Author Topic: How can you be at a higher tax bracket in retirement?  (Read 21144 times)

econberkeley

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How can you be at a higher tax bracket in retirement?
« on: April 14, 2015, 11:29:31 AM »
I see lots of discussion about Roth vs traditional IRA and whether someone will be at a higher or lower tax bracket during retirement.     I just don't understand how someone can be at a higher tax bracket during retirement? When you retire, you stop working so there is no wage income. You may have social security or pension, but that would be lower than wage income. You may have much higher net worth in stocks, but you don't pay taxes until you sell the stocks. It is no brainer for me to put my money in traditional IRA since I wil definitely be in low tax bracket. I will not pay any income taxes until standard deduction+exemptions for wage income and until $72,000 in dividend and capital gains income. What am I missing?

Apples

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Re: How can you be at a higher tax bracket in retirement?
« Reply #1 on: April 14, 2015, 11:33:18 AM »
First, income from a Traditional IRA is taxed as ordinary income, not as investment income.  Capital gains and dividend income tax rates are for money taken out of a taxable investing account.

Other members of this forum will have much better answers than I do for the rest of your questions.

Gone Fishing

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Re: How can you be at a higher tax bracket in retirement?
« Reply #2 on: April 14, 2015, 11:40:18 AM »
Not too difficult to do if you work longer than you "need" and end up with a large TIRA/401(k), then proceed to live the high life in retirement with travel, gifts, etc.  Even if you don't spend it right away, the RMDs can throw you in a high bracket when you turn 70.   

James!

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Re: How can you be at a higher tax bracket in retirement?
« Reply #3 on: April 14, 2015, 11:43:01 AM »
I've been wondering the same question. For a mustachian planning on FIRE, when does it ever make sense to contribute to a ROTH? I understand the whole conversion ladder, but I'm talking base contributions.

Not too difficult to do if you work longer than you "need" and end up with a large TIRA/401(k), then proceed to live the high life in retirement with travel, gifts, etc.  Even if you don't spend it right away, the RMDs can throw you in a high bracket when you turn 70.

But this theoretical person presumably also had very high earnings pre-retirement if they were living that life style and contributing enough to have the high tIRA...

bacchi

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Re: How can you be at a higher tax bracket in retirement?
« Reply #4 on: April 14, 2015, 11:44:04 AM »
Inherit and get stuck with RMDs.

teen persuasion

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Re: How can you be at a higher tax bracket in retirement?
« Reply #5 on: April 14, 2015, 11:52:37 AM »
Personally, we will be going from claiming 7 exemptions (when the kids were young) to eventually only 2 for DH and me.  We will also be losing all the child related credits we've enjoyed for years: child tax credit x 5 + 33% state match, EITC +30% state match, college credits.  Once we quit earning income, all sorts of tax shelters/credits go away: contributions to retirement accounts, retirement savers credit, etc.

Then there is the issue of RMDs - if your tIRA balances are high enough, eventually the increasing percentage you are required to withdraw will reach taxable levels, and higher income can force higher taxes on SS.  Those SS thresholds aren't indexed for inflation, either.

greatrussian

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Re: How can you be at a higher tax bracket in retirement?
« Reply #6 on: April 14, 2015, 11:55:39 AM »
There is no guarantee income tax rates will remain the same. Historically, the rates paid today are low - so it may make sense to lock in those rates, should they go up.

Here's a website showing some of those historical rates:
http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=456

Gone Fishing

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Re: How can you be at a higher tax bracket in retirement?
« Reply #7 on: April 14, 2015, 11:59:37 AM »
I've been wondering the same question. For a mustachian planning on FIRE, when does it ever make sense to contribute to a ROTH? I understand the whole conversion ladder, but I'm talking base contributions.

Not too difficult to do if you work longer than you "need" and end up with a large TIRA/401(k), then proceed to live the high life in retirement with travel, gifts, etc.  Even if you don't spend it right away, the RMDs can throw you in a high bracket when you turn 70.

