Why I Don’t Fret About Taxes

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On either side of the aisle these days, it’s not politically correct to be ambivalent about taxes. If you lean to the left, you’re supposed to feel the tax code should be more progressive, that taxes should be higher on the wealthy and on corporations. And if you lean to the right, you’re supposed to think there should be less taxes, less spending, and less government, all around.

And, almost everybody wishes the tax code were simpler. Though, if you’re in politics or finance — an advisor or accountant, perhaps — you might privately feel that our horrifically complex tax code is just great and should be left alone. After all, fear and confusion related to paying taxes is one of the primary drivers pushing customers or voters in your direction!

But I’m not in any of those camps. I have no interest in pushing a particular viewpoint. I’m just an early retiree in the middle of the road, who lives frugally, and wants to keep life simple. I’m interested in the current reality we all have to live in for retirement, whether we agree with it or not.

So, perhaps it comes as a surprise, but taxes are just not a primary concern of mine right now….

Fair Warning: I Tend to Downplay Taxes

Recently a thoughtful reader wrote me with the concern that people reading my blog and looking at their 401(k) balances would think of them as equivalent spendable dollars, without first reducing the sum by an amount for the expected tax bite. He encouraged me to write more on this piece of the puzzle.

That’s a fair concern. I don’t claim any special expertise on or interest in taxes, and I purposefully don’t write about them much here.

Most of my analysis tends to be “after-tax,” meaning I’m generally ignoring tax implications. And I need to be clear about that. (I heartily recommend reading Mike Piper over at Oblivious Investor for real tax advice.)

Fact is I loathe taxes and tax maneuvers. My philosophy is to keep my financial life simple, live frugally at low tax rates, and then pay my share without squabbling. The complexity and conniving that our tax code seems to invite, always feels like a colossal waste of time to me.

The Tax Bogeyman

Sure, I’d love to pay less in taxes. But I have no great interest here in arguing whether our current tax system is fair or unfair, or whether certain segments of society should or shouldn’t pay more in taxes, or whether the government does or doesn’t know how to spend your money better than you.

That’s all beside the point here. There is such revulsion to taxes in this country that there is a tendency to overreact to their impact, especially at lower and middle income levels.

The main thing I want to communicate is that the current tax climate actually doesn’t impact a frugal early retiree leading a modest lifestyle very much. The facts are that the effective tax rate isn’t that high for the amount of income that many of us will require to live a comfortable retirement.

But a lot of people with agendas — from politicians to bankers to financial planners — want to stir you up into believing that taxes will make or break your financial success.

One retirement site goes so far as to say that the #1 goal of retirement savings and spending should be to minimize taxes. Sorry, but I’m just not seeing that.

Another respected site says that taxes are your single biggest expense. But I’m not expecting that to be true in our experience either. Looking at our budget, I think we’ll easily spend more individually on gas, groceries, health insurance, and travel than we will on taxes.

When I was a few months from pulling the plug on my career, I went to a free consultation with a local financial planner from a respected regional firm. When they ran the projections for my retirement they used a 20% effective tax rate on all our income! That was wildly inappropriate, as I’ll shortly demonstrate. It took a marginal tax rate (which was still too high), and applied it to all our retirement income, disregarding the substantial portion which would be exempt from taxes. The end result significantly overstated our tax liability.

The New Law

With the American Taxpayer Relief Act, recently passed to avert (or postpone) the “fiscal cliff,” tax rates have apparently been decided for the near future. In short, income tax rates and capital gains and dividend tax rates will remain the same for couples making less than $450K.

The lower echelon of tax rates on those married and filing jointly for 2013 are as follows:

10% on taxable income from $0 to $17,850, plus
15% on taxable income over $17,851 to $72,500, plus
25% on taxable income over $72,501 to $146,400

Elsewhere, a mainstream blog analyzing implications of the recent fiscal cliff deal, quotes a financial expert and accountant who warns that the new legislation will impact retirees and baby boomers who “rely on interest and dividends.”

But read the law: taxes on capital gains and dividends will only increase for couples making more than $450,000/year. As I’ll show shortly, that level of income is not remotely representative of the typical retiree. I, and most of my readers, know that you can enjoy a grand retirement on a small fraction of that much income. So to imply that the rise in tax rates somehow impacts more than a very tiny fraction of real-world retirees is either misleading or foolish.

Another blog, from a favorite conservative investment advisor, reports that taxes have “gone up on 77% of Americans.” More capricious and heavy-handed government? No, it’s primarily the restoration of the 2% payroll tax cut to fund Social Security. To call that a raise in taxes in disingenuous on several levels: first of all this simply restores the status quo from before the recession, secondly it’s funding an extremely popular program from which many people will ultimately draw more in benefits than they pay in.

