There are only three things that are guaranteed in the life of a super early retiree: death, taxes, and second-guessing your personal approach to quitting your job and taking distributions.
You will scour blogs. You will devour forum posts. You will check books out of the library and consume them in bed while eating homemade nachos and getting cheesy grease stains on your comforter which will never, ever come out, even with baking soda and bleach and lots of scrubbing.
The goal? To find the One True Path.
The only problem is that it doesn’t exist. This is due to differences in peoples’ situations: income streams, asset allocations, and core personalities.
What do you yourself, then? You collect information on various approaches that have worked for other people, and then cobble the bits together into your own personal superplan.
Today I’ll walk through the construction of the superplan that I’ve decided to execute myself, and with any luck, you’ll find some of the details valuable in constructing your own.
Why You Need a SuperPlan
You hit your FIRE number. You understand the 4% rule. You’ve run simulators that tell you’re financially ready. Why can’t you just immediately quit and start living your dream life without doing all this extra stuff?
Simple. You still need to consider how to tackle the following.
Backup Plans and Additional Income Streams
It’s only once you’ve gotten all of that squared away that it’s finally time to wash that job right out of your hair.
Enough preamble. Let’s do this thing.
Fund Access, AKA Getting Your Money Out
Most of your money is probably in tax-advantaged accounts — 401(k), 403(b), Traditional or Roth IRA, etc. The end goal is to create a monetary workflow which ends with you pulling daily expenses out of a completely cash-based account, such as a money market or checking account.
At a high level, this workflow looks like this:
Mutual Funds -> 2-year laddered CD portfolio -> 1 year Cash Account
This structure will give you security and flexibility. If the market dumps 50% of its value in 2 months, you won’t worry as much because you have a couple of years of CDs to keep your living expenses covered while you wait for your mutual fund values to recover.
Establishing the Pipeline
- Roll your company-sponsored retirement accounts — 401(k), 403(b) — into your IRA. If you don’t have an IRA, this is a good time to set one up with Vanguard or another broker.
- Then establish a Roth IRA if you don’t have one. Most of the money that we ultimately transfer to cash in the form of CDs will originate from the Roth. This is because you can take principal out of your Roth IRA at any time, penalty free, as long as that contribution was made at least five years ago. Roth contributions are post-tax, after all — Uncle Sam has already got his cut. A quick example illustrates this best. You have a Roth balance of 80K. You contributed 5K a year over 10 years, making principal 50K and earnings 30K. This means you can take 25K out at any time without restriction or fee — this is the principal you added over the first five years. Next year, take another 5. Then another.
- You should simultaneously rolling money out of your IRA every year into your Roth. If you’re not familiar with this technique, read this detailed post by the Mad Fientist. The main points are:
- You are allowed one rollover event, AKA “conversion,” per year
- IRA funds are pre-tax, and Roth IRA contributions are post-tax. The conversion is a taxable event. You will be charged standard income taxes at this time.
- The beauty is that you’re retired. You have no income. So you will either avoid paying taxes entirely or pay a very low percentage.
- I plan on rolling 20K/yr. The Turbotax Taxcaster reports this will result in a bill of slightly over 1K to be paid to the Fed. Note that I could roll much more than 20K (Can do up to 36K for a single filer) but I want to leave myself a buffer for any additional income I might generate. Being in the 15% tax bracket has a critical advantage for retirees — If you are in this bracket or lower, you pay zero taxes on long-term gains and dividends. More on this later.
- Every year you’re retired, you’re continuing to move money out of your IRA into your Roth, and you’re doing so in such a way that your tax burden is about 5% on the total. Your Roth bucket grows larger and your IRA slowly goes down.
- After the fifth year of doing this, you can start to withdraw funds that you put in your Roth in Year 1 (20K). You can do this because that 20K is principal (AKA basis)
- This technique is referred to as laddering. Every year you build another rung as you slowly push money from one (inaccessible) place to another.
- You do need to carefully track your Roth IRA basis. This is the amount of your contributions minus any expenses. If you put 50K into your Roth over 10 years and it’s now worth 80K, your basis is still 50K. You should be tracking basis via form 8606, to be filed with the IRS yearly.
- While you’re waiting for the 5-year ladder to be established, you will either draw off of existing 5+ year old roth principal, or a taxable account.
Using the Traditional-to-Roth IRA laddering method, it is possible to withdraw funds from your IRA, convert them to the Roth either tax-free or at a very low marginal rate, and then five years later make withdrawals for personal use.
