lot of links to them--saves us the trouble of trying to be as clever and eloquent as you.
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Gone Fishing

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #3 on: June 30, 2015, 12:11:39 PM »
Good stuff, certainly worthy of a sticky!

EricP

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #4 on: July 07, 2015, 10:42:39 AM »
A few questions regarding these strategies.

1.  Are the gains on a Conversion Roth able to be withdrawn penalty free?

2.  How are Conversions taxed?  Marginal Rate?  IE: should I be doing only a certain amount every year?

My thinking is, sure I could set it up so I can pay no taxes, but is that really ideal, aren't you just frontloading your tax payments and potentially taking an overall hit?

A Conversion Ladder is something I see thrown around a lot, and that leads me to believe that Conversions are taxed at the marginal rate and that the gains are not able to be withdrawn penalty free, so I should be converting over money every year (to be used 5 years later) and paying taxes on it every year, instead of front loading my tax liability.

Is my thinking wrong?  How so? Help me out here.

arebelspy

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #5 on: July 07, 2015, 11:14:44 AM »
A few questions regarding these strategies.

1.  Are the gains on a Conversion Roth able to be withdrawn penalty free?

2.  How are Conversions taxed?  Marginal Rate?  IE: should I be doing only a certain amount every year?

My thinking is, sure I could set it up so I can pay no taxes, but is that really ideal, aren't you just frontloading your tax payments and potentially taking an overall hit?

A Conversion Ladder is something I see thrown around a lot, and that leads me to believe that Conversions are taxed at the marginal rate and that the gains are not able to be withdrawn penalty free, so I should be converting over money every year (to be used 5 years later) and paying taxes on it every year, instead of front loading my tax liability.

Is my thinking wrong?  How so? Help me out here.

1. Yes.  All money withdrawn from a Roth is tax free.  You pay taxes on money when you earn it, or when you take it out of a tax deferred account, like a 401k.  A Roth is not tax deferred, but the taxes are paid up front.

2. Yes.  So ideally you do the conversions in years that will result in no extra taxes (or any at all) being paid on them.

You are "frontloading" it in that you pay the taxes up front, but if you can do it after ER, when your taxes are zero, you'll never pay those taxes (you'll put it away tax deferred, roll it over and pay the taxes when your rate is 0, and then pull it out tax free from the Roth after the minimum 5 years has elapsed).

See this link for a more thorough explanation of the strategy:
http://jlcollinsnh.com/2013/12/05/stocks-part-xx-early-retirement-withdrawal-strategies-and-roth-conversion-ladders-from-a-mad-fientist/

And the links in the OP for how to do the step of "pay 0 taxes when you do the rollover".
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with a kid.
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MDM

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #6 on: July 07, 2015, 11:20:20 AM »
1.  Are the gains on a Conversion Roth able to be withdrawn penalty free?
Yes, subject to the age 59.5 restriction.  It's not quite that simple, but close enough for now....

Quote
2.  How are Conversions taxed?
As ordinary income.

Quote
Marginal Rate?
Depends how you define your income streams (see below)

Quote
IE: should I be doing only a certain amount every year?
Up to you.

Quote
My thinking is, sure I could set it up so I can pay no taxes, but is that really ideal, aren't you just frontloading your tax payments and potentially taking an overall hit?
Don't understand this question.  If you "pay no taxes" what tax payments are you "frontloading"?

Quote
A Conversion Ladder is something I see thrown around a lot, and that leads me to believe that Conversions are taxed at the marginal rate and that the gains are not able to be withdrawn penalty free, so I should be converting over money every year (to be used 5 years later) and paying taxes on it every year, instead of front loading my tax liability.
Conversions are taxed as ordinary income.  If you think of conversions as your "last" dollars of income, then yes they are taxed at your marginal rate.  If you think of conversions as your "first" dollars of income, then some of those dollars come tax free, some at 10% tax, some at 15%, etc.  In general it is best to think of optional income as your "last" dollars and thus analyze that option using your marginal rate.
« Last Edit: July 07, 2015, 11:23:23 AM by MDM »

AllieVaulter

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #7 on: July 07, 2015, 02:03:02 PM »
Thanks for collecting so many great links in one place!

