The Amazing Tax Benefits of Semi-Retirement

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I spent a lot of the first decade of my professional life complaining about income taxes. But I never took time to understand how we are taxed, how much influence we have over our tax burden, and how friendly the tax code is to retirees, particularly early retirees.

decreasing income taxes

One of the first posts I read on this site was Why I Don’t Fret About Taxes. It was eye opening to see how tax friendly early retirement is. I was further encouraged when Darrow shared how low his income taxes were in early retirement in 2014, 2016, and 2018 with minimal effort to optimize them.

My wife and I are taking a phased approach to early/semi-retirement. She cut back to working part time in 2012, five years prior to my retirement. She continues to work in that same role since I retired in 2017.

Making changes gradually gave us the confidence and courage to begin making major life transitions sooner than we otherwise would have. How does it impact our tax situation compared to full early retirement? (Spoiler alert: the answer is in the title.) Let’s dive into the numbers.

The Challenge of Comparison

It was initially my intention to share numbers from our actual tax returns over several periods: a household with two full-time incomes, one full-time and one part-time income, and then one part-time income only. 

My goal was to provide an apples-to-apples comparison of taxation in these different scenarios. It quickly became apparent how challenging that would be.

My last year of work was 2017. In 2018, the Tax Cuts and Jobs Act significantly changed the tax code. This law lowered tax rates, increased the standard deduction and eliminated itemized deductions for us and many others.

Our personal situation changed as well. My wife’s income has steadily increased each year. I began working on this blog in 2018. 

My writing provides some self-employed income. As such, I am  now responsible for paying both the employer and employee portions of Social Security and Medicare taxes that I hadn’t as an employee.

We switched to a high-deductible health plan in 2017 and opened a Health Savings Account (HSA) that offers new tax advantages. Prior to that we’d never been eligible for a HSA.

We rented out our current residence during the second half of 2017 and first half of 2018, financed by a home equity loan with a variable interest rate. After breaking even in 2017, we sustained a substantial loss in 2018 when the interest rate increased. The loss decreased our taxable income that year.

Finally, we moved from Pennsylvania to Utah in July, 2018. Our state income tax rate increased from 3.07% to 4.95%.

Apples to Apples

It’s easier to demonstrate the tax implications of semi-retirement using a scenario based on our numbers while controlling key variables. This allows an apples to apples comparison to demonstrate key principles.

The assumptions about this couple are as follows:

  • Filing taxes as married filing jointly with no dependents
  • Each individual earns a full-time equivalent of $90,000/year 
  • Taxable investments create $12,000/year of qualified dividends
  • Taxable savings create $1,200/year interest
  • Each spouse when working may contribute to a 401(k)
  • One of the spouse’s employers provide health insurance as a benefit
  • The couple is not eligible to contribute to an HSA
  • Taxes are based on the 2020 tax code

We’ll address the following tax implications in a separate discussion below:

  • Filing taxes as a single person or someone with dependents
  • Using Traditional and Roth IRAs
  • Social Security and Medicare taxes
  • State income taxes
  • Tax implications of purchasing medical insurance in early/semi-retirement

I double checked tax calculations against the Federal Income Tax Calculator from Go Curry Cracker!.

Federal Taxes for a Two Income Household

In our first scenario, both spouses are working full-time. Total earned income is $180,000. Total taxable income with investments is $193,200.

The maximum contribution to a 401(k) account is $19,500 per person in 2020. Since both partners are working, the couple’s total contribution is $39,000 which lowers adjusted gross income (AGI) to $154,200.

You would subtract the standard deduction of $24,800 to arrive at a taxable income of $129,400. Subtracting the $12,000 of qualified dividends gives $117,400 of income which is taxable at ordinary income tax rates.

The first $19,750 is taxed at a rate of 10% for $1,975. The next $60,500 is taxed at 12% for $7,260. The final $37,150 is taxed at a rate of 22% for $8,173. The total is $17,408.

Qualified dividends are taxed at a rate of 15% for married couples earning between $80,000 and $496,600. The dividends generate an additional $1,800 of taxes. 

The total federal income tax paid by this couple is $19,208 on $193,200 total income. Their effective tax rate is 9.9%.

The Impact of Cutting Back Work

The second scenario reflects the impact of one earner cutting back hours. After the birth of our daughter, my wife cut back to 30 hours/week. 

Cutting back one spouse’s earnings by 25% reduces the household pre-tax income by 12.5%. But that income would have been taxed at the highest marginal tax rate, so what does this do to after tax income?