Over time, your net worth, broken by account type, will (hopefully) end up looking something like this:
In this chart, you pull off of your taxable accounts (blue) for the first several years. During this time your Traditional IRA account balance is going down because you’re laddering into your Roth. And your Roth balance is rising because a) you are pushing more money into it and b) the market is going up.
Once your taxable accounts are depleted, you start dipping into your Roth, even as you continue to ladder your Traditional IRA balance over. By this time you should have plenty of 5+ year old basis in the Roth, and you’re well on your way.
You now have your stash of cash in your grasp.
Note: You must have at least 5 years of living expenses saved in either taxable accounts or as 5+ year old Roth basis in order to successfully execute this plan.
Since taxes are part of your allocated annual spend rate, you’ll want to do your best to keep costs down in this area. After all, taking road trips and eating healthy, awesome food will bring you more happiness than making charitable contributions to the government, right?
We’ve already gone over how to convert all of your tax-deferred 401(k) balances into post-tax Roth IRA balances with minimal charges. But, the other part of the equation is making sure that your dividend and capital gains are not taxed, either.
All you have to do in order to achieve this bit of dark magic is remain in the 15% tax bracket. This is $36,900 for single filers and $73,800 for married couples in 2014. If you are in this bracket or lower, you will pay zero taxes on long term gains and dividends.
Warning: If you creep into the 25% tax bracket on income, you have to begin paying paying 15% on qualified dividends and long-term capital gains. This makes it worthwhile to keep close tabs on your income so that you are prepared for the tax consequences of moving over brackets. A quick reminder: Your income will consist of:
- Money converted from your Traditional IRA to your Roth. In our example above, this would be 20K.
- Interest on CDs, checking accounts, and/or money markets, listed on 1099-INT.
- Ordinary (non-qualified) dividends on stocks or mutual funds that you hold in your taxable retirement accounts. For example REIT fund distributions held in a taxable account usually fall into this category because they’re not “qualified.”
- Any earnings from alternate income streams, e.g. rental properties, consulting or contracting.
Your investment broker will provide a statement at the end of the year (1099-DIV) which summarizes the distributions for you. Take care to track any distributions which count toward earned income in your taxable accounts. These are typically listed as “non-qualified” distributions, meaning, they don’t meet criteria to be exempt from US income tax.
Also keep in mind that as a single filer, you’ll receive a standard deduction ($6200) plus a personal exemption ($3950), giving you just over 10K of completely tax-free income to play with prior to having to pay anything based on your income bracket — $10,150, to be exact. This means that single filers can actually earn 47,050 instead of 36,900 before hitting the 25% bracket.
Note: 2014 IRS figures used for all values above: tax brackets, standard deduction and personal exemption.
I have about 28K in ‘ordinary income’ which breaks out like this:
- 20K/yr from the Traditional IRA to Roth IRA rollover.
- About 1.2K of REIT income, which are non-qualified dividends from my taxable accounts
- About $800/yr in other interest.
- 6K from “ordinary dividends,” also from my taxable accounts.
Then I also have 3K in “qualified dividends” as reported on IRS form 1099-DIV.
Taken together, I’ve earned 31K in income.
Why do I want to keep tabs on my income? Simple. If I get a side-hustle, I want to be aware of how much I can earn without getting bumped into the 15% bracket. Again, for a single filer this is about 47K (the 37K bracket, plus the 10K standard deduction/single filer exemption.)
This means I could safely make an additional 16K without crossing over the 47K line.
So what happens if I go over that 47K income limit? I’ll simply have to pay 15% on the qualified dividends and/or income that go over the threshold.
Let’s say I made 18K in extra income. This is 2K over the 47K income limit to keep me in the 15% bracket. At this point my ordinary income goes up from 28K to 46K.
But I also still earned that 3K of qualified dividends. In this case, the first thousand would be untaxed, but the remaining 2K would get taxed at a 15% rate. I confirmed this using the Turbotax Tax-Caster and plugging in values. (It’s highly recommended that you play around with the tool yourself a bit, especially if what I just explained didn’t come across clearly. Once you start plugging in a few sample numbers, you’ll get the idea.)
What’s the point of all of this? Simple. When you’re retiring early and living on a modest income, it pays to be aware of all inflows and outflows of money — and taxes are a signficant part of the equation. On that note, if you are earning additional income, you may pass into higher brackets and have to pay more.