EricP

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #8 on: July 08, 2015, 10:47:56 AM »
So, Conversions count as ordinary income.  So that gets you a standard deduction and a personal deduction, but still leaves you just shy of $20k.

The other $70k is coming from Long Term Capital Gains Space, Correct?  So in order to harvest that I need some taxable accounts, right?  Is there any other way to harvest that space then by having taxable accounts?  Taxable accounts which were funded using post tax dollars (IE frontloading taxes)?

MDM

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #9 on: July 08, 2015, 11:19:29 AM »
So, Conversions count as ordinary income.  So that gets you a standard deduction and a personal deduction, but still leaves you just shy of $20k.

The other $70k is coming from Long Term Capital Gains Space, Correct?  So in order to harvest that I need some taxable accounts, right?  Is there any other way to harvest that space then by having taxable accounts?  Taxable accounts which were funded using post tax dollars (IE frontloading taxes)?

Yes.  Note that the title of article is "Never Pay Taxes Again" - not "Never Pay Taxes Ever".

EricP

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #10 on: July 08, 2015, 12:01:47 PM »
So, Conversions count as ordinary income.  So that gets you a standard deduction and a personal deduction, but still leaves you just shy of $20k.

The other $70k is coming from Long Term Capital Gains Space, Correct?  So in order to harvest that I need some taxable accounts, right?  Is there any other way to harvest that space then by having taxable accounts?  Taxable accounts which were funded using post tax dollars (IE frontloading taxes)?

Yes.  Note that the title of article is "Never Pay Taxes Again" - not "Never Pay Taxes Ever".

Okay, so that's my point.  Do we really want to never pay taxes again?  Is that ideal?  Because this quote is in the top comment in a stickied forum

Quote
A common question when planning for ER is "What will my taxes look like?"

Well, if you've done it right, you can make your tax liability close to $0 in ER.

Is that even true?  Because if we're having to stick a significant portion of our money into taxable accounts that will be subject to income taxes on the source money and then taxes on the growth along the way, I find it hard to believe that is ideal.  It seems like an emotional decision of "never having to pay taxes again" is driving this and not a dollars and cents decision that this is best.

I understand that a lot of times people will have taxable accounts anyways because $23k is not enough, but if you're not even using up your tax sheltered space, why move into taxable accounts and front load your tax expenditures, when you could just put it in a Traditional and roll it over later.


arebelspy

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #11 on: July 08, 2015, 12:23:37 PM »
You are arguing against something no one has stated.  Yes, pretty much everyone agrees you should max out tax sheltered accounts before taxable accounts.
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EricP

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #12 on: July 08, 2015, 02:02:07 PM »
You are arguing against something no one has stated.  Yes, pretty much everyone agrees you should max out tax sheltered accounts before taxable accounts.

That's not what someone casually browsing through would be lead to believe.  Your opening comment makes it seem as though aiming for no taxes is the right thing to do. You even go as far as to state that if you've done it right, you'll hardly pay any taxes.  But that's hardly the case.  It's really just luck whether you are going to be paying taxes in retirement or not.  No one should be setting themselves up to pay no taxes in retirement, but if that happens, good for them.

That's my issue.  It's a misleading thread.  Sure, you haven't directly stated that one should put money in taxable accounts before tax-sheltered accounts, but for someone who doesn't know much that may seem to be the case.  And that's the type of people who are going to be reading these stickies. 

Bottom Line:  Making your taxes zero in retirement is not/should not be a goal and the amount of taxes you pay is irrelevant to whether you have "done it right."

Cheddar Stacker

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #13 on: July 08, 2015, 02:25:03 PM »
It's a misleading thread.....Making your taxes zero in retirement is not/should not be a goal and the amount of taxes you pay is irrelevant to whether you have "done it right."

I disagree completely on all your points....respectfully.

No one is arguing you should pay more taxes now. You don't have to pay any more now with this strategy, or any more later with this strategy; this is a way to pay the least amount over the course of your lifetime by spreading the taxable income out.

You are deferring as much as possible now via 401K/T.IRA/HSA/Other. If you are in a position to still have savings leftover, why shouldn't you put it into a taxable account, or real estate, or some other income producing asset? The alternative would be to have it sit idle in cash so it doesn't kick off any income. That would avoid paying taxes now as well, but it's hardly ideal.