But this theoretical person presumably also had very high earnings pre-retirement if they were living that life style and contributing enough to have the high tIRA...

When to contribute to a ROTH:  When you have low/no taxable income or cannot deduct a tIRA contribution due to being over the income limit.  For example: It may make very good sense for a a couple with 2 children and $80k gross income to make ROTH contributions if they have already used their 401(k)s to reduce their taxable income to $0.

As far as our theoretical higher bracket retiree goes, it doesn't matter what their income was, just that they ended up with a tIRA/401(k) sufficient to give them a higher taxable income than what they had while they were working.  Not too difficult to do when you stack on a taxable pension and/or SS.  It wouldn't surprise me at all if my parents end up in a higher tax bracket in retirement vs working when their RMDs kick in.

Gone Fishing

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Re: How can you be at a higher tax bracket in retirement?
« Reply #8 on: April 14, 2015, 12:05:58 PM »
There is no guarantee income tax rates will remain the same. Historically, the rates paid today are low - so it may make sense to lock in those rates, should they go up.

Here's a website showing some of those historical rates:
http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?Docid=456

The risk that tax rates may go up is very real, especially for high earners.  However, for a MMM style retiree, their taxable income will likely fall into what most people consider to be a poverty level or close to it.  If we get to the point where we are taxing the "poor" at the 25%+ brackets many of the ER bound are in, we are going to have much bigger problems to worry about.

Drifterrider

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Re: How can you be at a higher tax bracket in retirement?
« Reply #9 on: April 14, 2015, 12:25:48 PM »
I see lots of discussion about Roth vs traditional IRA and whether someone will be at a higher or lower tax bracket during retirement.     I just don't understand how someone can be at a higher tax bracket during retirement? When you retire, you stop working so there is no wage income. You may have social security or pension, but that would be lower than wage income. You may have much higher net worth in stocks, but you don't pay taxes until you sell the stocks. It is no brainer for me to put my money in traditional IRA since I wil definitely be in low tax bracket. I will not pay any income taxes until standard deduction+exemptions for wage income and until $72,000 in dividend and capital gains income. What am I missing?

It depends.  Child care expenses?  gone.  Home mortgage expenses?  gone (maybe).  HSA?  I am working to have MORE income in retirement than I have now so I expect my taxes and tax rate to climb.  What counts for me is what is on the NET PAY line and not what are on the deductions line.

forummm

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Re: How can you be at a higher tax bracket in retirement?
« Reply #10 on: April 14, 2015, 01:34:51 PM »
Predicting tax rates is hard. And I unfortunately won't have the problem of inheriting a lot of money. For me, my marginal rate is at least as high as I would expect it to be in the future. And I give the weight towards having money in hand now that I can decide what to do with later instead of for sure giving a lot of it away now and not having any options later.

spokey doke

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Re: How can you be at a higher tax bracket in retirement?
« Reply #11 on: April 15, 2015, 07:44:19 AM »
It seems as if it would be a decent problem to have.

terran

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Re: How can you be at a higher tax bracket in retirement?
« Reply #12 on: April 15, 2015, 09:11:12 AM »
I think the "easiest" way would be if you're young and relatively low income now, and expect your income to go higher as you age and that you plan to live a lifestyle in retirement more similar to your future higher income self than your current lower income self while getting that money from a traditional 401k/IRA. A doctor currently in residency would be a good extreme example of this.

It's also possible tax rates will go higher for everyone in the future.

sirdoug007

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Re: How can you be at a higher tax bracket in retirement?
« Reply #13 on: April 15, 2015, 10:53:45 AM »
GoCurryCracker does a pretty good job of shooting down all of the above stated reasons for a Roth: http://www.gocurrycracker.com/roth-sucks/

The key is (the very often misunderstood) distinction between marginal and effective tax rates.   The charts in his post are the best explanation of this phenomenon I have seen.