If you’re on top of it, none of these expenses will be of the unexpected variety, and you’ll handle everything in stride.
Cash and CDs
At this point we’ve figured out how to move money from our tax-sheltered accounts all the way into our checking account with minimal taxable losses along the way. This is good, because ultimately we’re going to be drawing money out of cash accounts to pay for our daily expenses.
But we can do better than your standard 0% return checking account, can’t we?
Here I’ll turn to CDs, AKA Certificates of Deposit. These savings vehicles which guarantee a certain interest rate, but simultaneously lock up your cash for designated periods of time, e.g. 6 months, one year, three years. The longer the date to maturity, the higher the rate you’ll likely receive. I’m establishing a 2-year ladder as a part of this plan. For a visual representation of the laddering concept, check out Ally Bank’s tool.
Right now CDs are only returning 1%ish. I’m planning on holding two years of living expenses in CDs (40K) which amounts to $400/yr, well worth the minimal effort required to establish the accounts. It’s worth noting that yields are low right now because we are in a low-interest rate environment. If inflation ever picks up, CD rates will drive higher. This is important for future planning, because you’ll be counting on the yield from your CD holdings to limit the erosion of real purchasing power in these accounts.
There are a number of other ways to skin this cat, though, if you’re not interested in CD laddering. You might simply leave your two-year cash buffer in a money market or high yield checking account. (Heck, you might decide you don’t need a two-year cash buffer at all.) Do some research and pick an option that works for you.
Reminder: I’m holding money in CDs so that I have the option to not draw money out of my index fund accounts every year. For example in 2008, in the crash surrounding the financial industry’s meltdown, I would have not renewed the CD, effectively destroying my ladder. The following year, when my CD funds were exhausted and the S&P was sitting around 1200 again, I would have reestablished the ladder. I will play through this scenario in more detail in the following post, Drawdown 4 : Examples, where I simulate how running this strategy through various market conditions would have fared. Also consider reading this post by Doug Nordman over at the Military Guide to Early Retirement, as it contains similar information.
Because when you’re planning and learning, repetition is a good thing.
Fact: Regardless of your personal politics, there can be no disputing that the Affordable Care Act (AKA Obamacare) helps the early retiree.
- Greater availability of non-employer-sponsored plans.
- No denial of coverage for pre-existing conditions
- Helps control rising insurance costs over time.
- Best of all, if you are a low earner, your insurance will be heavily subsidized by the government. And, since you are retiring early, it’s a near certainty that your income is low. Perfect!
Mr. Money Mustache wrote an extended post on health care in retirement and concluded that it’s typically best to choose high-deductible plans, and I completely agree. I’m a young, healthy guy and rarely have to go to the doctor. If I have a medical emergency, I have plenty of money available to handle a 5K deductible. To scope out costs, I headed over to healthcare.gov. This ended up redirecting me to my state insurance exchange for Massachusetts.
Harvard Pilgrim offers a “silver” 2K deductible plan for a 37-year old single nonsmoker for $270/mo, or 3240/yr.
Then I use the subsidy calculator provided by Kaiser, which tells me that given an income of 30K, I should expect to receive $750, making the total annual cost for insurance about $2500, somewhere around 200/mo.
However, if my income is only 22K a year (instead of 30), the annual subsidy rises from 750 to a whopping 1900. This makes the bronze plans cost about $300 for the entire year — very close to free.
I’m not yet 100% sure what plan I’ll choose, but you can clearly see that the cost isn’t going to be a major issue.
Subsidies increase along with premium cost, so there’s virtually no need to worry about this.
For example, I worked through scenarios at age 60, also using the Kaiser calculator. Similar plans then cost cost $5,500 (approximately double the same plan’s sticker price at age 37). But in this case the subsidy is now $4,369. This is because the subsidies are based on your ability to pay, i.e. your income.
Let’s hope the Fed never changes this to evaluate subsides based on net worth!
A Health Plan
My Dad loves to repeat himself. Every time I see him, he offers the same advice: Son, having Health Insurance Coverage is not the same as having a Health Plan. (Aside: Yes, he really does address me as “son.” Total goofball, that guy.)
At any rate, he’s completely on the mark here. You must have a plan to stay healthy as you age. This means eating right, exercising, getting enough sleep, and seeking loving, constructive relationships with others.