The way I read it, at least for now, Washington continues to protect the middle class.

The Numbers: A Frugal Retiree’s Tale

My brief Reader Survey, which many of you have taken, asks: “Assuming your home is paid for, about how much do you think you would need to live in retirement?”

With many hundreds of responses compiled now, the median answer to that question is “$4,000-$5,000/month.” So let’s say that $4,500/month, or $54,000/year is the average cost of living for prospective retirees reading this blog, the amount of income they must generate annually to live comfortably.

(I am aware that if you live in an expensive area, or have a more luxurious lifestyle, your number could be considerably higher than that, and some of what I say in this article may not apply to you. On the other hand, for the many people who require even less in retirement, then what I say here is even more applicable.)

For tax year 2013, the standard deduction for a married couple filing jointly is $12,200, and the personal exemption is $3,900 each. So that makes exactly $20,000 of income, for a couple, which is not taxed at all.

For our average retired couple that leaves, worst case, $34,000 in taxable income needed to cover the proposed $54,000 budget. Given the tax rates listed above, the first $17,850 will be taxed at 10%, and the remainder at 15%. Run those numbers and that means paying about $4,200 in taxes annually, or about $350 a month.

That is, worst case, an 8% effective tax rate on the original $54,000 income. Most retirees will pay less, some much less. Why? For starters, that calculation assumed you had no tax deductions.

But in our case there is a more significant factor: A big chunk of our savings (about half) is in after-tax accounts, where only the new gains or income will be taxed. (Many other retirees will have Roth accounts with similar tax characteristics.) So, as early retirees, much of the money we will consume in the early years of retirement will either be taxed at a lower rate, as investment income, or won’t be taxed at all!

Just because you have an expense in retirement doesn’t mean you’re going to have to pay full income tax on a commensurate amount of income. The money for paying that expense could come via withdrawals from an already-taxed account or Roth, or it could come from capital gains which are taxed at a lower rate or not at all. Any qualified dividends or long-term capital gains that fall into the 15% tax bracket, or below, will not even be taxed!

The bottom line: I expect we’ll be paying an effective income tax rate of less than 5% in coming years. And frankly, given the other variables in the retirement equation — investment returns, inflation, Social Security, health care — that small percentage in income taxes falls well down my list of concerns….

This May Not Apply to You If…

Of course, there are some readers for whom this relaxed attitude towards taxes does not work.

If you live in a high tax state, then state income taxes could add substantially to the Federal tax I’ve been discussing. (Though you’d be wise to re-evaluate your retirement location if feasible.)

Or perhaps you have the good fortune to be living on a multiple-six-digit income in retirement. If so, congratulations on your success in life. And, yes, your taxes are probably going up.

The new law enshrines higher rates for couples earning over $450K. And couples who make over $250K will also get hit with some increases because of the new health care law. People in these groups may be required to make some lifestyle changes, if they have been consuming nearly all their income each year.

The Fate of the Middle Class

So far, the politicians have largely spared the middle class from tax increases. And that’s why I can write, as I do, that taxes are not a top concern for a frugal early retiree.

CNN Money reports that only 0.7%  of all taxpayers will experience a tax increase. Most people, including a “middle class” whose definition has been expanded significantly, will not be affected by the latest from Washington.

Will this be the case going forward? Will the middle class remain safe from tax increases?

Who knows? But I don’t personally feel great cause for alarm.

Because, even if the major middle-class tax breaks are gutted, that would be unlikely to impact frugal retirees much. Another CNN Money article reports that the largest target is employer health insurance, given that workers with employer-sponsored health coverage don’t have to pay taxes on the share of premiums paid by the company. The other two prominent middle-class tax breaks are the mortgage interest deduction, and tax-deferral of retirement plan contributions. And, almost by definition, none of those items would be likely to affect the lifestyles of those at or near retirement.

Yes, the U.S. is in debt and there are bills to be paid. There is a widespread belief that taxes will somehow go up on most of us in retirement. Yet one political party is committed to no taxes, while the other party is committed to raising taxes only on the wealthy. And the middle class is largely responsible for electing them both. I don’t see how that formula leads to tax increases on middle-income retirees.

I’m more concerned about back-door mechanisms like inflation — which I do fret about.

Parting Thoughts

So taxes remain a back burner issue for me, because they haven’t been pivotal in my own retirement yet. They may not be trivial, but a 5% expense is simply not going to wreck our budget, or change our lifestyle.