You are not required to "fill up" the 15% bracket as GCC does, and as your reply #8 seems to imply. You can do this however you want. Just know you have a certain amount of tax free space due to the exemptions/deductions that are automatic. You have potential for additional tax free space if you have qualified investment income and stay in the 15% bracket. If your ladder needs 5 years to season, or you require more cash than the $20K of tax free space you might have, the money you spend can come from many sources. Cash reserves, rental real estate cash flow that may or may not produce taxable income, a HELOC, selling investments in a taxable account, bank interest, dividends, etc.

I don't plan to pay $0 tax in retirement since I will likely have a) a large IRA conversion to implement before RMDs kick in (I'll have 25-30 years) and b) some taxable income from part time work and business ventures supplementing my investment income. I would prefer to just pay 5% tax my entire life, and I think once I have more ability to control my taxable income I'll do just that. But I'm still doing everything in my power right now to reduce the taxable income currently residing in my 30-40% marginal rates.
Indecision may or may not be my problem.

sirdoug007

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #14 on: July 08, 2015, 03:23:21 PM »
I had no idea that wash sale rules didn't apply to profits.

That is great!  Cool deal that you can upgrade the cost basis in the 15% bracket with no tax! 

EricP

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #15 on: July 08, 2015, 03:41:51 PM »
It's a misleading thread.....Making your taxes zero in retirement is not/should not be a goal and the amount of taxes you pay is irrelevant to whether you have "done it right."

I disagree completely on all your points....respectfully.

No one is arguing you should pay more taxes now. You don't have to pay any more now with this strategy, or any more later with this strategy; this is a way to pay the least amount over the course of your lifetime by spreading the taxable income out.

You didn't actually disagree with anything I said.  I never said don't invest money in taxable accounts.  I never said don't use tax advantaged space in retirement.  All I'm saying is that paying no taxes in retirement requires a unique set of circumstances that many do not have.  This thread isn't "Take advantage of tax-advantaged space in retirement" it's "If you're doing it right you shouldn't pay taxes in retirement."

But the thing is, which everyone seems to be failing to miss is having the ability to not pay taxes in retirement is only a result of having the right set of circumstances.  Someone who isn't saving enough to need to use taxable accounts will pay taxes in retirement (unless they are spending less than the standard deduction plus personal exemption(s)) and that's the better scenario than setting it up so you pay no taxes in retirement.  But would the first paragraph lead someone to believe that?  No, absolutely not it would lead them to believe they are making mistakes and that's what I'm railing against.  Sure, you don't think that, but that's because you understand it very well, but someone who doesn't is going to get confused by seeing this thread because it definitely leads someone to believe that they should fill up taxable accounts so they can use the 0% Long Term Capital Gains.


starlight

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #16 on: July 10, 2015, 09:12:01 AM »

I'm trying to understand the "GoCurryCracker" methods explained in the above links.  Do these long term capital gains and qualified dividends have to come from a separate brokerage account or can one "harvest" long term capital gains and qualified dividends from a 401K or Roth IRA? 

I'm trying to figure out what our tax bill might look like in "retirement" ~13 years from now.  I have gone to the Turbo Tax TaxCaster, but do not know whether to count money drawn from a 401K or Roth IRA as income or possibly LTCG or QD?

Would the same apply to tax loss harvesting? 





 


Cheddar Stacker

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #17 on: July 10, 2015, 09:19:52 AM »

I'm trying to understand the "GoCurryCracker" methods explained in the above links.  Do these long term capital gains and qualified dividends have to come from a separate brokerage account or can one "harvest" long term capital gains and qualified dividends from a 401K or Roth IRA? 

I'm trying to figure out what our tax bill might look like in "retirement" ~13 years from now.  I have gone to the Turbo Tax TaxCaster, but do not know whether to count money drawn from a 401K or Roth IRA as income or possibly LTCG or QD?

Would the same apply to tax loss harvesting?

It's all income, but there are different types.