You don’t have to be over-the-top extreme — there’s really no need to ultramarathon purely for health reasons, for example — but it’s essential to take care of the basics. Do your best to stay off of medications and prevent conditions that will increase your cost of living even as they reduce the quality of your life. This is as simple as keeping your alcohol consumption to a minimum, not smoking at all, eating a lot of vegetables, and walking several miles a day.
After all, if you haven’t got your health, you haven’t got anything.
Part of a good retirement plan is putting a few checkpoints in place. These will be periods to reflect on the plan, review your numbers, make sure you’re feeling okay with how things are going.
Scheduled checkpoints are different from micromanaging. If you are looking at your finances every week, or even every month, you’re doing something wrong. Intelligent retirement plans should be constructed in such a way that this is not necessary — the whole point of quitting your job is to be free to live your life according to your own ideals and dreams. Being constantly worried about money is not my idea of freedom. So don’t micromanage — schedule a couple of dates a year to work over everything, and other than that, don’t stress.
My own plan is to do a full yearly financial reckoning in mid-Dec of every year, and a much briefer July review. In particular you’ll want to review any changes to the tax code which might affect your plan. If it turns out a course change is necessary, there’s still time to take action prior to the end of the taxable year.
Bottom line: You’ll want to learn about any potential bumps in the road well in advance of doing your yearly filing with the IRS.
July Review Activities
Here I’ll check in on available cash in the money market account. The big question is, will it last through the end of the year? Unless we encountered some very large unexpected expense items, the answer should be an easy ‘yes.’ I have an 18k/yr spend rate, so anything over, say, 15K in this account is going to result in a green light to stay the course.
Also I will consider whether or not I’m earning income. If so, I will evaluate potential effects on my health-care subsidy and dividend payouts from taxable accounts.
Mid-Dec Review Activities
Bulleted-list time. There’s lots to do here.
- Cash replenishment
- If the market has dropped less than 10%, stayed stable, or gone up, I will allow my CD-ladder to renew. At the same time, I will take next year’s estimated expenses out of one of my mutual fund accounts. This will initially be skimmed off of my taxable account. Once that’s nearly depleted, funds will be removed from my Roth.
- If the market has dropped more than 10% year over year, I will hem and haw about whether or not to renew my CD ladder or wait another year. I don’t have a hard-and-fast formula for how I will make the decision, but if the drop has been dramatic (say, 25% or more) I will definitely break a CD open, allowing the money in my mutual funds some chance to recover.
- Yearly 20K Traditional IRA to Roth IRA conversion. Potentially adjust upward as the government moves income brackets with CPI most years.
- Expense check-in. Did I hit my yearly target? Why or why not? If I’m significantly over my target, it may be necessary to adjust overall plans. If not, maybe I could plan on doing more travel the following year, or donating more to charity.
- Rebalancing in the Tax-Advantaged Portfolios.
- If my tax-advantaged portfolio allocations are 10% or more off the set goals, it’s time to move funds around to correct the ratios. I will not consider rebalancing in taxable accounts because exchanges are taxable events there.
- On the other hand, I will review potential loss or gain harvesting opportunities in taxable accounts.
- Reviewing changes in tax code: Am I affected by any new laws? In particular, have laws critical to my RE plan changed? Examples include revisions to IRA-to-Roth conversion event allowance, updates to income brackets, health care rules, changes to dividend distributions, etc…
- Simulation: I will execute cFireSim and Monte-Carlo calculators with my updated asset sheet to see how things look. 70% success rate or higher, and I’ll stay the course. However if the predictions are worse than that, this signals that a course adjustment may be necessary. More on this in the next sections.
- Cash replenishment
So what do you do in the unlikely event that things aren’t looking good anymore? Maybe you just finished your yearly monitoring task and your percentage chances of success are looking pretty bad.
It’s not the end of the world. Really, it’s not. There are things you can do to patch things up.
Patch #1: Spending cuts. Remove all non-essential purchases. Cancel trips, put a halt to all restaurant excursions, charitable giving, and other optional expenses. My estimated yearly expenses are currently 18K, but I believe I can get it down to 12 if needs be. This should allow me to ride out just about any total SS-type market scenarios. Except maybe a global contagion that wipes out 95% of the population. That’ll take generations to fix. (Luckily, I’d probably be one of the people that was wiped out, eliminating any need to give a damn about it.)