The couple’s total earned income in this scenario is reduced to $157,500. Total income with investments is $170,700. Subtracting $39,000 for 401(k) contributions lowers AGI to $131,700.

Subtracting the standard deduction of $24,800 leaves $106,900 of taxable income. Subtract the $12,000 qualified dividends. This leaves $94,900 taxed as ordinary income.

The first $19,750 is again taxed at 10% for $1,975. Then next $60,500 is taxed at 12% for $7,260. Only $14,650 is now taxed at their marginal rate of 22% for $3,223. The total is $12,458.

The qualified dividends are again taxed at 15% for an additional $1,800 of taxes owed. 

Their total federal income tax owed is $14,258 on $170,700. Their effective tax rate drops to 8.3%.

Working a little less allows this couple to keep about two more cents out of every dollar they earn.

The Impact of One Spouse Retiring

The third scenario reflects the impact of the full-time spouse retiring fully. This is what I did when I left my career in 2017. When married filing jointly, you can obtain a similar outcome if each partner worked 15 hours/week. 

The couple reduced their earned income by 62.5% from the first scenario. They pay tax on the remaining income at the most favorable rates.  

The total earned income in this scenario is $67,500. Adding in investment income brings total income to $80,700. Since only one spouse is working, they can contribute $19,500 to a 401(k), lowering AGI to $61,200.

Subtracting the standard deduction of $24,800 leaves $36,400 taxable income. Subtract the $12,000 qualified dividends. This leaves $24,400 taxed as ordinary income.

The first $19,750 is again taxed at 10% for $1,975. Only $4650 is taxed at the lower marginal rate of 12% for $558. The total is $2,533.

Qualified dividends are taxed at a rate of 0% for couples married filing jointly if taxable income falls below $80,000. Thus no tax is owed on this $12,000 of investment income.

The total federal income tax in this semi-retired scenario is $2,533 on $80,700 of total income. The effective tax rate is 3.1%.

The Tax Code is Much Friendlier to Low Earners

Semi-retirement allows you to earn a substantial amount of income and pay little in federal income taxes. You keep about seven cents more of every dollar you earn when compared to working full-time, everything else equal.

Semi-retirement also provides more time for your investments to grow. During this time, you eliminate tax drag on qualified dividends and long term capital gains.

The 0% long-term capital gains rate provides the opportunity to harvest capital gains, meaning more of your future income could be tax free with good planning. It also gives the opportunity for creative planning, using taxable investment accounts to produce tax free income to meet current spending needs while directing new earned income into tax advantaged accounts.

Getting Into The Weeds

Creating this apples to apples scenario is great for comparison and demonstration. But life can sometimes be messier. 

Let’s address some challenges as well as missed planning opportunities that were overlooked in this oversimplified scenario.

What About Singles and Kids?

When I wrote a post with similar tax planning scenarios in the past, a reader asked why I don’t include info for single folks as well. 

Taxes are complicated. I try to simplify things as much as possible by creating a single scenario in an attempt to avoid confusion.

The principles I outlined are universal. If you want to create your own scenario, here are the tax rates and income cut offs for 2020 summarized concisely. And here is a link to the free and simple income tax calculator I used to double check my numbers.

The other reason I tend to do these scenarios with a married couple filing jointly is… frankly because I’m lazy. As previously noted, this is based loosely on our own planning so it provides me familiarity.

However, I did make the hypothetical couple childless. That’s because kids don’t affect the calculations. They simply provide a $2,000 per child tax credit

If you have a dependent child or children, just multiply $2,000 by the number of children you have. Then subtract that number from the tax you calculated to get your final tax cost. 

What About IRAs and Roth IRAs?

I didn’t include IRAs and Roth IRAs because they also complicate the scenario. The ability to contribute to Roth IRA accounts and the ability to deduct traditional IRA accounts are dependent on your income in a given year. I couldn’t keep these variables constant for a fair apples to apples comparison.

Also, tax deductions are always more valuable when in the highest marginal tax rates. Roth IRAs are always more valuable for those with low enough income that they don’t pay federal income tax. In between, there is a gray area that is highly dependent on your personal situation

Working and earning less might provide more options to utilize these accounts to your benefit. Deductible contributions can be tremendously valuable for someone looking to lower taxable income to optimize for ACA subsidies (more on this below). 

A benefit we experienced was being able to fully contribute to Roth IRA accounts when decreasing our income as in the second scenario. Previously we had too much income to contribute. 

Someone who could not deduct an IRA when working full-time may benefit by being able to make a deductible contribution by earning less in semi-retirement. 