I understand that for others, especially those with bigger incomes to cover bigger expenses, tax impacts might be more substantial.

And, given all that, there is one final reason I don’t fret about taxes. Because, aside from running my financial life intelligently, preparing my tax returns, and voting, there is very little I can do about them.

So how about you? Politics aside, I’m interested in your practical concerns for taxes in retirement. How will they affect you? What hard numbers can you share?


  1. Darrow – Thank you so much for injecting a thoughtful analysis amidst the hyperbole and panic mongering so prevalent in the media. It’s good to have such a dependable voice of reason. Thanks for your continued efforts to bring your readers thoughtful commentary.

  2. Wow – what a great, straight-forward posting on the -real- story with our 2013 tax rates. I agree with your no-spin take on the new tax rates. (I am still shocked some are calling the Payroll tax snap-back as a tax increase — hello? Folks love SS, we need to fully fund it!). Keep up the great work – how about some thoughts on a future of raising interest rates/inflation? (Still 40-something and saving like a madman for an early retirement)

    • Thanks John. The quick answer to an inflationary future is to stay diversified and own assets that tend to keep up with inflation. Beyond that, I’m giving this a lot of thought as part of the “Can I retire?” and “Retirement income” questions. Hope to have more to say down the road. And best wishes for your mad saving. A high savings rate is the surest path to early retirement.

  3. Like you I do not worry about taxes. There is little we can do about the tax policy. I would not even care if they increased if there was a reduction in the waste in Washington.

  4. Great article. I stumbled on your blog a few months ago and have really enjoyed your viewpoint. I’m about 10 years behind you in the process.

  5. It’s unfortunate that the political noise distorts taxation reality, but you’ve provided a terrific service here by methodically showing why the tax issue is simply not the bogeyman it’s made out to be. In my own retirement planning, I’ve followed a few simple guides (which you, Mike Piper and others have espoused in other posts) — maximize tax-sheltered savings, favor tax efficient vehicles like index or low-turnover funds and largely favor longterm holding periods. Those are things the individual investor can control.

  6. I don’t see taxes being much of an issue as well with our household although we are only in our late forties and my wife continues to work. We have enough post tax investments to last us about a decade with no taxes due so when my wife finally decides to quit working then I’ll start transitioning some of the IRA money into a ROTH IRA in an attempt to minimize our lifetime tax obligation. With respect to how much money we will spend once we are both retired, I have a yearly budget of $65K (present day dollars) planned plus whatever taxes are due. The budget is $17K for health care/insurance, $22K for non-discretionary spending, and $26K for discretionary spending. The large discretionary spending category will provide us with quite a bit of flexibility in retirement since it can be reduced dramatically or completely if necessary.

    My experience with my lifetime of saving for retirement is that if you want the PRIVILEGE of being able to retire then you must live beneath your means.

    Darrow, thank you for providing such an excellent blog!

    • Thanks for the feedback Tom, and for sharing your retirement budget. That’s valuable information for others to know. And you’re right: Retirement is a privilege, earned through LBYM. Good to hear from you.

  7. Margie Johnston says:

    I think you may want to look at ALL the taxes we pay. Federal, state, property, real estate (doubled on us), purchases, etc. If we truly want a ‘fair’ tax code, we need to think about a flat tax, and I would recommend you read Steve Forbes concerning this issue. I don’t mind paying my fair share, and I would like to not worry about taxes, but as a retiree, I think it is a major concern. With a $16 Trillion deficit and shrinking workforce, tax increases on retirees seems likely, especially if we don’t reduce spending and bring down the deficit. We are frugal retirees (and were frugal when we worked also), and subtracting out our mortgage, our expenses are much higher then the medium that you quoted. Taxes do impact us as retirees, and impact decisions on where to live. You may not worry about taxes because the recent increase only hit those ‘wealthy’ people, but there aren’t enough of them to get the US out of debt and continue our exorbitant spending.

    • Looking at all taxes is a fair request. My post was focused on Federal income tax. Living in a low-tax southern state, the other taxes you mention are manageable here, but I understand that may not be the case for others. If your expenses are above average, you may want to review those with a fresh eye. Other than that, I just don’t want to get into politics or speculation here — I’m interested in specific numbers affecting retirees now. Thanks Margie.

  8. Thank you for exposing the marginal tax rate / effective tax rate obfuscation that some scare tacticians perpetrate. I believe most tax preparation software packages tell you on a summary page at the end of the calculations what your actual effective tax rate was for the tax year in question. While certainly spending patterns will change in retirement, you have outlined a clear-minded approach to thinking about the relative significance of taxes and inflation for informing decisions about retirement planning.

