The 15% tax bracket

[lifeplus]

I'm re-reading, The Simple Path to Wealth and the chapter on, "How do I pull my 4%" is pure gold - as is the whole book. One thing JL Collins talks about is trying to stay "within the 15% tax bracket."

I'm imagining this 15% bracket is the long term captial gains tax bracket. Is this correct?

Is so, I'm imagining withdrawls are taxed at LTCG rats. Is that correct?

I'm trying to understand what he means by 15% as that factors into doing a Roth Conversion ladder to stay within the 15% bracket post FIRE. If that's the 15% LTCG bracket then that would be up to $496,600 for married filing jointly in 2020.

[tarheeldan]

Roth conversions are taxed as ordinary income

[dandarc]

Tax rates have changed since 2016, the book has not - the 12% bracket today used to be the 15% bracket.

Logic probably follows just as well - 15% might be acceptable to you for a Roth conversion while 25% was not in 2016. 12% / 22% doesn't change much in that thought process.

[lifeplus]

Gottcha. So are withdrawls are taxed as ordinary income? Or maybe if you're selling shares you only pay LTCG on the growth. Trying to make sense of this. Thank you for helping me get there. I'm an eager student.

[terran]

All withdrawals from tax deferred (traditional) retirement accounts are taxed at ordinary income tax rates, so capital gains within the account are irrelevant. There are also penalties if you withdraw before you're 59.5 years old, although there are some workarounds.

[lifeplus]

@terran thanks for the info. I'm familiar with Roth Conversion ladders and thanks for the link.

How about taxable accounts? Are withdrawals taxed at all as money going in is post tax. I could see tax on the gains, but ideally as LTCG.

[secondcor521]

@terran thanks for the info. I'm familiar with Roth Conversion ladders and thanks for the link.

How about taxable accounts? Are withdrawals taxed at all as money going in is post tax. I could see tax on the gains, but ideally as LTCG.

Withdrawals from taxable accounts are not taxable at all.  It's equivalent to moving money from your savings account to your checking account.  It's just a transfer.

Activity inside the taxable account, however, is taxable.  If you sell investments at a gain or a loss, or if you receive dividends or interest, or if you receive capital gains distributions, or if a stock is acquired or performs a spinoff - all of these (and maybe some more I didn't think of offhand) have an impact on your taxes.  Generally speaking you'll receive a 1099-INT, 1099-DIV, 1099-B, or consolidated 1099 with the information on it for your tax return.

Generally, yes, you'll pay LTCG rates on investments you sell at a gain which you've held for more than a year.

[lifeplus]

@secondcor521 Thank you so much for that info. It's becoming clearer.

I understand that moving to FIRE and actually drawing income from your investments is something that is different for everyone and that the strategy changes over time. As a general, generic rule, when the time comes to pull money from your taxable accounts is that done by selling shares? And, when you do sell them I imagine that you're only paying tax on the growth/gains. Or would the entire sale count as income or just the gains?

[terran]

Once you're ready to start spending your savings it would be wise to turn off dividend reinvestment and spend those first. After that, yes selling shares is the way to go.

In a taxable account you'll only pay tax on the growth (sale price minus purchase price). If you've owned the share you sold for at least 1 year you'll pay tax at long term capital gains rates, which are 0-20% (sometimes plus 3.8%) depending on overall income, but probably 0-15% for most people on this forum.

For Roth (withdrawals aren't taxed) and traditional (withdrawals are taxed at ordinary income tax rates) the source of the withdrawal (dividend, interest, sale) doesn't matter as they're all taxed the same.

[secondcor521]

What terran said.

I'm 51.  Personally I spend random income and dividends first.  I then sell shares from taxable for living expenses as needed.  Pretty much all of my dividends are qualified, and all my shares sold so far have been LTCG, and I have low expenses with a paid off house and car, so the tax bite is pretty minimal.  I also am doing annual Roth conversions based on my tax situation each year.  I could cap gain harvest but in my situation the Roth conversions seem better to me.  I'm too young for SS and don't have a pension.

It's a lot to get used to since it's very different from a tax perspective.  And there's the emotional component to simply getting used to spending without an income.  But after a few years I've settled down emotionally and see how the mechanics of it all work, so I'm getting pretty comfortable with my situation.