Another planning opportunity for a married couple is to contribute to each spouse’s IRA, even if only one has earned income. This could allow the couple to defer more taxation with a traditional IRA or have more tax free investments by contributing to a Roth depending on which made more sense for their situation.

What About Social Security and Medicare Taxes?

Federal income taxes are not the only tax that we pay. Federal Income Contributions Act (FICA) taxes are 15.3%. Employers withhold them from our paychecks. 

The social security portion is 12.4%. Employees pay half (6.2%) and employers pay the other half. Self-employed individuals pay both portions, the full 12.4%.

Medicare tax makes up the other 2.9%. Similarly this is split evenly between employees and employers. The self-employed pay both portions.

Unlike payroll tax which is progressive (as you earn more, you pay a higher rate of taxation), social security is regressive. You pay a flat tax on every dollar of income up to an income cap of $132,900 in 2020. Medicare tax is a flat tax, applied from your first dollar of income with no income cap.

This tax picture may not seem so rosy. However, unlike income taxes, which are a straight expense, Social Security Taxes provide a direct return to you in the form of benefits paid in retirement.

According to, “Social Security calculates your average indexed monthly earning during the 35 years in which you earned the most.” You benefit by paying more into Social Security.

Consider the following scenarios for someone contemplating early retirement with only 20 years paid into Social Security. 

  • Scenario 1: Work two more years earning $90,000/year, then retire 4 years sooner.
  • Scenario 2: Cut down to ⅓ time work now. Earn $30,000/year in semi-retirement for 6 years.

In either scenario, you would have paid Social Security taxes on $180,000 of income over six years, for an average of $30,000/year. However, in the second scenario you would have earned the $180,000 much more tax efficiently from the perspective of federal income taxes while potentially achieving a better life balance years sooner.

What About State Taxes?

I refrained from writing about state income taxes, again because of my desire for simplicity and clarity in these scenarios. State income taxes vary considerably. Seven states don’t tax income, eleven more (including the two where we’ve lived) have flat income tax rates, and the remainder have progressive tax structures.

Within that framework, rates vary widely as does policy on what type of income is taxed. It is best to first learn how your state taxes income. Then decide whether it’s even worth your time to develop a strategy for state income taxes. If so, develop one based on your circumstances.

States with progressive taxes may provide an opportunity to leverage the federal income tax strategies. States with a flat tax would be similar to thinking about FICA taxes. 

If thinking about relocating in retirement, you could consider opportunities for domestic geoarbitrage. However, tax planning is only one consideration and in my opinion far from the most important.

What About Healthcare?

Before I dove into the numbers on Affordable Care Act (ACA) Subsidies, I thought the biggest drawback to semi-retirement was that having earned income would make health insurance unaffordable. 

For this final point of discussion, I’ll share actual numbers from our 2019 tax return to challenge that assumption. Our MAGI last year was $73,000.

Plugging that number into the Kaiser Family Foundation Health Insurance Marketplace Calculator with our specific geographic location and family demographics (two adults and one child) reveals that we would receive a subsidy of $725/month and pay $595/month for a silver plan through the ACA.

This is more than we pay to purchase insurance through my wife’s employer. But it is still reasonable.

Because we weren’t buying insurance through the ACA, we did nothing to optimize our MAGI in 2019. I’ve outlined our current tax planning strategy. We could have contributed about $15,000 more to my wife’s 401(k) and contributed $12,000 to traditional rather than Roth IRAs. 

Lowering our MAGI by $27,000, from $73,000 to $46,000, would drastically increase our subsidy and lower our premium costs. Running the numbers with the lower MAGI shows we would pay only $270/month while receiving $1,050/month in subsidies.

***A reader, Mister DS, pointed out an error in the comments. Deductions for traditional IRA are added back to AGI when calculating MAGI. Thus the correct calculation would be based on a MAGI of $58,000. Insurance premiums would cost $425/month with a subsidy of $890/month.

We could then meet our spending needs by selling off investments with long-term capital gains which would be taxed at 0%. The capital gains do count toward MAGI.

For this reason, we’re working to harvest capital gains to increase tax basis now while our income is relatively low, but we aren’t yet relying on subsidies to keep insurance affordable. When we sell shares later to fund lifestyle they will be mostly cost basis, which is not taxable income, and less capital gains.

When choosing your own health insurance, you also have the ability to choose a HSA compliant high deductible plan and contribute to an HSA. Choosing to do so gives more control over your MAGI and thus your insurance premiums.