Patch #2: Work-for-pay of some kind. Sure, this isn’t fun, and you’ll likely be looking for a job at the worst possible time (a major recession) but if you can score something, it’ll help get you over the rough patch. Your expenses are likely very low, making even a small amount of supplementary income go a long way.
Patch #3: Social Security. I believe it’ll be around in some form or other, even 30 years from now. The general population will not allow these social safety nets to simply disappear; too many folks depend on them to get by. The social security benefit calculator tells me that I’ll be eligible for payments of 1800 or so (today’s dollars) when I turn 62, even if I never earn another dime.
Worst case, let’s pretend the program has been systematically gutted between now and my retirement age, and I’m only going to see half of the current estimated payment. Turns out that $900 will cover 90% of my bare-bones (12k/yr) expenses. It won’t be fun, but if things are really that bleak, I’ll gladly take it.
Patch #4: Home Equity. If interest rates are low, you can get a HELOC and tap that account. Or you can sell your residence and become a renter for a while. While this isn’t a great option because you’ll probably be trying to sell in a depressed market, which will mean potentially taking a loss, the fact still remains that it’s an option if you’re in dire straits.
MMM has a related article on this if you’re looking for additional ways to help yourself feel safe when you finally decide to bounce on your job.
A Note on Alternate Income Streams:
If you’ve read all of the above and are feeling nervous, you probably have a high aversion to risk. That’s perfectly fine — it means you strive to always achieve the safest path possible.
In this case, consider going into retirement with an altogether different strategy. Review DRIP investing, or consider being a landlord. Combining rental income with high yield blue-chip stocks is a great way to ride through the worst of bear markets with a smile — you’ll hardly be affected.
At this point, you know how to access your money, avoid taxes, and get high-quality and affordable health care in retirement. In addition, you know that you can easily shift plans around a bit if you need to make adjustments, based on market conditions. And worst case, you have a skeletal back-up plan to put into action if things really go south.
Question: What’s left, to do, other than quitting? I’d really like to quit soon.
Answer: Calm down there, bucky. We still have to work our way through a few specific historical scenarios to see how things would have gone.
In the next post, we’ll take a look at what would have happened had you retired using the Superplan immediately prior to a major downturn. Specifically we’ll examine 1928 and 2008, in Part 4: Examples.
Also on the menu will be some tweaking of asset sheets and spend rates, to see what effect certain changes would have on the plan. I’m most interested in comparing downsizing the house to not downsizing the house.
Drawdown Part 2 : Simulation << >> Drawdown Part 4 : Examples
Great post! Lots of specific info instead of the usual high-level picture I keep finding elsewhere.
For the cash cushion you’ve proposed, are you including those 2 – 3 years of expenses in your portfolio of ~33 years of expenses? Or are they extra on top?
The reason I ask is because I’d expect those (relatively small, but still significant) accounts to end up with a negative real return (compared against something like the CPI–though you’ll probably manage to “inflate” less than the general population) and that could bring the overall return of your portfolio down a bit (and this probably can’t be accurately modeled in many of the simulation tools).
Good question. You’ll see in the examples section of the next post that I re-jigger my asset sheet to move money into CDs and quickly re-run cFireSim to produce an updated chance of success. Yes, there will be a small negative return over time on CD and MM accounts, absolutely no doubt about it. Better CDs and MM than strict checking, though — these accounts allow me to chase yield a little to mitigate the downward impact.
If I were into more so-called stable income streams, like being a landlord or DRIPing my way to RE, I wouldn’t find the 2-year CD buffer to be necessary and might hold just a single year instead as an emergency fund. But I’m still currently planning on doing this (RE) with paper assets. During the examples section, if I find it’s just not working out to my satisfaction, my strategy may change, but I believe that it’ll carry me through. Part of the fun in doing these exercises is not being 100% certain of the outcome in advance 😉
No question that you’re further along than 99% of retirees and, given the flexibility built into your plan, I’m sure everything will turn out fine. Regardless, I was thinking/researching a bit more last night about cash buffers and I ran across this:
I don’t think you need to (or even should) make any changes to your plan, but I thought the conclusions (that cash buffers don’t really help from a strictly mathematical perspective–even if they may help psychologically) were surprising/interesting. This has kind of pushed me to lean in the other direction (i.e. to not bother with > 1 year cash buffers).
