How to think about taxes in early retirement

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  • Avatar redpen1 
    Status: Physician
    Posts: 11
    Joined: 01/22/2018

    Thank you again WCI members for the collective wisdom.  Im having difficulty understanding the potential impact of taxes in a possible early retirement scenario…

    Spouse and I are both 51 years old.

    We live in PA currently.

    Kids are 16 and 12.

    My W2 salary= $425K/yr.  Spouse W2 salary = $15K/yr.

    We have no debt.  We own a home worth $650K with no mortgage.

    Retirement accounts (401k and IRA) combined= $1.33M

    Taxable= $5.15M (all at Vanguard, mostly Total Stock Mkt/Index 500 type of accounts) with AA of 97% stock funds, 2% bond funds, 1% cash for all accounts including retirement

    529 accounts= $240K total

    HSA= $20K

    In 2018 Vanguard says we had Dividends (mostly qualified)= $78,600, LTCG= $52,300, STCG= $3400 for a passive total of $134K

    Over the past 12 month we spent less than $120K.

    Currently family healthcare is provided by employer.


    1. Would Roth conversions make sense at some point if I stop working? If so how much $ per year should we ideally convert?

    2. If I stop working what would be the federal and state tax rate (currently in PA) on the passive dividends and capital gains?

    3. If I work part time (now as a doctor or future ski instructor or similar) would the earned income increase the tax rates on the passive dividends/LTCG such that part time work becomes disadvantageous?

    4. If I stop working what do we do about healthcare? Purchase from the marketplace?

    5. How much cash should I hold? Should I put all further cashflow toward cash to be able to pay taxes on future Roth conversions?

    6. In 5 years we can relocate prn.  Is a residence in an income tax free state something to consider?

    7. How should we think about the income tax hit by doing Roth conversions vs. the loss of tax savings on dividends and LTCG if we have earned income by doing the Roth conversions?


    Sorry for the many questions.  We are trying not to let the tax tail wag the dog, just trying to understand how to best prepare for the near future. Thanking everyone in advance….


    #197019 Reply
    jfoxcpacfp jfoxcpacfp 
    Status: Financial Advisor, Accountant, Small Business Owner
    Posts: 7315
    Joined: 01/09/2016
    1. Probably
    2. 0% – 15%, depending
    3. Possibly
    4. Possibly
    5. It depends
    6. Of course, many other things to consider
    7. I don’t know how you should think about it

    I feel like i just beat @peds to the punch. However, for such an impactful decision, you really should consider a financial checkup with a fee-only advisor who can answer your questions specific to your personal situation.

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~ 270-247-0555

    #197038 Reply
    Avatar Peds 
    Status: Physician
    Posts: 3604
    Joined: 01/08/2016
    I feel like i just beat @peds to the punch.

    Click to expand…

    ha. ill say out of coffee.

    this is basically how many spreadsheets should i make to model income/taxes. the answer: a bunch.

    #197040 Reply
    Vagabond MD Vagabond MD 
    Status: Physician
    Posts: 3169
    Joined: 01/21/2016
    Disability Insurance

    I am similarly situated and have similar concerns and questions. And yes, there are likely an infinite number of spreadsheets and models to answer your questions. However, a previous WCI guest poster ( living off a $10M+ nest egg, spending $400k per year, broke it down like this:

    $100k Necessities (I would include health insurance, rent/home maintenance, auto expenses, groceries, pets, etc.)

    $100k Discretionary (TRAVEL, dining out, occasional splurge purchases)

    $100k Give away (to charity and adult children)

    $100k taxes (Fed income, cap gains, and state income tax)

    While this is simplistic and far from a one-size fits all answer, it might be a good starting point for those of us who are lousy at spreadsheets, the 25% per category. Our spending is likely to be less, so we drop the numbers down a bit, but keep the percentages.

    "Wealth is the slave of the wise man and the master of the fool.” -Seneca the Younger

    #197046 Reply
    q-school q-school 
    Status: Physician
    Posts: 2336
    Joined: 05/07/2017

    Congrats on killing it!
    Your net worth is pretty exceptional even considering your income. Strong work

    #197048 Reply
    Liked by SLC OB
    Avatar StarTrekDoc 
    Status: Physician
    Posts: 1718
    Joined: 01/15/2017

    6M+ on 120k annual spend?   Kids set with 529 for the most part.   -RE  easy with plenty of buffer.