Semi-Retirement Is Very Tax Efficient

Making the jump from full-time work and a high savings rate to full retirement and drawing down assets is intimidating for many. We were among those afraid to plunge fully into early retirement.

Semi-retirement can feel a lot less risky and allow you to dip your toes into the water sooner than you may otherwise feel comfortable. I’m happy to share that this path offers many of the same tax benefits as full early retirement.

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[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. After achieving financial independence, Chris began writing about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. Chris also does financial planning with individuals and couples at Abundo Wealth, a low-cost, advice-only financial planning firm with the mission of making quality financial advice available to populations for whom it was previously inaccessible. Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He has spoken at events including the Bogleheads and the American Institute of Certified Public Accountants annual conferences. Blog inquiries can be sent to Financial planning inquiries can be sent to]

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  1. Hi Chris, nice overview. For state taxes, I had similar questions a couple years back and decided to do some hypothetical taxes for all the states in which I might be interested in living. The results were all over the map and some were surprising…especially, for example, the difference between California and Massachusetts, two high-tax states that treat the early retirement scenario completely differently. The results are here:

    1. P4J,

      Agree that you really have to dive into specifics of your situation. UT & PA have similarly flat tax rates and middle of the road as far as rates. However, they are quite different as to how they tax investment income and SS income. Also, UT has the higher income tax rate of the two, but property taxes are so much lower here and with our relatively low (and likely trending lower over time) income, the lower property taxes will likely mean an overall tax win for us over time.

      Thanks for chiming in.

  2. When first I retired, people could not believe how ow my taxes were. Since then, despite having increases in SS and my annuity, my taxes are lower yet. Bush cut them and Trump cut them again. In addition I am eligible of a larger standard deduction.

    This has all translated to a 2% overall tax rate. No FICA, State (Nevada), or Local taxes. Compared to working in Ohio – wow.

    1. Agree Shawn. I was shocked to learn how low taxes can be in retirement, or even in a situation like ours where we have a substantial amount of earned income.

      Some may argue that recent tax cuts have rates at or near all-time lows, which is a fair point. A solid counterargument though is that there is a lot of political rhetoric about taxing the rich, but little will to raise taxes across the board. As long as taxes are based on income and not assets, I think retirees will continue to benefit. If we ever have a massive overhaul to a system based on assets, then things could change I suppose.

  3. Although long-term capital gains are taxed at 0%, they count toward MAGI and may decrease any subsidy amount for the ACA.

    1. Excellent point Susan. Thanks for clarifying that point that I totally failed to mention. I’ll amend the article as soon as I get a chance.


  4. Thanks for the analysis. I have done similar scenarios, Currently, down to 32 hours per week. Have a fairly large IRA from multiple employers. My thoughts are convert as much of my and wife’s IRAs to ROTHs before we have to make the RMDs and stay in the 12% tax otherwise fall into the 22%. In our case we need less than 100K to live on. SS and pensions provide up to 75K. Goal now is to pay off the mortgage and eliminate a 14K expense. People don’t realize how good the Trump tax cut is for most people. Stay below ~100K, pat 12% on the margin. Live in a state that does not tax SS and your biggest expense will eventually be your property taxes.

  5. Thanks for an informative and helpful column, but I am confused about your thinking on the ACA. I wonder if if the Kaiser calculator is wrong, or if I am misunderstanding something here.

    My understanding is that the subsidy cliff for two people in 2019 is a MAGI of $65,840, four times the 2018 Federal Poverty Level. (I nearly had a train wreck on our taxes this year because I thought the 2019 cliff was based on the 2019 Federal Poverty Level and cut it a bit close!) I’m sure you know that if you go over the cliff amount by even $1, no more subsidy. I don’t think that MAGI amount varies by state on the continental U.S. For 2020’s taxes, the amount will be $67,640.

    So if your MAGI is $73,000, you are not eligible for any subsidy under ACA. This is the reality my husband and I have been living with for the last few years after retiring at ages 59 and 60 — very carefully keeping our income under the cliff in order to keep the subsidy. We have an HSA health care policy, and that deduction has been really helpful.

    I tried entering an amount of $66,000 on the Kaiser calculator and it told me that’s 390% of the poverty level — but I just don’t think that’s right and neither does TurboTax, based on my experience doing our taxes this year.

    So please straighten me out if I am mixed up on this! And thanks again for your blog, I really find it helpful.