Very interesting article – appreciate the sharing. I agree with the conclusions — that straight analysis shows that there’s a greater risk of portfolio devaluation due to holding too much in cash/mm/cd than market downturn, but at the same time I know myself and DW: We will sleep better and manage things more smoothly with this approach. It’s one thing to know math, and another to know yourself. If you’re overwhelmingly ruled by rationality, not carrying that buffer may not be an issue for you psychologically, and it has the added bonus of being more straightforward and potentially even resulting in better retirement returns. My own approach isn’t quite as simple or efficient, but that being said, it should do the trick.
Completely agree! I think you’ve got exactly the right attitude and you’re making the right decision for yourself and your situation.
Seems like a solid plan. I tend to think a bit riskier (e.g. Bond allocation instead of CDs) but otherwise pretty similar. We will probably end up with a lot in Roths and taxable, since our effective tax rate is currently ridiculously low, owing to kids.
Heh, yes, a reduced tax burden is one of the many nice things about, as you might say, having goblins around. I think being a little riskier is perfectly fine — history and math tells us that your strategy of carrying more in bonds will work out perfectly well during downturns. I didn’t make it entirely clear in the post, where I focused on the practical reasons for having a 2-year cash buffer, but the complete truth is that I’m carrying CDs for mostly mental security purposes. Hard to be worried when you have that much gold coin sitting in a chest next to your bed.
Great post! You have confirmed my own drawdown strategy in detail. Plus I learned some more ideas. Keep up the great work!
Glad that these details are helpful. I just learned, btw, that the first year of health care may cost more because when you initially enroll they evaluate magi for the previous 12-month period to determine need. Since I’ll be retiring in 2015, this means they’ll be looking at 2014 where I’ve had good earnings.. Bronze plan, here I come!
I will of course look at ways to apply for reimbursement once 2015 has ended and it’s possible to prove I only earned 22K or so.
That is a very thorough post. I especially like the 401/ira/roth section. It is still unknown whether I will use the 72-t distribution or not. I had originally been thinking about the 72-t distribution to gain access to my 401k if needed. This rollover method you described looks like a better tax strategy and I can determine the withdrawal amounts from the 401k to the IRA each year if I understood you correctly.
I also looked into the 72-t distributions to access tax advantaged accounts prior to retirement. The conclusion I came to is that rollover method provides much greater flexibility overall. Yes, you can determine the rollover (conversion) amount from the 401(k) to the IRA each year. Just want to keep an eye on your tax bracket because it’s counted as ordinary income. This is part of the reason I want to move only 20K a year — the first 10K is not taxed at all due to deductions and the second 10K is taxed at at the 10% rate, which is awesome. If you’re willing to pay a bit more in taxes you could get closer to the edge of the 15% bracket, allowing you to move perhaps 46K/yr (single filer limit: 36K+10k standard deduction/exemption) or more if you’re filing jointly.
Note: I updated this content on Sept. 07 2014 to correct some misinformation. Specifically I revised details regarding taxation on qualified dividends. Incorrect: There’s no “line” that you trip over which suddenly makes it necessary to pay 15% on all qualified dividends. Correct: If your income passes the 15% bracket, you will pay this percentage on the overage amount. Thanks to MMM forum user Cheddar Stacker for pointing this out and helping me to provide accurate planning information.
You mention reviewing your tax situation in January. You (and others) may want to review your tax situation in December instead. Your options for responding to changes in tax law may diminish after December 31. It could be disappointing to find out in January that a tax law had changed and your response is more limited now that the tax year has closed.
Thank you for the thoughtful feedback – completely agree. I’ve updated the post to reflect that reviews should be conducted in December to give you time to take action based on tax code changes. Also updated the content in the new blog location which is https://livingafi.wordpress.com/
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thanks for the informative post!
I had a question about this line :
Warning: If you creep into the 25% tax bracket on income, you have to begin paying paying 15% on qualified dividends and long-term capital gains. ”
The statement is a little ambiguous. I’m not sure if 15% is the rate all long-term capital gains or just the marginal rate on the last bit of capital gains. When I play with Taxcaster it seems to imply it is the marginal rate. If you only consider long-term capital gains, a married couple with just the standard deduction and exemptions with $100K in long-term capital gains only pays $885 in taxes (taxable income of 79,700, 25% marginal tax bracket). But someone paying making $94k in LT cap gains pays zero taxes (taxable income of 73,700, 15% bracket). So it looks like a marginal tax rate on the gains above the 73,800 cutoff between the 15/25% brackets (15% of $5900 is $885).
