Author Topic: tax strategies  (Read 3333 times)


  • Walrus Stache
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tax strategies
« on: March 02, 2012, 04:05:07 PM »
I am by no means an accountant, so I'm looking for someone with more knowledge than me to shoot holes in the following plan.  This isn't about how much money to save, it's about how much money you can take from your savings while still minimizing tax liabilties.

If my math is right, then it looks like my effective tax rate in retirement will be near zero.  This suggests that most people on the path to early retirement should avoid a Roth IRA in favor of their tax-deferred accounts.

Here's why:
In early retirement, a married couple with no dependent children can claim the non-itemized standard deduction (12k) plus two personal exemptions of 3700 each for a total of 19k.  This means they can withdraw at least 19,000/year from their 401k or other tax-deferred savings plan without paying any tax at all, assuming they have no other source of taxable income.  Having kids at home raises this amount.
The 10% tax bracket for married couples then extends up to 17k of after tax income, meaning they could withdraw an additional 17k annually from the 401k while only paying 1700 in tax.
This means they can withdraw a total of 19k+17k= 36k/year in income from their 401k while only paying 1700 in taxes, for a net tax rate of only 4.8%.
If they also have taxable investment accounts  from which they can draw 20k/year, half from contributions and half from earnings taxed at the long term capital gains rate of 15%, then they will only pay (15% of 10k=) 1500 in tax on this additoinal 20k.  Yes, I know the cost basis accounting method may complicate this picture, but assuming averages makes the math easy.
This would provide a gross income of 20k+36k = $56,000 per year at an effective tax rate of (1500+1700)/56000 = 5.7%.  Net pocket money, $52,800 for groceries and bills and property taxes, assuming they've done in their mortgage.
If that isn't enough for them to support themselves, they can then withdraw from their Roth IRA completely tax free.  Principal can be withdrawn penalty and tax free, regardless of age, so their income could climb above 56k/yr without incurring any additional tax liability.
I realize that there are complications associated with withdrawing 36k/year from a 401k before age 59.5, but I think these are surmountable obstacles with 72(t) withdrawals and/or Roth IRA rollovers.  The tax rates, though, just seem unbelievably low to me, so I suspect I may be missing something here that a more knowledgeable forum participant will be able to point out for me.
Does a married couple really only pay 5.7% effective tax on up to 56k of income?
If that's the case, then putting money into the Roth IRA seems like a pretty weak deal when I have to pay a much higher effective rate right now in order to do it, and this makes 401k style plans look a LOT more attractive.  I can see a Roth benefit for anyone who's already maxing out their tax-deferred accounts, but that's not the usually-recommended order of savings.  This suggests to me that people on the early-retirement path should avoid the Roth IRA in favor of their tax-deferred accounts like the 401k.
« Last Edit: March 03, 2012, 08:01:21 AM by sol »


  • 5 O'Clock Shadow
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Re: tax strategies
« Reply #1 on: March 03, 2012, 06:06:11 PM »
You're quite right that careful planning about where your income comes from will have dramatically different tax consequences. This is thanks to high voter turnout by the elderly, and Wall St influencing the tax code.

Some notes:

  • The 10% tax bracket is part of the Bush tax cuts. If that expires, it will return to 15%
  • Similarly -- and you've probably already considered this -- tax law will change in the future. I don't think it's far-fetched to expect social security or medicare tax to be added to 401k disbursements in the future.
  • The tax rate could potentially be even lower, depending on the allocation of their investments. Consider that municipal bond interest is tax-free.