L/T Capital Gains and Qualified dividends stand on their own as Qualified investment income taxed at either 0%/15%/20%/23.8%. In order to have this type of income, you need to invest in a taxable (after-tax) investment vehicle, sometimes called a brokerage account. This is not a 401K or IRA. Totally separate.

Drawing down your Traditional 401K/IRA accounts creates ordinary taxable income. It will be included in AGI and taxable income, and taxed according to the graduated tax tables for ordinary income at either 10%/15%/25%/28%....

Tax loss harvesting is only a viable option in your taxable brokerage account. It can reduce ordinary income up to $3,000/year.
Indecision may or may not be my problem.

starlight

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #18 on: July 10, 2015, 09:54:12 AM »
Thank you Cheddar Stacker,

"L/T Capital Gains and Qualified dividends stand on their own as Qualified investment income taxed at either 0%/15%/20%/23.8%. In order to have this type of income, you need to invest in a taxable (after-tax) investment vehicle, sometimes called a brokerage account. This is not a 401K or IRA. Totally separate."


This clarifies and simplifies matter quite a bit.  But, my DW and I each have a Roth IRA, which are funded after tax.  Will LTCG and tax loss harvesting work in those accounts? 


MDM

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #19 on: July 10, 2015, 10:15:26 AM »
DW and I each have a Roth IRA, which are funded after tax.  Will LTCG and tax loss harvesting work in those accounts?

No.  I can see why you might want to use tax loss harvesting there, but given a Roth's tax free withdrawal why would you want to apply LTCG tax?

dandarc

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #20 on: July 10, 2015, 10:30:24 AM »
I had no idea that wash sale rules didn't apply to profits.

That is great!  Cool deal that you can upgrade the cost basis in the 15% bracket with no tax!
Yeah it is pretty cool.  However, with the ACA, keep an eye on those subsidies too.  Before ACA, tax-gain harvesting was closer to a no-brainer.  But if you bump your income up high enough, you could lose many thousands of dollars in health insurance subsidies, so you know, tread carefully there.

We're far enough away to have not done any kind of thorough analysis on this aspect even for our own purposes, but I'm hoping by the time we FIRE (if we actually RE), there is a wealth of knowledge on how to figure this.  You know, assuming the rules are still similar enough to today.
Link to my journal, so I can find it quickly - http://forum.mrmoneymustache.com/journals/dandarc's-journal/

starlight

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #21 on: July 10, 2015, 11:57:31 AM »
DW and I each have a Roth IRA, which are funded after tax.  Will LTCG and tax loss harvesting work in those accounts?

No.  I can see why you might want to use tax loss harvesting there, but given a Roth's tax free withdrawal why would you want to apply LTCG tax?

Thanks MDM.  I am just trying to understand the strategies applied by the GoCurryCracker links.  I thought I might be able to apply it to my particular situation, having only 401K and Roth IRA accounts.  (I do plan on opening a brokerage account soon, so I'll have to dig more in to the details, to figure out the mechanics of this maneuver). 

It seems like Jeremy at GoCurryCracker has a good system in place for minimizing taxes, as I now understand it he must be using only funds from a brokerage account to harvest losses and LTCG, not a 401K. It looks like if he declares income as LTCG he will be taxed at zero rate if he stays in the %15 income bracket.   

Using the turbotax taxcaster with 50K income in retirement from 401K, without any other deductions, out federal taxes today would be $3,491, so not too terrible. 


Indexmantra

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #22 on: September 28, 2015, 02:23:47 PM »
I have a feeling I'm going to like this new category ;)

I love your site. I have read all of your articles. You are my hero Jeremy!

MDM

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #23 on: December 04, 2016, 02:45:40 AM »
EDIT: Some of GCC's other tax-related posts, per a suggestion:
Quote
Separately, I just realized that the "Roth Sucks" post isn't included in the Go Curry Cracker sticky, so I would also suggest adding it there:
http://www.gocurrycracker.com/roth-sucks/
It's worth noting that, while much (all?) of the remaining advice is good, GCC is incorrect when advising people how to evaluate the tax effects of traditional vs. Roth.  Bogleheads, Michael Kitces, and The Mad Fientist clearly get it right.  Comments from The White Coat Investor (TWCI) and The Finance Buff (TFB) are less clear, but TWI seems to err the same way as GCC, while TFB gets it right.