If you have too much income because of RMDs 1) that is due to poor tax planning 2) this is not actually a problem as you will be swimming in money!

Middlesbrough

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Re: How can you be at a higher tax bracket in retirement?
« Reply #14 on: April 15, 2015, 11:09:10 AM »
Lower SWR on 401k means higher risk of higher taxes in the future.

Numbers Man

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Re: How can you be at a higher tax bracket in retirement?
« Reply #15 on: April 15, 2015, 12:22:09 PM »
GoCurryCracker does a pretty good job of shooting down all of the above stated reasons for a Roth: http://www.gocurrycracker.com/roth-sucks/

The key is (the very often misunderstood) distinction between marginal and effective tax rates.   The charts in his post are the best explanation of this phenomenon I have seen.

If you have too much income because of RMDs 1) that is due to poor tax planning 2) this is not actually a problem as you will be swimming in money!

I have to agree with GoCurryCracker. I remember LOLing when the Roth Conversion became a reality. Why would anyone want to pay a higher marginal tax rate on converting deferred funds into taxable funds. My income in retirement will be roughly 1/2 as much as my current wages. Most of the IRA & 401(k) money I invested would have been taxed between 25% and 33% federal. My retirement income will be taxed at 10% or less. It also helps to do proforma tax returns in advance of your retirement years to help you plan for your budget and taxes. I will also use non taxable lifetime gains from a house sale to bridge a few years before I start withdrawing from my deferred plans. For those who think tax rates might go up in the future. They might go up or might go down. I can only plan for today's reality. Also, it seems to me that with today's class warfare going on that higher earners might get taxed more in the future but lower earners (including retirees) might face lower brackets in the future. One just has to look at the subsidies for lower earners that purchase Obamacare to get a hint at where the government is heading on tax policy. Also, I have a friend in his mid eighties that must withdraw only about 5% for his RMD. He's a very savvy investor with a large portfolio. But my point being that even with the mandated RMD, it's not too much past the recommended 4% withdrawal rate.

Wolf359

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Re: How can you be at a higher tax bracket in retirement?
« Reply #16 on: April 15, 2015, 02:33:55 PM »
1. By Choice.  Let's say you plan to move from a lower tax state to a higher tax state in retirement.  If you move to a state with higher income taxes (to be near your kids, perhaps), your taxes will be higher.  Simply staying in a state that's having problems balancing its budget may subject you to higher taxes in the future.

2. Future taxes. The government raises taxes.  As stated before, you can't predict tax rates.  Do you predict political harmony, balanced budgets, reduced federal debts, and a booming economy?  Or do you think there's a chance that there may be continued political gridlock, deficit spending, and a slow economy with lower federal revenues.  Which scenario is more likely to result in increased taxes (eventually)?  Do you think they're going to resolve the Social Security shortfall with increased revenue (taxes), decreased benefits (lower payouts, taxing benefits, delaying retirement age), or a mixture of both?

3. Inflation.  With FIRE, you're by definition retiring early, so you have a longer retirement period.  Let's say that your investments successfully matches the inflation rate so you have exactly the same buying power.  Someone who in 1985 (30 years ago) retired with $40,000 in retirement income indexed to inflation has an $87,000 income today.  The government generally does not adjust tax rates to account for inflation.  If you plan on a long retirement, and you believe there will be inflation during that timeframe, then you will be in a higher tax bracket eventually.  You still have the buying power of a lower income, but 30-40 years later, you'll have the tax bracket of an inflated income.

4. RMDs.  It's been stated that if you're facing RMDs that raise your tax bracket, then you did poor tax planning.  That's a circular argument.  You're doing the tax planning because you might face RMDs.

5. Safety margin.  You may plan for a very conservative SWR to account for your longer retirement period.  If your worst-case scenarios don't come to pass, you may actually end up with a retirement income that exceeds your working income.  I'd like to have this "problem."