    The biggest unknown as you mentioned is health.   ACA has you covered for next 14 years, so that’s the biggest expense with the unknown copay variable –but even that has a cap and you can run a supplemental if you want;

    FL is a great destination for East coast folk for tax-free environments.

    –1st world problems.   Congrats!

    #197061 Reply
    Avatar Bmac 
    Status: Physician
    Posts: 284
    Joined: 10/21/2017

    I’m curious as to why you had so much capital gains. Did you sell a lot? Our taxable account with all Vanguard index funds threw off plenty of dividends (mostly qualified) but no LT or ST capital gains in 2018.

    #197083 Reply
    Liked by E5797, ENT Doc
    Avatar Peds 
    Status: Physician
    Posts: 3604
    Joined: 01/08/2016
    Did you sell a lot?

    Click to expand…

    or owns actively managed funds.

    #197094 Reply
    Liked by E5797, Vagabond MD
    ENT Doc ENT Doc 
    Status: Physician
    Posts: 3019
    Joined: 01/14/2017

    My first thought is what others posted about – why so much in LT/STCG??  I would address that as tax-efficiently and as quickly as possible if you’re looking to optimize your future tax situation.  Care to provide more details?

    My second thought is that you have a very aggressive asset allocation for someone your age who is thinking about retiring soon.  You sure you want to do that?

    As to your questions:

    1.  You don’t mention your asset allocation in your retirement accounts, nor did you break down how much is in what.  Is that a traditional IRA or Roth?  Or both?  Yes, it makes sense to do Roth conversions.  If I were in your situation I’d get all my taxable money into tax-efficient funds (sounds like you either sold this year or are in actively managed funds too) and live off the dividends while converting up to X tax bracket (whatever you’re comfortable with but I wouldn’t go past 12/15% unless it made sense to) – after you are eligible to, of course.

    2.  This is hard to know because of your LT/STCG situation.  If this is because of a one-time sale then you are right on the margin of paying zero federal tax.  PA still gets their 3.07% I believe.  But again, I’d use the next 5 years to get your money out of active management if it’s in there.

    3.  Yes, it would increase your taxes.  But you still have more take-home money.  Just because your marginal rate of taxation goes up doesn’t mean it’s no longer efficient to work.  Whether the decreasing efficiency of work (less take home money for every marginal dollar earned) is “disadvantageous” is a personal decision.  But you’ll still have more take-home money, even with your dividends being taxed more.

    4.  Health sharing ministries, healthcare marketplace.

    5.  You can pay taxes from dividends too.  As to how much cash to have, I’d make sure you have enough to get you through a rough 5 year stretch of market returns.  Whether in CDs or short-term bonds I’d have something there.

    6.  Yes, absolutely.  Don’t forget, selling your house and buying another of lesser value frees up some of that $650k of equity too.  PA is a tricky beast.  Charges very low income tax, doesn’t tax your 401k, pension, SS, IRA income….but it’s one of 7 states with an inheritance tax.  So I’d downsize the home, live it up in PA, then move to another state a year before my death…or much before.  😉

    7.  Always think on the margin.  But also look at optimizing after-tax income flows.  There are calculators for all this BTW, including a fairly involved Bogleheads spreadsheet called the Retirement Portfolio Model, and the Optimal Retirement Planner.  Keep in mind your earnings have a marginal effect on multiple levels – your div/CG tax rate, your income tax rate, tax credits, expected family contribution to college, and your social security tax rate (though I’d advise deferring this to 70 and get your conversions done before then).  At what tax rate did you save when you put the money in?  You know you’re winning if you are at a lower marginal rate on conversion.  But I think a combined method of living off taxable, conversions, and taking SS and any other RMDs later has been show to optimize overall after-tax wealth (Kitces had a post about this).

    #197117 Reply
    Liked by Hank, E5797
    Avatar NephronDon 
    Status: Physician
    Posts: 18
    Joined: 06/11/2018

    I am in similar position. However, my retirement accounts make up 40% of our household net worth.

    Long term, I would be concerned about:

    1. Net Investment Income Tax: additional 3.8% tax for investment income > $250,000 (married filing jointly). Net investment income includes interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities and businesses that are passive activities to the taxpayer. Your dividends and capital gains have a good likelihood of reaching this threshold by the time you retire.