Everyone agrees that the tax cost of a Roth contribution is the marginal savings rate one could have had by using a traditional contribution.

The issue is whether one should use a marginal or an effective rate on withdrawals to calculate the tax cost of a traditional contribution.  The discussion can get heated at times.  For example, see this almost nine year old thread: Roth vs Traditional 401K - Bogleheads.org.

Although at first glance the use of one's effective (aka overall) withdrawal tax rate might seem correct, it is in fact the marginal rate calculated by dividing the amount of additional taxes that will be due (or reduced) by the amount of income involved that should be used.

References:
Bogleheads
The main reason to prefer one type of account over the other is the comparison of marginal tax rates

Michael Kitces
the dominating factor that most drives the outcome is a comparison of an individualís current versus future marginal tax rates

The Finance Buff
Let t0 be the marginal tax rate now, and t1 be the marginal tax rate at retirement time.
Until you know you can generate from your Traditional 401(k) enough income to fill the lower brackets...

The Mad Fientist
it canít really be thought of as trading a marginal rate for an average one

The White Coat Investor
Marginal Tax Rate At Contribution Vs Marginal Tax Rate At Withdrawal

Jeremy

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #24 on: December 05, 2016, 02:18:44 AM »
I have a feeling I'm going to like this new category ;)

I love your site. I have read all of your articles. You are my hero Jeremy!

Sorry for the very late reply. Thanks Indexmantra!

EDIT: Some of GCC's other tax-related posts, per a suggestion:
Quote
Separately, I just realized that the "Roth Sucks" post isn't included in the Go Curry Cracker sticky, so I would also suggest adding it there:
http://www.gocurrycracker.com/roth-sucks/

It's worth noting that, while much (all?) of the remaining advice is good, GCC is incorrect when advising people how to evaluate the tax effects of traditional vs. Roth.  Bogleheads, Michael Kitces, and The Mad Fientist clearly get it right.  Comments from The White Coat Investor (TWCI) and The Finance Buff (TFB) are less clear, but TWI seems to err the same way as GCC, while TFB gets it right.



It's been nearly 2 years and you are still pointing out that you don't like my Roth post, so let me applaud you for your persistence :)

We've had this conversation a few times, and it feels a bit like a stereotypical family Thanksgiving dinner:

A high school kid is really excited because in Science class he properly calculated how far they would launch an experimental canon ball.

When the Uncle everyone loves hears this story, he immediately points out how the high school kid should have used differential equations rather than linear algebra, failed to account for the curvature and rotation of the Earth, and didn't properly factor in wind speed, wind direction, and the density of the atmosphere.

It probably isn't his fault (he's probably an Engineer or something) but the result is that the high school kid is heart broken.


This same type of conversation happens in real life all the time.

People ask, "should I invest in a Traditional or Roth IRA?" Well meaning good samaritans immediately start talking about marginal tax rates, the different tax treatment of the two types of IRA, the RMD, potential inheritance factors, etc...  Notice the great availability of blog posts and Internet articles that say this very thing (thanks for summarizing them here.)

And 99% of those people (sub-optimally) throw their hands up and say, "Fuck it, I'll just invest in a Roth. At least I know I won't pay more tax and I can at least get my contribution back anytime if I want to buy a jet ski." (The 1% who don't say that frequent the MMM forums ;) )

The sad thing is, the high school student wasn't wrong. And neither am I.

For the target audience of my blog (median to high income earners who are happy to save a high percentage of income to retire early) they will have greater lifetime wealth (and minimize their lifetime taxes) by choosing Traditional over Roth. They will benefit greatly from the 0% and 10% marginal tax rates on withdrawals. They don't need to use differential equations or account for the curvature of the Earth. When they read my blog post, they make the right choice.

Now you might say, but they could do better! This is possibly true, for some very specific and limited circumstances.

There might be an optimal Roth/Traditional/Brokerage account split that results in maximum wealth and minimum taxes, but that requires predicting future investment return. Whoever figures that out will deservedly receive the Nobel Prize in Economics.

Until that time, I'm content with "clearly getting it wrong." But you are still welcome to come hang out at a GCC Thanksgiving.