[lifeplus]

@secondcor521 and @terran this is super helpful. I'm 47 years old and about 8 - 12 months away from being FI. I'm trying to dig into all the details of withdrawal and appreciate this crash course as well as personal insights in how you've learned how to settle down emotionally. That will be me for sure so this is great to hear.

I'm curious if you hold any bonds in your portfolio?

I currently do not, but could roll one of my 401ks into a traditional IRA and put them into VBTLX, for instance. And, to bring it back to topic too, I'd imagine that transfer would be taxed upon the transfer from 401k to IRA and then taxed as ordinary income if I pulled from the bonds as LTCG, is that correct?

[secondcor521]

I hold about 3% of my AA in bonds.  In VBTLX actually.

I do this because that is what I calculate to be the maximally safe AA for my particular inputs, which are mostly my life expectancy, my current spending, my SS, my side income, my investment expenses, etc.  I could go more into the math, but basically with a 40 year horizon and taking 25x my expenses as my FIRE stash, the safest AA is about 90/10.  Since I have more than 25x my expenses, the rest is 100% stocks because that excess is for my kids, hopefully 30 years down the road.

Transfers from traditional 401(k)s to traditional IRAs are not taxed at all.  Reallocations inside of 401(k)s and IRAs to or from VBTLX or any other investment has essentially no tax consequences.  As mentioned previously, any withdrawal from tax deferred (401(k) or traditional IRA) is taxed at ordinary income tax rates, plus sometimes a 10% penalty if you're younger than 59.5 and not converting to a Roth and not meeting any of the other exceptions.

[lifeplus]

@secondcor521 what does your AA look like? Would you mind sharing? You nearly did below, but curious. Also, how have you determined your "maximally safe AA?" I've used FireCalc and cFIREsim, but I haven't found it to matter much whenever I go from 100% index funds, which is where I'm mostly at now, to adding 10% bonds. The success rate only changes by about 1% point. I'm curious if you have any tips, or tools for getting ones AA fine tuned? I'm working to do that now.

[secondcor521]

@secondcor521 what does your AA look like? Would you mind sharing? You nearly did below, but curious. Also, how have you determined your "maximally safe AA?" I've used FireCalc and cFIREsim, but I haven't found it to matter much whenever I go from 100% index funds, which is where I'm mostly at now, to adding 10% bonds. The success rate only changes by about 1% point. I'm curious if you have any tips, or tools for getting ones AA fine tuned? I'm working to do that now.

My AA is 97/3, as mentioned before - 96.85/3.15 if you go to two decimal places.  If you include cash, it's 96.44/3.14/0.42.

My maximally safe AA method is as follows.  May not be right, but it's what I do.  I'll try to explain each step as to why.

1.  I plug all of my actual numbers in to FIREcalc.  For the term, I take 90 minus my age.  The reason for this is to start with the actual situation I'm in and take a conservative estimate on life expectancy (i.e., I have only about a 20% chance of making it to 90).

2.  I then select the 95% spending level success in FIREcalc and replace my spending amount in FIREcalc with whatever that number is.  The reason or idea here is to stress my actual situation a little bit and reveal AA differences.

3.  I then choose the AA option on the investigate tab.  This shows me how success rate varies with AA.

4.  I then choose the highest stock AA that is consistent with maximum success rate.  (Tie goes to higher stock allocation, basically).  I choose higher stock AAs because they typically have higher residual values for the same success rate.  This AA is typically 90/10.

5.  I then divide my stash into two piles:  One which I will spend before I die, and one which I won't.  I take my current actual spending and multiply that by 25 and that is the first pile.  The rest of my stash is the second pile.

6.  The first pile is allocated according to the result in step 4 - 90/10 in this case.

7.  The second pile is allocated 100% stocks, because I expect that to go to my kids when I die in 30 years or so.

8.  My spreadsheet does the math between first pile and second pile for me and spits out the target AA to bonds.  Since my spending is an input in step 5 above, the bond allocation increases slightly as I spend more.

At the moment my target bond AA in step 8 is 3.23%.  My actual bond AA at the moment is 3.15%.  Given that I'm in the expensive part of the year (Christmas is a big spending period for me), that's close enough.