Is that how you see it? And if it is a marginal rate on long-term capital gains and you have more than long-term gain income, then how much of the long-term gain is taxed at the 0% brackets and how much is taxed at 15%?
Yes, it’s the marginal rate on “the last bit” of gains only, i.e. 15% applied to the gains above the cutoff. In your 100K example this is 15% of 5,900. We get 5900 from Cap Gains Income (100k) minus standard deduction + exceptions (20300) giving you 79700 in taxable income. 15% bracket is 73800, leaving 5,900, and 15% of that is 885.
Again, you are exactly right.
>>And if it is a marginal rate on long-term capital gains and you have more than long-term gain income, then how much of the long-term gain is taxed at the 0% brackets and how much is taxed at 15%?
It’s helpful to remember that you pay tax on your income first. So let’s say you worked at McDonalds made 20K last year in payroll income, in addition to your 100K cap gains.
Your (deduction+exemption) is 20,300, so you first apply that to your 20K income. Congratulations, you do not have to pay any taxes on your 20K of earnings.
Additionally, you still have $300 left of deduction+exception money to apply to your capital gains.
So let’s do that: You apply the final 300 to your 100K of capital gains, leaving you at 99700.
Then you subtract the 15% bracket from this total: 99700 minus 73800. This leaves you with 25,900 of capital gains on which you will be taxed at the 15% bracket.
15% of 25,900 = $3885 = the total you’ll owe in this scenario.
Hope this makes sense.
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This is a really great article on a topic I’ve been wondering about since the election myself. Just recently retired. We’re still young (I’m 28), but if the subsidies go away it may prove challenging for our budget particularly in the 5-10 years before Medicaid kicks in. The unsubsidized premiums can easily hit $1,500 a month for a family of four and you have the out of pocket costs each year on top of that. Will keep my eyes peeled for more info on how this shakes out.
On a slightly unrelated but cheerier note, I vaguely recall reading in a past post that you’ve been playing League of Legends. Do you still play? What role do you main?
I’m not sure that you’ll see this, JP – it looks like you accidentally commented on an older article instead of the current Obamacare article — but yeah, I still play. Mostly ARAM instead of Summoner’s Rift because I like the constant insane pace and I also don’t have to keep up on all of the ever-changing rules and metas in the main game type. Playing ARAM is kind of like eating dessert all day.
I don’t main anyone but I have a short list of favorites: Fortune, Veigar, Maokai, Blitz, Amumu, Annie, Lux. So fun. Since I play ARAM I get the opportunity to play just about everyone, too, due to the random champ select.
If you do see this, let me know what your own favs are.
Congratulations on your own ER!
Doesn’t look like the 1 rollover event per year applies to IRA>Roth IRA conversions. Here’s from the IRS website:
The one-per year limit does not apply to:
-rollovers from traditional IRAs to Roth IRAs (conversions)
-trustee-to-trustee transfers to another IRA
Excerpt from “Rollovers of Retirement Plan and IRA Distributions” on the IRS website.
Good article, very informative, lots of good info….
I’m single and have a annual active pension of $37,986: I received monthly deposits now. I have tax-deferred IRA’s (457, 401(k) of $225,000. In addition to my current income (pension), I am employed and continuing to save. I will be completely retiring within the year. (No debt, own my home, health insurance coverage via retirement) My plan is to draw an additional 10k per year, when I retire, and keep my gross taxable income under 48k. Question: Is there any big advantage to trying to convert my IRAs to a Roth….? The way I see it, as long as I stay in the 15% tax bracket I’m good to go…. $3500 a month (after income taxes and health insurance) is way more than enough to live off of as my total monthly expenses (all bills, prop. taxes, home insurance, food, etc..) is between $1500-$2000 a month. (The extra monthly money will be put into cash and after tax investments)… Thanks for a response.
Great article. Thanks for posting. I’ve been thinking about this topic a lot these days, even though we’re still ~8 years from RE. Here is to hoping they Feds don’t change the Roth laddering and ACA subsidy rules.
I realize this is a very old (yet helpful) post, but should it be updated (or perhaps a corrective post) to indicate current tax penalty for IRA rollovers (Trad to Roth)? The example here indicates that you’d pay 1k on a 20k conversion. Current rules indicate a much higher amount ($2,400). That’s not to say that Roth Laddering isn’t something that FIRE folks should consider. Just good to know the tax impact when thinking about “if” to do it, “when”, and “how much” annually.
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