The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: J on January 12, 2014, 09:29:38 PM
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(Please note: this is not a political post, nor do I want this to become a political thread about taxes and the uses thereof. I'd like to keep this entirely a financial discussion about the numbers, please.)
In thinking about Mustachianism and early retirement, I'm a big fan of reducing or eliminating entire classes of expenses and regular bills permanently: avoiding loans, having a paid-off house, generating electricity, self-insuring for all but the most catastrophic disasters, etc. I'm a big fan of paying up front to eliminate a bill permanently, even if the payoff would take a long time; let's call it a disproportionately high value placed on not receiving and paying bills every month/year.
I realized that taxes are some of the most difficult regular expenses to reduce or eliminate, as well as those I'd place the highest value on reducing or eliminating. I'd like to give some thought to the scenario of making changes to reduce those expenses, even if those changes were outside my normal comfort zone.
(I'd be willing to hear about non-US countries as well, though the vast majority of countries with similar standards of living have far higher tax rates. However, if you happen to know of countries with particularly Mustachian-friendly low taxes, particularly capital gains taxes, I'd be interested to hear about them.)
With that in mind, the four major classes of taxes that seem most likely to affect Mustachians are federal/state income taxes, federal/state capital gains taxes, state sales taxes, and property taxes. (I'm leaving out gas taxes and other consumption-based taxes, since they're proportional to consumption, and likely to be a very small fraction of a Mustachian's tax burden.)
First of all, it seems like the pre-retirement and post-retirement scenarios will differ drastically here. Pre-retirement, it almost certainly makes more sense to live in a state with a sales tax rather than an income tax, since that tax will be proportional to consumption rather than income, and a Mustachian will have far more income than expenses. Post-retirement, income will come entirely from capital gains, and can be tuned to match expenses, so sales tax and capital gains tax will matter much more.
At the federal level, there's no sales tax or property tax to worry about. Income tax is an issue pre-retirement, but mostly an unavoidable one (apart from the various well-known advice here regarding tax-deferred retirement accounts, which can only protect a very limited amount of income and are not necessarily friendly to early retirement). It seems like the best approach here is to find the highest-paying job you can get and retire early.
Federal capital gains tax is a rather interesting case. We can safely assume that any investment used for retirement will fall under long-term capital gains, having been held for more than a year. The long-term capital gains rate for income in the lowest two tax brackets (10% and 15%) is zero, and that currently applies to incomes less than $36,250 for single folks and $72,500 for married folks. As the most recent post on the MMM family's expenses show, it's quite possible for an entire family to live on $25k, and it's safe to say a single person could live on less than that. Since capital gains income after retirement can mostly be directly tuned to match expenses, it should theoretically be possible to avoid any federal taxes after retirement.
State capital gains taxes vary quite a bit, but are generally far less friendly than federal. Many states have little to no distinction between short-term and long-term capital gains, and many simply tax it as income. Furthermore, many states do not have a minimum threshold on capital gains equivalent to the federal 0% bracket. There are a few states which appear to have no capital gains tax at all, but I've found little to no information on the tax brackets of states that do have them, and in particular if there are any states which have capital gains taxes in general but have a 0% bracket at the bottom.
Finally, state property taxes. These can vary wildly by locality, not just by state. A very few states do have laws that allow, effectively, paying off the future property tax burden of your property in a lump sum, and not owing any future property taxes; that would be quite appealing, but it would do little good if those same states have substantial capital gains taxes or sales taxes, and I don't have up-to-date information on which states allow this. I also have little to no information about any other ways that would allow reducing or preferably eliminating property tax burdens; details welcome.
So, to summarize, it seems like the best strategy would be:
- While working towards retirement, live and work in a state with minimal income taxes (bearing in mind cost of living and other expenses)
- Retire to a state with no sales taxes and either no capital gains taxes or a 0% bracket for capital gains below a threshold.
I'd welcome any additional thoughts or information that would either help identify the most ideal states based on the strategy above, or provide details that might change that strategy.
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At mustachian levels, most state taxes are slim to nil. In fact, I'd choose a state with low property tax over one with no income tax.
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Though state taxes do indeed factor into things, I feel it is completely overwhelmed by other factors such as earning power(Living in California is expensive, living in California can also drastically increase your earning power as well depending on your occupation) and climate(Sure, Nevada doesn't have state income taxes... and Alaska would pay you to live there... but I disagree with the climate/activities).
This is discounting some choices such as New Jersey vs. surrounding area, where New Jersey is a pretty tax-heavy state compared to some other nearby states from what I've heard.
