Taxes during retirement

[Portis]

I have a couple questions here from a new guy just getting into FIRE.

1) I understand the 4% rule, but what I haven't seen information on is if taxes should be taken into account.  When people say you need 25x your expenses, is that including your estimated tax bill?

2) From what I understand the tax rate on qualified dividends and long term capital gains is 0% if your ordinary income is under $78,000.  And this is also exempt from social security and medicare tax?  Do I need to make sure I have funds in my retirement accounts allocated properly to be considered long term capital gains and qualified dividends during retirement?

Thanks

[matchewed]

1) Yes
2) Retirement funds are considered normal income during withdrawal, the only consideration is whether taxes were deferred or not.

[seattlecyclone]

I have a couple questions here from a new guy just getting into FIRE.

1) I understand the 4% rule, but what I haven't seen information on is if taxes should be taken into account.  When people say you need 25x your expenses, is that including your estimated tax bill?

Should you include your taxes in the 4%? Yes, but your taxes probably won't be very high. Since I see you quoting the $78k number for tax-free capital gains, I assume you're married? In addition to $78k of capital gains you can realize without owing income tax, you also have a $24.4k standard deduction that gives you space to do some IRA conversions for free. Add those up and you can have a bit over $100k of gross income completely tax-free. Note that this requires the bulk of your money to be in a taxable account to sustain this much capital gains and dividend income compared to your IRA income.

Supposing you take full advantage of your retirement accounts while working and therefore have a bigger fraction of your savings in retirement accounts, you'll still be taxed at a very low rate. Suppose you do $50k of Roth conversions each year during retirement. You'll get the first $24.4k free under your standard deduction. The next $19.4k is taxed at 10%, and the last bit is taxed at 12%. Total federal tax would be $2,684, or 5.37% of your Roth conversion. That's not a huge amount. Definitely take it into consideration, but don't fret about it too much either.

2) From what I understand the tax rate on qualified dividends and long term capital gains is 0% if your ordinary income is under $78,000.  And this is also exempt from social security and medicare tax?  Do I need to make sure I have funds in my retirement accounts allocated properly to be considered long term capital gains and qualified dividends during retirement?

The allocation of assets in your IRA doesn't matter for tax purposes. It's all taxed at regular income tax rates upon withdrawal from a pre-tax account, and generally tax-free if withdrawn from a Roth account. No social security or Medicare tax is charged for retirement account withdrawals or capital gains income.

[MustacheAndaHalf]

For a Mustachian who retires early, don't rely on the 4% rule.  If you take 4% of your nest egg and use that for as your annual expenses, you go broke about 1 time in 5 (20%).  A withdrawal rate of 3% raises your chance of success from 80% to 93%, using Vanguard's calculator and 60/40 (60% stocks/40% bonds):
https://www.vanguard.com/nesteggcalculator

I'd recommend getting a feel for success rates using a simulator, and Vanguard's is the simplest to use that I've found.

[matchewed]

I'd argue that you can rely on the 4% rule but not with the current understanding you've demonstrated. You OP need to understand taxes and how they're applied to your income and what types of income before you can start determining whether you can rely on the 4% rule or whether you can determine if you understand it.

MAH, do you have any data to back up your 20% failure rate? I'd prefer not to derail this thread but you've provided a relatively outlandish claim with no data.

[arebelspy]

I'd say even more outlandish is the 7% failure rate on a 3% WR. 

If those numbers are coming from the linked calculator, that calculator isn't good. (And may be monte carlo with some weird inputs.)

[ysette9]

For a Mustachian who retires early, don't rely on the 4% rule.  If you take 4% of your nest egg and use that for as your annual expenses, you go broke about 1 time in 5 (20%).  A withdrawal rate of 3% raises your chance of success from 80% to 93%, using Vanguard's calculator and 60/40 (60% stocks/40% bonds):
https://www.vanguard.com/nesteggcalculator

I'd recommend getting a feel for success rates using a simulator, and Vanguard's is the simplest to use that I've found.

This sounds like complete nonsense. For a 60/40 US portfolio the perpetual withdrawal rate (amount that will never have you run out of money and also preserves your principle) is 3.6%. https://portfoliocharts.com/portfolio/withdrawal-rates/
Make that 50% US stock, 40% world stock, 10% treasuries and your perpetual withdrawal rate is up to 3.8%.

You can also run simulations with a narrower set of investment data over longer time periods using cFIREsim and come to similar conclusions.