All in good fun,

Jeremy

MDM

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #25 on: December 05, 2016, 12:05:29 PM »
Internet conversations can be difficult.  Yes, a discussion over a Thanksgiving dinner could probably resolve this in 5 minutes - ok, maybe 10. :)

I appreciate your desire to help people do the right thing.  Perhaps it's like Dave Ramsey getting people to invest by saying "you'll earn 12%."

Dave probably knows that 12% is unlikely, and you know that someone's marginal withdrawal rate will determine whether they made a good choice when contributing.

It's also true that the consequences of misguessing are worse if one is wrong when guessing to use Roth.  An incorrect choice of traditional means one has too much taxable retirement income - cry me a river.  An incorrect choice of Roth means one's retirement income is much lower than expected, and that can be a real problem.

Fortunately the math is simple.  No differential equations needed.  As posters such as KlangFool at Bogleheads like to remind people, it takes a large traditional balance to generate enough income at a 4% WR to reach even the 15% or 25% brackets - if that is the only income.
The tables below show the AGI and corresponding 25X traditional balance needed to reach the beginning of the bracket shown in the first column.
Bracket
AGI
25X Amount
Single
10.0%$10,350 $258,750
15.0%$19,625 $490,625
25.0%$48,000 $1,200,000
28.0%$101,500 $2,537,500
33.0%$200,500 $5,012,500
35.0%$423,700 $10,592,500
39.6%$425,400 $10,635,000
MFJ
10.0%$20,700 $517,500
15.0%$39,250 $981,250
25.0%$96,000 $2,400,000
28.0%$172,600 $4,315,000
33.0%$252,150 $6,303,750
35.0%$434,050 $10,851,250
39.6%$487,650 $12,191,250

For those with pensions (and, although decreasing, that's still a sizeable fraction), those numbers would be lower by 25X the annual pension amount.  That leads to posts such as Most TSP Participants Should Switch To the Roth TSP, which seems good advice for people in that situation.

I think giving incorrect reasons to encourage what will be good for many does a disservice to all, whether it is those being "tricked" into doing the right thing or those who really should do something different if they knew the correct reasoning.  But that is a debatable point, and perhaps is more a style difference than anything else.


Jeremy

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #26 on: December 09, 2016, 09:10:11 AM »
Not incorrect. Not a trick.

MDM

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #27 on: December 09, 2016, 11:29:19 AM »
Not incorrect. Not a trick.
I guess you'll have to explain the assumptions you are using, because the simple math supports the use of marginal withdrawal rates.

There is a similar current thread at Bogleheads that mentions the equivocal White Coat Investor post, so I'll just paraphrase the example from the linked post:

"A single person makes enough traditional contributions in previous years to give (with growth) a $1.2MM balance at retirement. Withdrawing 4%/yr would be $48K/yr, which after standard deduction and exemption, is $37,650/yr.  The tax on $37,650 is ~$5,184 or 10.8%. But, $37,650 is also the start of the 25% bracket, so any additional ordinary income will be taxed at 25%.

Now, for the new year, the person continues to work and again has a choice of traditional or Roth.  They can't go back and change what was done in previous years, but they can choose for the new year.

Assume in this new year she is in the 15% bracket. Using marginal vs. average the comparison would be 15% vs. 10.8% and the choice would be traditional. Using marginal vs. marginal the comparison would be 15% vs. 25% and the choice would be Roth.

Because an additional year's traditional contribution would cause (again, assuming a 4% WR) taxable income to increase above $37,650, the marginal rate applies and the new year's contribution should be Roth."

Are there assumptions you are using that differ from the ones in the example given above (or the wording from the Bogleheads link if you prefer)?  As stated, the math is simple: if a traditional contribution is made in the new year, the person will save 15% but will pay 25% tax on withdrawals due to that contribution.  Using marginal vs. average would give the wrong answer.  But if you have a different scenario in mind...?

Jeremy

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #28 on: December 09, 2016, 11:53:40 PM »
I guess you'll have to explain the assumptions you are using
Again?

Are there assumptions you are using that differ from the ones in the example given above

It isn't necessary to find other examples to compare to, I've provided two of them in the post that shall not be named that very clearly outline all of the assumptions. There are even graphs.

