My most recent “End of the Rainbow” column in ACEP NOW was about just how low your taxes can be in early retirement. Huge shout out to Physician on FIRE for the inspiration for this one. The original column ran here and is reproduced below.


One of my partners retired early and said she basically pays no taxes at all. Can that be true?


A basic understanding of our tax code can be extremely valuable when doing financial planning with or without a formal advisor. The media and even politicians often mistakenly assume that a high earned income is what defines wealth. In reality, a wealthy person has a high net worth, not a high earned income. That misunderstanding, however, has resulted in a tax code that primarily taxes income rather than wealth. So although physicians who make $400,000 per year may have a negative net worth, they will still have a high tax bill.

Our Progressive Tax Code

Newly minted attending physicians are often shocked to realize just how highly their income is taxed. The progressive nature of the tax code means that the more income you make, the higher the percentage of your income that goes toward income taxes. When it comes to taxes, earned income is the worst kind of income there is. Not only do you have to pay payroll taxes such as Social Security and Medicare on the income, but the taxes might even be calculated using a completely different (and higher) set of tax brackets than unearned income! This might result in an emergency physician paying an effective tax rate (total tax divided by total income) in the 30 percent range and a marginal tax rate (the rate at which the next dollar earned is taxed) in the 45 percent range!

There are not a lot of methods to dramatically lower your tax bill while you are working full-time as a physician. The largest tax breaks are usually tax-advantaged savings accounts such as 401(k)s and health savings accounts (HSAs). However, there is one method that has been used by some physicians to dramatically lower their tax bill: retiring early!

Taxes Can Be Very Low In Early Retirement

Many physicians, used to paying a very heavy tax burden during their working years, are surprised by just how low their retirement tax bill might be. They no longer have to pay payroll taxes at all and might even move to a state without an income tax. Deductions and exemptions they might have been phased out of before are now available again. Some of their income is likely to be tax-free, and a significant part of it is taxed using the lower qualified dividends/long-term capital gains scale. When you combine all of this, it is entirely possible that your retired partner isn’t paying income tax at all. Let’s run the numbers and see just how much income a couple could have without having to pay taxes.

An Example

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Let’s assume a married couple is 55 years old, newly retired, but with one high school student and one college student. They are not yet receiving Social Security and have no pension. Their house is paid off, they don’t give much to charity, and they live in a tax-free state, so they have decided to just take the standard deduction. Their spending money comes from a large taxable investing account where the basis (eg, what they paid for the mutual fund shares) is about half the value of the account, some small Roth IRAs, an HSA, and large traditional IRAs from rolling over their 401(k)s from when they were working.

Let’s say they take $10,000 from their Roth IRAs and another $5,000 from their HSA. Their taxable account kicks off $10,000 from municipal bond interest (tax-free) and $20,000 from qualified dividends. They sell another $20,000 worth of shares from the account. Finally, they withdraw $35,000 from their tax-deferred accounts using the substantially equal periodic payment (SEPP) rule to avoid paying any penalties for withdrawing prior to age 59.5. That is a total spending amount of $100,000. What is their tax bill on that income? It’s $0. No tax at all is due.

How can that be? Let’s go through the items one by one.

  • The $10,000 Roth IRA withdrawal is not taxed at all.
  • The $5,000 HSA withdrawal used for health care expenses is not taxed at all.
  • The $10,000 in municipal bond interest is not taxed at all.
  • Half of the sold mutual fund shares ($10,000) are basis and thus not taxed at all.
  • The other half of the shares are subject to long-term capital gains taxes. However, in this case that is the 0 percent bracket.
  • The qualified dividends are subject to tax as well but like the long-term capital gains, only at 0 percent.
  • That leaves the $35,000 tax-deferred account withdrawal to be taxed at ordinary income tax rates.

However, we haven’t even touched this family’s deductions or credits. First, we can subtract their $12,600 standard deduction and their $16,200 personal exemptions. That leaves $6,200 of taxable income, which results in a tax bill of $620 because it is all taxed in the 10 percent bracket. However, this family qualifies for a nonrefundable child tax credit of $2,000. Thus, no tax would be due. And we didn’t even consider the likely possibility of this family receiving the American Opportunity Tax Credit (a credit of up to $2,500 paid toward college tuition).

Maintaining Your Standard of Living in Retirement

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While $100,000 might not seem like much when compared to the gross salary of an emergency physician, with a dramatically reduced tax bill, without student loans, with no need to save for retirement or college, and with a paid-off mortgage, $100,000 may very well be enough to allow you to maintain your preretirement standard of living.

Even if you decide to have a more luxurious retirement than $100,000 of spending per year, you are still likely to have a dramatically lower tax bill in retirement. It might not be $0, but it will probably be closer to $0 than to what you are paying now. In fact, early retirees often deliberately increase their tax bill by doing Roth conversions of tax-deferred money in order to lower their overall lifetime tax burden, but that’s a subject for another column.

What do you think? Do you think it's fair that someone could spend $100K a year and not pay any taxes on it? Why do you think our tax code penalizes income so much and wealth so little? What will you do to minimize your tax bill in retirement? Have you considered retiring early because you're sick of paying so much in taxes? Comment below!