I read that GoCurryCracker post and I agree with much of it.  But his home residence doesn't have an income tax, and he's living mostly overseas in very low cost-of-living locales.  I'm not planning on doing that. I'm funding tax-deductible before Roth, but I'll still fund Roth if I can.  I'll also convert to Roth when I can, especially if I'm between jobs or maybe in early retirement.

TomTX

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Re: How can you be at a higher tax bracket in retirement?
« Reply #17 on: April 15, 2015, 02:45:27 PM »
My pension at 54 will take  us almost to the top of the 10% bracket after standard deduction and personal exemptions.  I will have 401k money to deal with. Once we draw SS at 70, RMDs would likely push us into the 25% bracket. May as well do Roth conversions @ 15% when I retire before taking SS. My parents failed to do this and are now into the 25% bracket,  when they could have done Roth conversion @ 15% by filling that bracket each year since retirement.

I know, I know ... Boglehead problems.

dsmexpat

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Re: How can you be at a higher tax bracket in retirement?
« Reply #18 on: April 15, 2015, 03:16:17 PM »
In 2014 my wife and I found ourselves in the -8% tax bracket (as in Uncle Sam gives us 8 cents extra for each dollar we earn) but unfortunately our credits were capped at 0% tax because they were non refundable. Fortunately we had maxed our ROTHs over traditional IRAs to pay as much tax as we could but it still wasn't enough. Most people on here seem to earn 6 figures but on low incomes shit gets weird and some tax can be good.

TomTX

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Re: How can you be at a higher tax bracket in retirement?
« Reply #19 on: April 15, 2015, 03:23:50 PM »
In 2014 my wife and I found ourselves in the -8% tax bracket (as in Uncle Sam gives us 8 cents extra for each dollar we earn) but unfortunately our credits were capped at 0% tax because they were non refundable. Fortunately we had maxed our ROTHs over traditional IRAs to pay as much tax as we could but it still wasn't enough. Most people on here seem to earn 6 figures but on low incomes shit gets weird and some tax can be good.
Excellent time to convert traditional to Roth and suck up the credit.

sirdoug007

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Re: How can you be at a higher tax bracket in retirement?
« Reply #20 on: April 15, 2015, 03:36:07 PM »
3. Inflation.  With FIRE, you're by definition retiring early, so you have a longer retirement period.  Let's say that your investments successfully matches the inflation rate so you have exactly the same buying power.  Someone who in 1985 (30 years ago) retired with $40,000 in retirement income indexed to inflation has an $87,000 income today.  The government generally does not adjust tax rates to account for inflation.  If you plan on a long retirement, and you believe there will be inflation during that timeframe, then you will be in a higher tax bracket eventually.  You still have the buying power of a lower income, but 30-40 years later, you'll have the tax bracket of an inflated income.

The IRS updates tax brackets annually to account for inflation so this isn't an issue.

beltim

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Re: How can you be at a higher tax bracket in retirement?
« Reply #21 on: April 15, 2015, 04:01:25 PM »
GoCurryCracker does a pretty good job of shooting down all of the above stated reasons for a Roth: http://www.gocurrycracker.com/roth-sucks/

The key is (the very often misunderstood) distinction between marginal and effective tax rates.   The charts in his post are the best explanation of this phenomenon I have seen.

That article is excellent, and I agree that the charts are a good visualization of marginal and effective tax reasons.  But gocurrycracker did not shoot down all of the reasons people have given in this thread.  In fact, he specifically says:
Quote
If you have an effective tax rate today of 0%, not uncommon for students and others in temporary low income situations, a Roth 401k or IRA is a great idea
and
Quote
It is also not a bad idea if you’ve already maxed out your Traditional 401k and have additional funds to invest.  When saving a high percentage of income, this SHOULD be the case.  Instead of putting an extra $5,500 into a brokerage account, you could put them in a Roth

And, as is usual, gocurrycracker neglected to take into account state taxes, which for capital gains and dividends are often larger than federal taxes for people on this message board. 