...

The above is way too complicated, and I'm probably way too analytical about it.  Honestly anything within 5 to 10 percentage points is probably about the same.  So I would say that it's really not necessary to dial it in any closer than that.  So I see differences between 60/40 and 100/0 and 30/70, but I don't see any meaningful difference between 80/20 and 75/25 and 85/15.  And even less between 60/40 and 62/38 and that sort of thing.

[lifeplus]

@secondcor521 Thank you so much. This is incredibly helpful.

I started digging in a bit more to firecalc and found that a 15% bond ratio will yield a 99.1% chance of success (1 cycle failed). And at 10% bonds it dropped to a 98.1% success rate (2 cycles failed). What success rate are you personally comfortable with? I'm factoring a constant withdrawl rate of 3.5% vs 4% even though I know that will vary depending on lots of factors (market, lifestyle, location, side gigs). I'm also not factoring in any SS as I just dont' know if it will be available. I know it will not be available in the capacity it is now when I can access it (62 - 70 years of age).

Because I'm 100% stocks at the moment (VTSAX mostly). When we FIRE we are planning on rolling either DW or my 401k into a traditional IRA and invest it into VBTLX (Bonds) to get the 10-15% AA and conversion ladder the remaining into a Roth which we'd put into stocks (VTSAX). Do you see any issues with this? I'm not super familiar with Bonds, but need to start getting more familar with them so I understand them better.

[secondcor521]

@secondcor521 Thank you so much. This is incredibly helpful.

I started digging in a bit more to firecalc and found that a 15% bond ratio will yield a 99.1% chance of success (1 cycle failed). And at 10% bonds it dropped to a 98.1% success rate (2 cycles failed). What success rate are you personally comfortable with? I'm factoring a constant withdrawl rate of 3.5% vs 4% even though I know that will vary depending on lots of factors (market, lifestyle, location, side gigs). I'm also not factoring in any SS as I just dont' know if it will be available. I know it will not be available in the capacity it is now when I can access it (62 - 70 years of age).

Because I'm 100% stocks at the moment (VTSAX mostly). When we FIRE we are planning on rolling either DW or my 401k into a traditional IRA and invest it into VBTLX (Bonds) to get the 10-15% AA and conversion ladder the remaining into a Roth which we'd put into stocks (VTSAX). Do you see any issues with this? I'm not super familiar with Bonds, but need to start getting more familar with them so I understand them better.

I'm personally fine with a 94.28% success rate according to my spreadsheet.  I came up with that number by looking at situations around that 95% success rate, and looking at the failures, noticing that most of them are start years in the late 1960's and early 1970's, and believing that the future will be better in the past specifically in that we have learned from that history and won't repeat it to that degree.  Others may chime in and think people should be more cautious, and that's fine.  I think it's up to each individual to make those tradeoffs.  I also think that people have different appetites and capacity for risk, and have different levels of contingency plans if things don't work out.  I have a high capacity for risk and have quite a few contingency plans available, so that's how I ended up where I did.

The one potential issue with having a Roth ladder in VTSAX is this:  the amount you can take out (tax-free penalty-free) five tax years later is only the dollar amount of the conversion done five years previously, *regardless* of whether that conversion has grown or shrunk during that intervening five years.  To say the same thing a different way, if you Roth convert $50,000 today and put it into VTSAX in your Roth, then five years from today (well actually 1/1/2026) you'll only be able to withdraw $50,000, even if that $50,000 has grown to $75,000.  The extra $25,000 in this example is considered earnings, and is not withdrawable without penalty after 59.5.  And if the amount shrinks, then obviously removing the $50,000 is problematic because you may starve your Roth ladder for subsequent years.

So depending on how tightly you run things, if you're relying on your Roth ladder for spending money, and you Roth convert to create your ladder, and then the value of those investments drops significantly for long enough, then you run the risk of running out of dollars to withdraw and spend.

Personally I simply took the risk - I think I decided if things went sideways I'd just go back to work, or start a 72(t) or something.  And things happened to turn out fine (well, so far anyways).  But it's certainly a risk to be aware of.