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At mustachian levels, most state taxes are slim to nil. In fact, I'd choose a state with low property tax over one with no income tax.
I would as well, primarily because I don't anticipate income tax mattering after retirement. Do you have any particular details on states with low or high property taxes? (Keeping in mind that property taxes more than any others frequently vary by city and county, not just state.)
Though state taxes do indeed factor into things, I feel it is completely overwhelmed by other factors such as earning power(Living in California is expensive, living in California can also drastically increase your earning power as well depending on your occupation) and climate(Sure, Nevada doesn't have state income taxes... and Alaska would pay you to live there... but I disagree with the climate/activities).
This is discounting some choices such as New Jersey vs. surrounding area, where New Jersey is a pretty tax-heavy state compared to some other nearby states from what I've heard.
Earning power only applies pre-retirement, where I'd certainly agree that you have a lot less flexibility in location; it's still worth considering location, but I'm much more concerned about post-retirement. Post-retirement, living expenses matter but job availability and earning power don't. And in any case, living expenses are something already covered in many other places; I was particularly hoping to evaluate various state tax regimes independently. It's certainly only one of several factors to consider, but it's the one I'm trying to consider in this thread.
(As an aside, California's expensiveness and its earning power are not higher than the rest of the country in the same proportion; last time I evaluated it, the additional expenses far outstripped the additional income.)
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Assuming retired Californian couple, with a median-value $400K home, $50K/yr taxable income, and $20K/yr sales taxable purchases:
$5,000 property taxes
$1,000 California income taxes
$1,800 California sales taxes
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$7,800 total
Assuming retired Texan couple, with a median-value $250K home, $50K/yr taxable income, and $20K/yr sales taxable purchases:
$6,125 property taxes
$1,600 Texas sales taxes
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$7,725 total
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We're retired; have been retired for 6 years now. There are a LOT of factors involved in deciding where to live. There is no way I'd live far from my family - my children and grandchildren are too important to me.
You can live in a state with low taxes and few services, since that is what taxes pay for. We live in a state with no income tax but a high sales tax. So be it. I live here because my family is here and I like the climate. Sure, I could live in Texas for a fraction of what it costs here, but I'd rather be stabbed in the eye with an icepick than live there.
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(As an aside, California's expensiveness and its earning power are not higher than the rest of the country in the same proportion; last time I evaluated it, the additional expenses far outstripped the additional income.)
I think that depends on what type of employment you're talking about. I wouldn't be surprised if that's right for jobs that are roughly interchangeable all around the country. But there are certainly categories of jobs where the opportunities in some specific locations are of a different sort than their nominal equivalents elsewhere, and the pay gap is probably much greater for those.
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I've found that state taxes are only one part of the cost of living.
I think that pre-retirement, you need to find the highest income and lowest cost of living for your profession. I'm in finance and for me it meant Atlanta, Ga and I've been really happy with the results. The only issue here is if your company moves your office, a very short commute can turn hellish.
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Federal capital gains tax is a rather interesting case. We can safely assume that any investment used for retirement will fall under long-term capital gains, having been held for more than a year.
I know before writing this, you discounted the value of tax-sheltered retirement accounts as a likely proportion of a RE portfolio, and to the extent that's true, this won't be so relevant, but my understanding is that withdrawals from 401Ks are taxed as regular income, not capital gains. As many people aren't aware of this, it's worth mentioning ...
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One addendum to the Texas/California comparison -
In California we have something called Prop 13. Your property tax is capped - once you buy your home, it can only go up by a certain small percentage per year (1%?). So, if you buy a home in California and stay put, eventually your property taxes will shrink relative to inflation.
(This law was passed because so many elderly people were getting priced out of their paid-for homes by big increases in property taxes due to property bubbles).
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One addendum to the Texas/California comparison -
In California we have something called Prop 13. Your property tax is capped - once you buy your home, it can only go up by a certain small percentage per year (1%?). So, if you buy a home in California and stay put, eventually your property taxes will shrink relative to inflation.
(This law was passed because so many elderly people were getting priced out of their paid-for homes by big increases in property taxes due to property bubbles).
Another reason to like CA.
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Find one of those aforementioned states where property taxes vary wildly by location, then find a cheap location. My parents live in rural Ohio. Most property taxes go directly to the local schools and, for better or for worse, people in my hometown don't give a rats ass about education. On the bright side, my parents pay a cool $600/year in property taxes on their house which the county values around $80k.
Also, some states (PA and IL for sure) don't tax "retirement income". In IL, traditional to Roth conversions at any age fit that retirement. Its not the only state that does this. But, sales tax is high and property taxes in many places are as well, although they again vary by city and school district like Ohio.