There are other reasons that one might prefer a Roth to a traditional account that tend not to apply to people on this forum.

dorothyc

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Re: How can you be at a higher tax bracket in retirement?
« Reply #22 on: April 15, 2015, 04:28:55 PM »
I've been wondering the same question. For a mustachian planning on FIRE, when does it ever make sense to contribute to a ROTH? I understand the whole conversion ladder, but I'm talking base contributions.

Not too difficult to do if you work longer than you "need" and end up with a large TIRA/401(k), then proceed to live the high life in retirement with travel, gifts, etc.  Even if you don't spend it right away, the RMDs can throw you in a high bracket when you turn 70.

But this theoretical person presumably also had very high earnings pre-retirement if they were living that life style and contributing enough to have the high tIRA...

I'm maxing out my 401K, and also putting money into a ROTH, as it means the growth is tax free, which an after tax account would not be. I can't deduct contributions to a Traditional IRA, as I am covered by a 401K plan at work.
Edited to add: I'm in California, which has high state income tax too.
« Last Edit: April 16, 2015, 07:56:19 AM by dorothyc »

brooklynguy

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Re: How can you be at a higher tax bracket in retirement?
« Reply #23 on: April 15, 2015, 05:48:41 PM »
That article is excellent, and I agree that the charts are a good visualization of marginal and effective tax reasons.  But gocurrycracker did not shoot down all of the reasons people have given in this thread. 

Yeah, for all the counterpoints and nuances, people should also make sure to read all the comments to the article and, if you're really interested, this thread (which Jeremy of GCC heavily participated in):

http://forum.mrmoneymustache.com/investor-alley/go-curry-cracker-roth-vs-taxable/

EDIT:  Actually this is the thread I was thinking of, but they're both good reads for anyone interested in reading more on this topic:

http://forum.mrmoneymustache.com/investor-alley/potentially-all-savings-into-401kafter-tax-but-how-much-into-taxable/
« Last Edit: April 15, 2015, 06:43:13 PM by brooklynguy »

econberkeley

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Re: How can you be at a higher tax bracket in retirement?
« Reply #24 on: April 16, 2015, 11:33:33 AM »
My head hurts :-)

beltim

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Re: How can you be at a higher tax bracket in retirement?
« Reply #25 on: April 16, 2015, 01:03:03 PM »
My head hurts :-)

Do you have any specific questions we can help answer to make things clearer?

Papa bear

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Re: How can you be at a higher tax bracket in retirement?
« Reply #26 on: April 16, 2015, 01:11:29 PM »
Simple, pensions + SS + 30 years of paying off double digit rental properties. (No depreciation or interest, etc), RMD of traditional retirement accounts, no dependents, etc

Will be KILLING my parents.  Including my father who retired at 33... 


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Wolf359

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Re: How can you be at a higher tax bracket in retirement?
« Reply #27 on: April 16, 2015, 01:39:04 PM »
3. Inflation.  With FIRE, you're by definition retiring early, so you have a longer retirement period.  Let's say that your investments successfully matches the inflation rate so you have exactly the same buying power.  Someone who in 1985 (30 years ago) retired with $40,000 in retirement income indexed to inflation has an $87,000 income today.  The government generally does not adjust tax rates to account for inflation.  If you plan on a long retirement, and you believe there will be inflation during that timeframe, then you will be in a higher tax bracket eventually.  You still have the buying power of a lower income, but 30-40 years later, you'll have the tax bracket of an inflated income.

The IRS updates tax brackets annually to account for inflation so this isn't an issue.

Of states with income tax, 23 fully index income tax for inflation, two (California and Oregon) partially index for inflation, and 18 states plus DC don't index at all (and are subject to bracket creep).  Related but also important -- not all states index deductions and credits for inflation.  The Federal Government does not automatically index the Alternate Minimum Tax for inflation.  I haven't run the numbers to see if a typical retirement income triggers AMTs.