Based on some sensitivity analysis I did last weekend with these tools, if you add in a touch of flexibility, your success rate goes up even higher. In our personal case, I was modeling success rates in the mid-to high 90% with a 4% or slightly higher withdrawal rate over a 60-year retirement if we were willing to reduce our spending by 10% in bad market years.

We each have to decide for ourselves what we are comfortable with, but starting out with better data is a big first step.
I strongly encourage people to spend time playing with these tools to understand the variables and how little changes impact success.

[matchewed]

So looking at that vanguard tool, yes it is monte carlo. Running the basic 60/40 gives a 91% success rate. Running a basic 60/40 through cfiresim gives a 95% success rate. So the delta between them isn't crazy and the variables driving it can be explained between historical and monte carlo as well as the added variables in cfiresim.

IOW simple!= better. Know the tools and what drives them so that you can make more accurate and reliable statements.

[Portis]

Thanks for all the input.

To reply to what seattlecyclone said about the tax rate of retirement witdrawals, im curious if anyone has recommended reading for roth vs pretax contributions.

Ive done some reading on it, but they seem to be very simple arguments that i dont know if the argumwnts have been fully fleshed out.

My current fed tax rate is around 5.5%, so i assumung based on the reading ive done, that roth contributions are my best bet.  My current savings plan will have us contributing 60% roth and 40% pretax between my wife and i

[matchewed]

Thanks for all the input.

To reply to what seattlecyclone said about the tax rate of retirement witdrawals, im curious if anyone has recommended reading for roth vs pretax contributions.

Ive done some reading on it, but they seem to be very simple arguments that i dont know if the argumwnts have been fully fleshed out.

My current fed tax rate is around 5.5%, so i assumung based on the reading ive done, that roth contributions are my best bet.  My current savings plan will have us contributing 60% roth and 40% pretax between my wife and i

Well it depends, what are your goals? What will be your expenses in FIRE (assuming that is your goal)?

I notice you have a case study already going. Why don't you use that to pivot towards a tax discussion within that thread so that the relevant specific information can be in one spot?

[arebelspy]

The bottom line is: you need to plan to cover ALL your expenses. Taxes are an expense.

Whether it's a cheap one (possibly even zero or negative) or an expensive one depends on your situation, your investments, etc.

GCC had 5 years in a row where they had a net negative $4 tax burden, besides many other benefits (such as tax loss harvesting and Roth IRA conversions).

I pay taxes each year, because we have a lot of real estate income. Real estate income is partially sheltered from depreciation, but if your properties cash flow a lot, which ours do, it's doesn't fully cover that income, and then you pay taxes on it.

It let us FIRE very early, so I don't begrudge the taxes paid now (versus if we had retired 8 years or so later on equities, we could also have no tax burden right now, but we'd have paid plenty of taxes along the way while employed for more years... I'll take our current situation). 

So our income needs to cover our spending, and the taxes on that income, yes. (Ditto the side-gig income.)

What your situation looks like can vary. Try to optimize it, then don't worry about it.

Really, the first two sentences (the first one line) of my post covered it. :)

[MDM]

Thanks for all the input.

To reply to what seattlecyclone said about the tax rate of retirement witdrawals, im curious if anyone has recommended reading for roth vs pretax contributions.

Ive done some reading on it, but they seem to be very simple arguments that i dont know if the argumwnts have been fully fleshed out.

My current fed tax rate is around 5.5%, so i assumung based on the reading ive done, that roth contributions are my best bet.  My current savings plan will have us contributing 60% roth and 40% pretax between my wife and i

5.5% is an effective rate, and that is not the correct rate to use.  One should compare marginal tax saving rate now vs. expected marginal tax rate on traditional withdrawals later.

See Traditional versus Roth - Bogleheads for good details.

[MustacheAndaHalf]

Yes, I was quoting Vanguard's retirement simulator.

Running a basic 60/40 through cfiresim gives a 95% success rate.

Are you talking about http://www.cfiresim.com/ ?  I don't see where you're getting the 95% success rate.

[matchewed]

Yes, I was quoting Vanguard's retirement simulator.

Running a basic 60/40 through cfiresim gives a 95% success rate.

Are you talking about http://www.cfiresim.com/ ?  I don't see where you're getting the 95% success rate.

I'll break this out to it's own discussion on one of the other sections of the forum. I'll @ you so you know.