The Taxman Leaveth: Low, Low Taxes in Early Retirement

AUGUST 01, 2016
Physician on FIRE

During our years of wealth accumulation, a.k.a. working, we pay a pretty penny in taxes.  We become accustomed to knowing that after a certain point, we might only see about half of each additional dollar earned.  Adding up federal & state income tax and property taxes, many physicians will have annual tax bills exceeding $100,000.  If you’ve managed to accumulate a sizable nest egg over 20 years or less, you’ve no doubt contributed at least $1 million to the coffers of the taxman.

Fear not. Much, much lower tax rates are on the horizon for the aspiring early retiree.  Let’s crunch some numbers and examine what you might expect to pay when you hang up the stethoscope for the last time.

Take the example of someone like Dr. Benson from the 4 Physicians article who was on track to retire with $3 million in about 20 years with $120,000 in annual spending.  As you’ll see below, he ended up with $3.3 million.  Will he require $120,000 a year in retirement?  Of course not.  He paid off his $36,000 a year mortgage, he’s no longer contributing to a 529, and his children are off on their own.

To maintain the lifestyle he and his wife have enjoyed, his spending will be closer to $70,000.  Since they expect to travel more, let’s give them $80,000 a year for a comfortable retirement.  This represents a super-safe 2.4% withdrawal rate.  With $100,000 in annual spending, the withdrawal rate would still be a paltry 3%.  They can expect to watch their nest egg grow most years in retirement with this level of spending.

Taking a look at how Dr. B arrived here in his early fifties, we see that he wisely has his nest egg spread out among different account types.  He maxed out his tax-deferred savings, while contributing to  personal and spousal backdoor Roth IRAs.  His HSA has grown nicely, and more than a third of his nest egg is in a taxable account.  Allow me to display this saving and compounding in a handy little spreadsheet.  I do like spreadsheets.




We’re assuming 4% real (inflation adjusted) returns, so spending power is preserved.  For the taxable account, I accounted for a half percent tax drag*, so that account has returned 3.5%.

*This tax drag assumes a portfolio of passive index funds with 2% qualified dividends taxed at 25%.  The tax on qualified dividends could be as low as 15% if you have no state tax and keep AGI under $250,000, avoiding the 3.8% medicare surcharge.  In that best case scenario, the Bensons could have had a 3.7% real return on their taxable account in the working years.

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