Plus, the tax code still treats inflation as income, even if they raise the tax bracket.  For example, if you get a current I-Bond with a 0% fixed rate and a 1.5% inflation rate, you're taxed on the inflation, even though you didn't have any real returns.  Your real return after taxes is negative.

The original point is that inflation can contribute to putting you in a higher tax bracket in retirement.

Doulos

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Re: How can you be at a higher tax bracket in retirement?
« Reply #28 on: April 16, 2015, 02:05:23 PM »
If you had a high edge condition type income.  by that I mean, you (and spouse) are at the very top end of the 15% bracket after you deduct your 401k, HSA, and take your 12k deduction for married fileing jointly.

~128k gross income.
- 18k x2 401k.
- 6650 HSA (~7k)
- 12k standard deductable
= 73k = 15% bracket top

Taxable net.
~128k
- 18 x2 401k
- 7k HSA
= 85k

Take home pay (missing state tax) Assuming you live in one of the 7 states with no tax while working; Texas for example.
x .85 (15% tax)
= ~$72k
https://turbotax.intuit.com/tax-tools/tax-tips/Taxes-101/States-with-the-Highest-and-Lowest-Taxes/INF23232.html

If you live off of a reasonable $30k yearly budget to save for FIRE.
Savings figures.
$72k - 30k = 42k
+ 18k x2 401k
+ 7k HSA
= $85k total saved+invested per year.

Say you work for longer than usual to achieve a very low SWR of 2%. 
$30k / 0.02 = $1.5M.  - Large, 'safe' total for FIRE.

Assuming a reasonable 6% returns after inflation, in today's dollars.  Starting at $0 saving that $85k per year above.
http://www.moneychimp.com/calculator/compound_interest_calculator.htm
13 years gets you $1,676,090.66

So you have $1.68M and retire.
Years later at 70...
So say this started at age 20 for the couple. and they still get that 6% while living off that 30k for 37 years. (today's dollars, you would adjust for inflation)
(age 20+13 = 33, taking SS at 70, 70-33 = 37 years)
Unfortunately the calculators hate a negative number here.  The estimates I get say you end up with roughly $8M.

So, at 70 years old, with $8M in today's dollars.  38% of your investments are in taxable and 55% of your investments are forcing you to take 5% out (mentioned above at RMD)
- not 100% sure how RMD works.  Taking that 5% at 70 for this math.
38% of 8M is ~3M.
6% growth of 3M fully Taxable = $182k
55% of 8M is ~4.4M
5% RMD of 4.4M = $220k
$182k+$220k = $402k annual income. (in todays dollars)

$400k is the 33% bracket, barely, if you make even a little more you are 35% or 39.6%.
You could split that really.
The $220k is treated at income.  So that puts you in the 28% bracket.
The $182k is variable and capital gains.  This would be in the 15% bracket.

You could probably stall on the capital gains, or try some kind of loss harvesting plan.  But that tax is going to catch up with you eventually.

Anyway.  You and your spouse would be in an awesome financial position and definitely a higher tax bracket.

act0fgod

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Re: How can you be at a higher tax bracket in retirement?
« Reply #29 on: April 19, 2015, 05:31:41 AM »
I think the "easiest" way would be if you're young and relatively low income now, and expect your income to go higher as you age and that you plan to live a lifestyle in retirement more similar to your future higher income self than your current lower income self while getting that money from a traditional 401k/IRA. A doctor currently in residency would be a good extreme example of this.

It's also possible tax rates will go higher for everyone in the future.

This is the scenario for my wife and I.  I'm also a health professional.  Trying to figure out when our retirement income will be less than our current income is tough to predict.  In retirement we expect to have significant investments and a pension that is greater than 50% of base pay at the time we retire, which will be much higher than our current base pay.  Last year was likely the first year where we earned more than we will in retirement.  This year we will have a lower taxable income because a large portion will be tax free due to military deployments.

fartface

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Re: How can you be at a higher tax bracket in retirement?
« Reply #30 on: April 19, 2015, 07:55:36 AM »
GoCurryCracker does a pretty good job of shooting down all of the above stated reasons for a Roth: http://www.gocurrycracker.com/roth-sucks/

The key is (the very often misunderstood) distinction between marginal and effective tax rates.   The charts in his post are the best explanation of this phenomenon I have seen.

