More Favorable Retirement Tax Rate Revealed

Our taxes are complete and in the mail as of yesterday! I am so thankful because even though we use an accountant, getting our taxes done feels like a part-time job for the months of February and March.

Related: Income Taxes Not A DIY Project

This was the first year we got a good look at what our post-working tax rate might look like. Because we’ve been exercising a lot of stock options each year, our taxable income has stayed very high over the past few years. A drop in the MegaCorp stock price in 2018 meant we held off exercising a lot of options and lived mostly off cash savings.

This strategy meant our taxable income went way down. We still ended up itemizing our return, but our actual Federal tax rate dropped an amazing 20 points! It was much lower than the tax rate I had built into our overall retirement plan.

It was hard for me to assess what our tax rate would look like in retirement when we put together our overall plan and projected out our finances over the next 35+ years. I kept our inputs as conservative as possible and kept the tax rate very high. Our financial planner used a lower, but still conservative tax rate in his model.

With our 2018 taxes now complete, I am seeing that our assumed tax rate in retirement represents a significantly bigger than expected financial buffer built into our plan. I’m not sure what it represents over the next few decades, but I see now that it will be tremendously positive.

With MegaCorp stock back on the upswing (+30%) in early 2019, I am again exercising a lot of options. That means our tax rate will jump up again this year and stay relatively high until I turn 55 in a few years and our stock options are all exercised. Then our tax rate will then drop permanently. That gives me a few years to size up the value of a a much lower tax rate in our retirement model. Unless the government radically changes things in the meanwhile!

What tax assumptions have you made in your retirement planning financial model?

Image Credit: Pixabay

12 thoughts on “More Favorable Retirement Tax Rate Revealed

  1. I am assuming current thresholds with a inflationary increases. Why are stock options taking a lot of tax. Are you gaining a lot more than your capital gains allowance? Can you not stagger them to reduce tax?

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    1. We are exercising them over 10 years. Stock options are taxed as ordinary income when they are exercised. Appreciation after the exercise are taxed at the lower capital gains rate.

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  2. My tax assumption (living in an all-blue state and a nation that spends far more than it takes in every year) is that taxes will become more burdensome than they already are. If the present is less punitive than feared, it’s a temporary pleasure. Once socialists realize the audacity of some citizens to reach FIRE, they will burn with anger at the “unfairness” and siphon as much value away from assets (through taxes) as possible. When no one is better off than anyone, their insistence on “equality” will be achieved.

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    1. I agree that is the direction things will likely head. Taxes in the USA are still much less than most other developed nations. Despite Senator Warren’s proposals, the Supreme Court has ruled many times that a ‘wealth tax’ is unconstitutional. That being the case, I hope to soon be income poor and live off of savings.

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  3. This week’s federal threat endangers future investment of capital by taxing unrealized gains now (before potential gains have been received). So it’s not a tax on what “wealthy” people have, but what they MIGHT have IF they did something they’re NOT doing (which is receiving investment consequences, either gains or losses, in the present rather than the undetermined future). https://www.wsj.com/articles/top-democrat-proposes-annual-tax-on-unrealized-capital-gains-11554217383

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    1. This guy running for President too? Haven’t heard of him. Only in the Democratic Party can it be considered to be a good strategy to announce tax increases as part of why you should be elected!

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  4. I’m planning that when I retire within 36 months that I will have ten years of cash to make up the difference between pension and current income, I have no mortgage. Tax rate is not so much of an issue with the cash cushion, my tax “problem “ is my dividend income. I know first world problem. My block to retirement is that I have a real problem with spending my nest egg. I had anxiety about pulling 529 money out of accounts to pay for kids college.

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    1. With that much of a cash cushion, you won’t have to worry too much about tax rates. That said, inflation is another ‘invisible tax’ government foists on us. When it’s only 2% a year, it doesn’t seem like much, but I’ve found it is one of the most sensitive variables in our FIRE plan.

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  5. Do you have any idea how much of the decrease in your tax rate was driven by tax reform? Even though I am still working and we earned about the same amount in 2018 as we did in 2017, our tax rate dropped by more than six percentage points to the lowest rate we paid since 2012!

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    1. Our income changed a lot, so I’m not exactly sure. Certainly the change in the top rate would have affected us had we made the same amount as the previous year. That said, our state and local taxes in Minnesota are extremely high – one of the highest in the country – so we got stung on the change in SALT deductions.

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  6. We also experienced our lowest Federal and State taxes in well over thirty years. We are in our second year of early retirement, and the new tax reform also had a big impact. We live primarily on rental income in early retirement, so depreciation shelters a large portion of our income. The new QBI deduction also provided us with a significant reduction, and we used the standard deduction for the first time in a very long time, as our house is paid for and we no longer have significant other itemizable expenses in retirement. We actually had our first refund in over thirty years…needless to say, I’ve already adjusted my estimate quarterly payments to make sure I’m not loaning Uncle Sam my money again this year! 😜 We have a few years before we reach 59.5 yrs old, when our other retirement accounts begin to kick in, so we are expecting to remain in a lower tax rate for the foreseeable tax future.

    To your commenters points… Hopefully the current tax reforms continue, and the future remains bright. If we can solve some of the immigration issues (to keep our population stable) and keep the economy percolating, I believe middle America will keep the current administration in place for four more years. With six more years of Conservative reforms, and I think Capitalism continues to win. Socialism simply doesn’t work. But we have to ensure America continues to provide opportunity for everyone. We can’t let the lowest 50% of the population become so desperate, that it opts for the false promises of Socialism. I think the key is education. We must, once again, educate the population on the conservative principals of personal finance, so they can win. We’ve lost this education in our schools, and let’s face it…in most of our homes. We (the FIRE community) are the exception. Blogs like yours help immensely, but we also need to formalize it in our public and private schools (IMO). The current education system (and Media) keeps our population ignorant of personal finance (and many other issues). I worry that it’s by design to keep the masses in line. We need to educate our future population on how to win, our country’s future depends on it.

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    1. Great comments, Thom – I couldn’t agree with you more!

      Personal Finance education is a really BIG deal. I see a lot of millennials and Gen Z folks very interested in the FIRE movement and frugal living. I’m hoping they are the silent majority of those generations and more than offset the socialist activists. Unfortunately, the parties tend to be controlled by the most extreme sides of their ideology.

      Recently I saw that a guy who biked from Coast-to-Coast spent the full day at my (and my son’s) former high school sharing his experience in different classes. I thought if they could make time for that, I wonder if they could make time for someone to share their FIRE experience and the principles that guided them? Something I will check into for sure!

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