    2. What do you anticipate your marginal tax bracket will be at age 70? If you anticipate that your required minimum distributions (RMD) may put you at a higher marginal tax bracket, I would take distributions early and plan Roth conversions to fill up lower marginal tax brackets while you still can. I anticipate that the amount that you want to set aside for  Roth conversions will vary year to year, as capital gains distributions is unpredictable. (Yes, we have active mutual funds in our taxable accounts. My advice to young attendings: invest in index funds in your taxable accounts, active funds [if you believe in them] in your retirement accounts).

    These are good problems to have in general. Congratulations on your financial foresight. I

    I am deploying some savings to get out of my estate and tax bracket to:

    1. My kids’ 529 accounts (Vanguard Nevada)

    2. My kids’ UTMA gift accounts into Vanguard target date funds.

    3. Irrevocable trusts in the benefit of my children.

    Healthcare costs is the biggest unknown: we are mostly doctors in this forum, so we should be most educated on this! For me, this exemplifies the state of dysfunction of U.S. healthcare insurance system, politics aside. I am trying to figure out a retirement benefit that covers health insurance to bridge me to Medicare in the future, otherwise I need to plan to pay through the nose for an “affordable” ACA exchange plan.

    #197120 Reply
    Avatar redpen1 
    Status: Physician
    Posts: 11
    Joined: 01/22/2018

    Thank you everyone for your thoughtful comments.  Ill try to fill in some of the gaps…

    In taxable we have about 60% invested in TSMI/500 index.  We also have $700K total in vanguard health care fund (basis is now $575K) and have had this fund for 15 or so years.  Capital gains for 2018 (mostly LTCG) was $45,600.  The fund has done well over the years.  Is this a keeper? If not when to sell?  We also have $100K in a global equity fund.  I tried to diversify about 15 years ago before I knew anything about tax inefficiencies.  This fund yielded $6650 in capital gains in 2018. If I sell this now I believe it will add marginal income.

    In retirement we have $1.33M, almost evenly divided between me and spouse.  Of that only $75K is Roth IRA, the majority is tIRA/401k.  The IRA is mostly in vanguard TSMI/500 index or similar funds.  The portion at employers’ fund houses are in equity growth funds.

    Regarding asset allocation I know its aggressive.  I think Im ok with this.  I consider the absence of a mortgage a kind of bond equivalent.  If the market tanks we can live off passive income.  I did not freak out or sell, but rather bought in 2009.  Im considering holding a few years worth of cash ($200K or so) as a kind of buffer to use in a down market.

    Please can I provide any additional info?  I so appreciate the honest feedback.

    #197132 Reply
    Avatar Peds 
    Status: Physician
    Posts: 3604
    Joined: 01/08/2016

    Regarding asset allocation I know its aggressive.  I think Im ok with this.

    Click to expand…

    Im considering holding a few years worth of cash ($200K or so) as a kind of buffer to use in a down market.

    Click to expand…

    these statements are in direct competition with each other, albeit small % in the grand scheme.


    Is this a keeper? If not when to sell?

    Click to expand…

    no. only if it tanks and you can TLH.

    #197134 Reply
    Liked by Tim
    ENT Doc ENT Doc 
    Status: Physician
    Posts: 3019
    Joined: 01/14/2017
    Earnest refinancing bonus

    Yeah get rid of that healthcare fund over a few years. One of my mistakes as well. Too bad about your TIRA. Can’t you just roll that into a 401k and do a backdoor Roth? Better than being in taxable..

    #197170 Reply
    ENT Doc ENT Doc 
    Status: Physician
    Posts: 3019
    Joined: 01/14/2017

    I don’t think the OP needs to worry about the NIT, especially if they address the healthcare fund. As for healthcare coverage, see the following calculator:

    You can easily orchestrate living off saved cash, Roth contributions, dividends, etc. so as to live the good life and incur a low MAGI, which will qualify you for a boatload of subsidies. This can bridge you to 65, provided you don’t retire at age 50.

    #197692 Reply
    Avatar Antares 
    Status: Physician
    Posts: 458
    Joined: 01/20/2016

    I stress over similar questions. But I can’t help but find humor in the “should I move to a no income tax state” idea.

    As 93% of my investment portfolio is in tax-deferred retirement accounts, I am moving TO Pennsylvania, because of family, the lower cost of living than NYC metro where I am now, and importantly, no state taxes on retirement account distributions or social security!

    #197740 Reply
    Liked by q-school, ENT Doc

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