If you have too much income because of RMDs 1) that is due to poor tax planning 2) this is not actually a problem as you will be swimming in money!

THIS is very good IF you're in a similar situation as GoCurry. He FIRE'd at an unusually early age -- I think early 30's?

Each mustachian has different circumstances. I'll give myself as an example. I've got a tentative target FIRE date of age 48. Maybe even 50. VERY OLD by mustache standards.  I'll also be eligible for a pension at age 55. Even if I FIRE @ 48 that only gives me 7 years to convert about 20K/year from my tIRA to Roth. With my current stash, I'd need 20+ years (like GoCurry's got) to fully convert it all.

Currently, DH and I max out our Roths each year PLUS I contribute $1450/month to my 403b and another $400 into my pension.

So..you've got to look at your FIRE age & other circumstances. Late 40's? Pension eligible?

Also, consider your current tax bracket.

We're currently in the 15% bracket and that's why we do this "hybrid" approach.  We tax shelter a great deal to stay in the lower bracket but also hedge with 11K/year in Roth contributions. Not sure if what I"m doing is perfect, but it's the best strategy I can come up with presently.

Roland of Gilead

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Re: How can you be at a higher tax bracket in retirement?
« Reply #31 on: April 19, 2015, 08:08:41 AM »
I too find it a bit silly when people suggest we would be at a higher bracket in retirement.

In 2014 we paid $57,000 in just federal income tax, $12,000 in SS and medicare, total of $69,000 in just those three taxes.

We retired end of march 2015.

In 2016 we will pay $0 in federal income tax, $0 in SS and medicare, and get back about $7,000 in ACA subsidies and cost sharing for our insurance.

Higher bracket!  Hah!

Wolf359

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Re: How can you be at a higher tax bracket in retirement?
« Reply #32 on: April 20, 2015, 09:00:03 AM »
I too find it a bit silly when people suggest we would be at a higher bracket in retirement.

In 2014 we paid $57,000 in just federal income tax, $12,000 in SS and medicare, total of $69,000 in just those three taxes.

We retired end of march 2015.

In 2016 we will pay $0 in federal income tax, $0 in SS and medicare, and get back about $7,000 in ACA subsidies and cost sharing for our insurance.

Higher bracket!  Hah!
I'm well away from retiring, but I'm mapping out my retirement income streams.  Perhaps I'm doing it wrong.  What will spike my retirement income is the fact that I have 401-K and IRA accounts.

If I retire early, my income will effectively go to zero.  So initially, like you, my income will be lower.  I intend to live off taxable accounts as long as possible, to keep my taxes low and in control (dividends are effectively tax-free if income is below $70K).  That lets the retirement accounts continue to compound tax-deferred for as long as possible.

HOWEVER, Social Security will kick in (at 70), and at 70-1/2 Required Minimum Distributions (RMDs) on my 401K and IRA will require me to withdraw. (Those withdrawals count as regular income.)  If all goes well, those retirement accounts will have been compounding enough that the RMDs will spike my income higher than they were when I was working.  RMDs at 70 are actually low, but by the end of the decade they're pretty high.

If you are going to face RMDs at 70 1/2, then you may want to take advantage of your current 0 tax bracket to convert some of it to a Roth.  You'll pay 0% tax until you get up to the next tax bracket.

When looking at life expectancy, don't forget that it's an average.  That's the age at which half the population has died.  That means 50/50 that you could be alive, especially if you're generally healthy.  Plan on longevity so you don't run out of money. 

Roland of Gilead

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Re: How can you be at a higher tax bracket in retirement?
« Reply #33 on: April 20, 2015, 09:39:02 AM »
Yes, of course convert to Roth when you can do it for free or near free.