As I mentioned:
For the target audience of my blog (median to high income earners who are happy to save a high percentage of income to retire early) they will have greater lifetime wealth (and minimize their lifetime taxes) by choosing Traditional over Roth. They will benefit greatly from the 0% and 10% marginal tax rates on withdrawals.

Very clearly stated assumptions:
- living on 50% of after-tax income
- plan to continue to spend that amount in retirement
- retirement is early - have years to do Roth IRA conversions at 0/10% marginal rates - 0/10% is lower than working tax rate


For some reason, I think you want my post to be a generic one size fits all and covers every situation kind of post. That is not what it is. Perhaps you can write that post on your own blog.


Now, for the use of marginal vs effective tax rates... I show a clear example of a median income family withdrawing ~5x their annual spending from a Traditional 401k/IRA in one year. Why would they do this? Maybe to prove a point, I dunno. The effective tax rate for that year is 13.2%. (As compared to their effective 1.0% rate to cover their normal spending.)

Some of those dollars (the marginal dollars, if you will) are taxed at 25%. Yes, in this contrived and infinitesimally small probability example that nobody will every choose to do ("very specific and limited circumstance"), this particular family could have had lower lifetime taxes by contributing a small percentage of their portfolio to a Roth back in the day at a 15% marginal rate.

But their 13.2% effective tax rate is still lower than the 15% marginal rate they saved on the contribution. They are still ahead of the game by 1.8%.


Now, importantly, how much of a difference does this make in their life? Should they spend hours debating the merits of the different types of tax deferred accounts with strangers on the Internet? Should they agonize annually over their contribution amounts and ideal Roth/Traditional/Brokerage split?

With the small 15% marginal rate Roth contribution years earlier to replace the portion of this massive one-time withdrawal that is taxed at 25%, they instead have an effective tax rate of 10.8%. This is very clearly shown in the graph in my post.

Averaged over a 30 year retirement, with 29 years at a 1% effective tax rate and one year at 10.8% or 13.2%, the effective tax rate during retirement is a difference of 1.32% vs 1.40%.

This is what it means to be wrong. For a contrived example that will never happen. (I think efficient is a better word.)




MDM

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #29 on: December 10, 2016, 07:22:49 AM »
I guess you'll have to explain the assumptions you are using
As I mentioned:
For the target audience of my blog (median to high income earners who are happy to save a high percentage of income to retire early) they will have greater lifetime wealth (and minimize their lifetime taxes) by choosing Traditional over Roth. They will benefit greatly from the 0% and 10% marginal tax rates on withdrawals.
Very clearly stated assumptions:
- living on 50% of after-tax income
- plan to continue to spend that amount in retirement
- retirement is early - have years to do Roth IRA conversions at 0/10% marginal rates - 0/10% is lower than working tax rate
Thanks, the part above is where we are in "violent agreement." :) 

What I mean is that, for the situation you describe, people will be much better served by traditional than Roth - no disagreement whatsoever.  My apology if I wasn't clear about this.


Quote
Now, for the use of marginal vs effective tax rates...
This is the only issue where it seems there is a difference of opinion.  For situations such as the non-pensioned, high savings, low expenses early retiree you describe above, and for the ultra-high income person described by White Coat Investor, one can use either marginal or effective and get the same answer: traditional is better.  But what about different, very real and non-contrived situations?

For the general case, it is good to give people "the right tool for the job."  The right tool for evaluating withdrawal taxes is the marginal rate.  In this you are disagreeing not only with me, but also Bogleheads, Michael Kitces, The Finance Buff (TFB), etc., in the general literature, and well-respected contributors such as seattlecyclone here.

Or maybe we don't disagree?  Someone who looks a lot like you once said You need to compare current marginal rate vs expected future marginal rate to determine which is best.  I could certainly agree with that!

Your quote was in the context of someone having a good pension, and agrees with the logic in Most TSP Participants Should Switch To the Roth TSP.  But if one used the average tax rate on retirement income, it could appear traditional is better in this situation, when you and TFB agree it is not.