    I am still 18-20 years from from retirement, and with the present state of the nation’s economic affairs I am not optimistic about the long term stability of the current tax structure. So, I am favoring after-tax retirement investing as a means of ‘locking in’ current tax rates. Beyond that, I am in your camp, there is not much point in fretting about taxes far down the road.


  9. Great article! You’ve been upgraded from my spam email account to my real one. 🙂

  10. I’ve kept track of my federal taxes, including income and Soc Sec, as well as state taxes for years. For most of the last 20+ years or so my total federal taxes have been around 22-24% of Adjusted Gross income, usually a marginal tax rate of 25-28% being single. State income taxes generally run an additional 5-6 %. I do ok but I’m not exactly a rich guy. Taxes take a Big bite out of my income. They are a big expense!

    • Thanks for sharing those numbers Don. Looking at my records from when I was working, I see an effective Federal rate of from about 16% to as high as 27% one year when I was self-employed. But it appears to me those rates will be much lower now in retirement, as detailed in my post. We’ll see.

  11. Hello Darrow!

    I just discovered your site during my lunch time investment reading today, and I’ve been devouring posts ever since. Love it!

    It seems like we have very similar investment philosophies and backgrounds. I’m 47 and my wife is 45 and we’re both working toward the goal of retiring at 50. Coincidentally, I concluded a few years ago that an after tax annual income of $60k would be about right for us.

    Fortunately, I started investing straight out of college in 1987 (I’m an electrical engineer) , so I’ve got more than 25 years under my belt. I’ve also been focusing much of my efforts in the past 10 years on building post tax investments.

    I have one question that I am hoping you can help clarify for me. I get it that qualified dividends and capital gains are taxed at a zero rate for folks in the 15% and lower brackets (i.e., < $72.5k income married, 2013), and this is central to much of my tax planning. But what exactly happens if/when the income goes above that limit?

    I had a financial adviser at work tell me recently that capital gains and dividends are NOT treated progressively like other income. So in effect, when you hit $72,501, you are suddenly liable for 15% on ALL capital gains and dividends. So assuming all income is from dividends or capital gains, your tax bill would go from $0 to $10,875 because of that one incremental dollar!

    This makes no sense to me, and I have been searching the web for an answer for a couple weeks now (which is actually how I stumbled across your site). I am not a fan of most financial advisers, but this guy was provided “free” by my employer. And IMO, he was a text book fund salesman, so I took his advice with a grain of salt.

    Of course, I realize you are not an accountant, lawyer, adviser, planner, yada, yada…..But what’s you OPINION on this? Have you ever discussed it with a “documented” adviser?


    • Welcome Jay, glad you’re enjoying the blog, and congrats on your early retirement progress!

      Thanks for the interesting question. That’s one I’ve pondered in the past, though it hasn’t risen to the top of my investigation list until just now. First the caveats: not only am I not a professional advisor or accountant, but I’m not even particularly knowledgeable on tax matters. That said, here’s how I attempted to answer your question:

      I fired up my copy of TurboTax for tax year 2011 (the latest I’ve got), and started a test return. I went straight to the Capital Gains Speed Entry Worksheet and entered a sale with an $88,000 gain. Going back to Form 1040, I see that, after subtracting $19,000 for the standard deduction and two exemptions, that leaves a taxable income of $69,000. (The 15% bracket in 2011 for married filing jointly ends at $69,000.) TurboTax shows a tax due of $0.

      Next, I went back to the Worksheet and bumped the gain up to $89,000. Now Form 1040 shows taxable income of $70,000, so we are $1,000 into the 25% bracket for 2011. And TurboTax now shows a tax due of just $150. (Which looks right, since qualified dividends and long-term capital gains falling into the 25%-35% tax brackets are supposed to be taxed at 15%, and 15% of $1,000 is $150.)

      So, assuming I did everything right — a fairly big assumption when it comes to taxes — there is no “capital gains cliff” as you go above the 15% tax bracket.

      I hope that helps, but please don’t take it as gospel. I’d recommend confirming this on your own via tax software or a professional. And, whatever you find out, please let us know. It’s a question of great interest to frugal retirees living off their investment assets!

      • Thanks for the quick response. I hadn’t thought of trying that little experiment. I use TurboTax too, so that answer works for me!

        The disk for the 2012 version has been laying on my desk for a month or so. Maybe I’ll install it this weekend and see what it tells me. Since, I’m still shackled by the corporate chains, I have to put off stuff like that till the weekends…