We will actually *need* to convert to Roth to generate enough income for a married couple to push us over the 133% poverty level and allow us to qualify for a subsidized silver ACA plan.  It may be that by the time age 70 rolls around we have half a million or more just in Roths.

planner10

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Re: How can you be at a higher tax bracket in retirement?
« Reply #34 on: April 30, 2015, 07:48:17 AM »
One example I haven't seen mentioned in this thread yet.

Even if you are in a lower tax bracket in retiring you should consider contributing to a ROTH if:
 you make a lot of money and pay a lot of taxes and you don't have a traditional IRA (and can't contribute to one due to income limitations).  In that case I don't see a down-side to making a taxable contribution to a traditional IRA and rolling it into a ROTH.  You were going to pay ridiculously high taxes on that money anyway.  At least this way it grows tax free and when you eventually make a withdrawal you won't be taxed again, even if that second tax would be lower.


brooklynguy

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Re: How can you be at a higher tax bracket in retirement?
« Reply #35 on: April 30, 2015, 08:05:55 AM »
In that case I don't see a down-side to making a taxable contribution to a traditional IRA and rolling it into a ROTH.

The downside is locking up the earnings inside the Roth account until traditional retirement age or facing taxes and penalties on those earnings.  But that consideration may be outweighed by other considerations.  This is all discussed in excruciating detail in the Go Curry Cracker article mentioned above (particularly in the addendum and the comments thereto), and the related MMM forum threads linked to in post # 23 above.

Wolf359

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Re: How can you be at a higher tax bracket in retirement?
« Reply #36 on: April 30, 2015, 11:23:41 AM »
1. By Choice.  Let's say you plan to move from a lower tax state to a higher tax state in retirement.  If you move to a state with higher income taxes (to be near your kids, perhaps), your taxes will be higher.  Simply staying in a state that's having problems balancing its budget may subject you to higher taxes in the future.

2. Future taxes. The government raises taxes.  As stated before, you can't predict tax rates.  Do you predict political harmony, balanced budgets, reduced federal debts, and a booming economy?  Or do you think there's a chance that there may be continued political gridlock, deficit spending, and a slow economy with lower federal revenues.  Which scenario is more likely to result in increased taxes (eventually)?  Do you think they're going to resolve the Social Security shortfall with increased revenue (taxes), decreased benefits (lower payouts, taxing benefits, delaying retirement age), or a mixture of both?

3. Inflation.  With FIRE, you're by definition retiring early, so you have a longer retirement period.  Let's say that your investments successfully matches the inflation rate so you have exactly the same buying power.  Someone who in 1985 (30 years ago) retired with $40,000 in retirement income indexed to inflation has an $87,000 income today.  The government generally does not adjust tax rates to account for inflation.  If you plan on a long retirement, and you believe there will be inflation during that timeframe, then you will be in a higher tax bracket eventually.  You still have the buying power of a lower income, but 30-40 years later, you'll have the tax bracket of an inflated income.

4. RMDs.  It's been stated that if you're facing RMDs that raise your tax bracket, then you did poor tax planning.  That's a circular argument.  You're doing the tax planning because you might face RMDs.

5. Safety margin.  You may plan for a very conservative SWR to account for your longer retirement period.  If your worst-case scenarios don't come to pass, you may actually end up with a retirement income that exceeds your working income.  I'd like to have this "problem."

I read that GoCurryCracker post and I agree with much of it.  But his home residence doesn't have an income tax, and he's living mostly overseas in very low cost-of-living locales.  I'm not planning on doing that. I'm funding tax-deductible before Roth, but I'll still fund Roth if I can.  I'll also convert to Roth when I can, especially if I'm between jobs or maybe in early retirement.

I forgot an obvious one:
6. Working beyond your number.  If you have saved enough to FIRE, but keep working beyond that point, your continued contributions can cause your retirement account to exceed your working income, especially if you started early in life.