Quote
This is what it means to be wrong. For a contrived example that will never happen. (I think efficient is a better word.)
But it's not just contrived examples, is it?  It doesn't matter whether it is a pension, or previous traditional contributions, or anything else (e.g., as Spork notes, inheritance) that fills lower brackets.  Once those are filled, the results of any future traditional contributions are withdrawn at marginal rates.

We agree that when both marginal and average withdrawal tax rates give the same answer, it doesn't matter which one uses.

It really boils down to when the marginal withdrawal rate suggests Roth, but the average withdrawal rate suggests traditional, what should one do?  The simple math says Roth, so one should use marginal, and you agreed in the quoted comment.  But here it seems you disagree, so...?

Jeremy

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #30 on: December 10, 2016, 08:02:19 AM »
My interest in debating this further is much lower than my interest in doing anything else.

In all cases, the early retirees reading my post will pay less taxes by choosing Traditional.

Today I fixed a toy car using a spoon as a screwdriver. The right tool is the one that works.

MDM

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #31 on: December 10, 2016, 09:48:47 AM »
My interest in debating this further is much lower than my interest in doing anything else.
In all cases, the early retirees reading my post will pay less taxes by choosing Traditional.
Today I fixed a toy car using a spoon as a screwdriver. The right tool is the one that works.
No problem, people can read the thread and come to their own conclusions.

We probably haven't said much that wasn't said in this thread nine years ago: https://www.bogleheads.org/forum/viewtopic.php?p=172441#p172441.  It being the Christmas season, I'm happy to cast my lot with Redbeard and Greenberry:
Quote from: Greenberry
Quote from: mptfan
Greenberry, I think you misunderstood what I have said.  I have never said that it is ALWAYS better to contribute to a 401k than a Roth....
As I think I said, I agree with your conclusion that traditional 401k is usually better than Roth and it seems we are almost completely in agreement about that and other points.  However, the reasoning you use about effective tax rate to arrive there is mathematically incorrect.  The only thing my post above was addressing is that the PROCESS you use to arrive at that conclusion is just plain wrong.

Example:
Quote from: mptfan
Quote from: redbeard
It really is the marginal tax rate you need to consider in the future, not
the average one. At some point if you trade off enough from the IRA to the Roth, you will start to impact your future marginal tax rates. However, even then it is still the marginal tax rates you need to consider, not the new average tax rates.
redbeard, I understand your point, but it is wrong.
Redbeard is correct in his explanation, and with all due respect, mptfan, it is you who is not understanding the math.

arebelspy

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #32 on: December 10, 2016, 11:03:05 AM »
Today I fixed a toy car using a spoon as a screwdriver. The right tool is the one that works.


I really hope this analogy is true, and not just to prove a point; makes it so much better.  :D
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Jeremy

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #33 on: December 10, 2016, 12:15:43 PM »
Today I fixed a toy car using a spoon as a screwdriver. The right tool is the one that works.


I really hope this analogy is true, and not just to prove a point; makes it so much better.  :D

100% true :)

arebelspy

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #34 on: December 10, 2016, 12:28:00 PM »
Awesome.  Time to start marketing the Spoondriver! (Patent pending.)
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with a kid.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (occasionally) blog at AdventuringAlong.com.
You can also read my forum "Journal."

Jeremy

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #35 on: December 10, 2016, 07:57:08 PM »
Awesome.  Time to start marketing the Spoondriver! (Patent pending.)
Making money in retirement is just too easy

runewell

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Re: Taxes in Early Retirement (GoCurryCracker Links)
« Reply #36 on: January 25, 2017, 09:08:58 AM »
It's really just luck whether you are going to be paying taxes in retirement or not.  No one should be setting themselves up to pay no taxes in retirement, but if that happens, good for them.

Totally disagree.  There is nothing wrong with minimzing your tax bill using legal means.  Failure to do so is just a lack of planning and education on tax-related matters.  That doesn't mean that everyone's taxes should be zero, just that a lot of it is decisions within our control, like living on a budget.

The real luck is putting yourself in a situation that continues to work despite whatever changes Congress eventually makes.
« Last Edit: January 25, 2017, 09:11:08 AM by runewell »
Please leave Dicey out of this! Have you not been paying any attention? Trolls are not welcome here!