    1. Jane,

      I appreciate the feedback and to be fair, we haven’t yet navigated ACA subsidies as we’re still on insurance provided by my wife’s employer. You had me second guessing myself so I double checked my figures against Go Curry Cracker! who also has an ACA premium calculator. I got the same results +/- a few dollars of what I had in the post per the KFF calculator.

      If you find something different where I am in error, please let me know and I’ll happily amend so as not to steer anyone down the wrong line of thinking. But I’m fairly confident that my numbers are accurate as I have a lot of confidence in both of those calculators.


      1. Hi Chris,

        Thanks for all the helpful information. Were you using more than 2 people when doing the HSA calculator? For 2 people I believe the cliff is $65,840 as Jane stated. If not I’ve misunderstood ACA’s website and need to be educated. Just trying to I ensure I’m not missing something.


        1. Ed,

          Thanks for the catch. That is the discrepancy. I stated in the article that I used our actual AGI in the calculator. I also reverted back to our actual situation and ran our numbers for a family of 3. If I take our daughter’s information out of the calculator, you are correct that our base AGI would put us over the subsidy cliff. For two of us with the tax planning to bring our MAGI down, our premiums would be $343/month with a $717/month tax credit.

          I amended that section to hopefully make it less confusing. Thanks again.

      2. It just dawned on me that you probably have a family (like Curry Cracker), while our kids are all grown up. So of course you have a higher household threshold than we do. So glad to understand why we got different results. Thanks a lot for getting back to me!

        1. No problem. I did change that to highlight my family situation. There was an actual error in that section related to calculating your MAGI. I corrected that as well to make it as accurate and clear as possible.

  6. Thanks, Chris. I always find great value in reading your articles. One thing; in the last paragraph of the section on healthcare, you mentioned that one can opt for a HDHP that allows the use of a HSA. However, I don’t think that’s always the case. The HHS sets its own out-of-pocket maximum for health plans under ACA. These maximums are generally higher than the IRS’s O-O-P maximums. The healthplan must meet the IRS rules (rather than HHS rules) to qualify as a HDHP and, thus, allowing tax-free HSA contributions. see a discussion near the bottom of this article []

    In my zip code (western PA), I found zero ACA plans that would qualify as HDHP under IRS rules.

    1. Thanks for the feedback Kalote. Every time I write about the ACA I get feedback that it works better or worse than I describe. Often I get both opinions on the same post. I’ve learned that there is great variability in the number of provider options and how well the system works in different states, and even different areas of the same state. I suppose I should learn to use more general language and not assume that the system works in practice as it should in theory.


  7. Great article. I plan to retire next year (63) and start rolling over trad. IRA’s to Roth. My only problem is this would put me in the 22% bracket which will cost a pretty penny seeing the majority of our assets are in regular IRA’s. I will have to determine that fine line that makes it worth the cost in order to avoid large RMD’S at 72.

  8. Hi Chris,

    There is certainly tax benefit to being in those lower brackets. I wrote a while back that if you happen to be a 4% groupie (like me), the 2020 standard deduction for a married couple is equivalent to a $572,570 portfolio. That’s even after paying Medicare ($360) and Social Security ($1,538) FICA taxes. Just another way of looking at it.

    Some easy reverse engineering will get you there. In other words, if you are willing to work just enough to fill up the standard deduction bucket, you could potentially reduce your portfolio requirements by about 572k. It is obviously nice if you have a skill set that can get you there with minimal effort or hourly commitment. Also, the income potential falls off as we get deeper and deeper into traditional retirement age (theoretically partially replaced by social security). But it can give younger retirees a higher confidence level in their approach (particularly in a lean FIRE scenario). It also seems like this is somewhat indexed for inflation as that standard deduction bucket grows.

    Oh, and if you are not a 4% groupie like me, just adjust the % / multiplier accordingly : )

    Happy Monday.


    1. Agree Max. And we spend about $50k/year and are super conservative, so that would reduce our 4% (Not feeling super) Safe Withdrawal Rate down to an ultra-safe 2% WR. The other part about just having to take the courage to start down the path to semi-retirement is, at least in our case, the hard part is not figuring out how generate $25k/year, but finding a way to make only $25k/year. YMMV.


  9. Awesome Article! I’ve been messing with ACA calculations for different scenarios for us lately since we’re close to FI, so it is nice to see someone else talking about it.

    One question/comment: From what I read, unlike 401k and HSA contributions, IRA contributions do NOT reduce your MAGI since to get MAGI you take your AGI and add back IRA deductions (among other things). Are you seeing the same thing, or is there some hack that I’m unaware of to use your IRA to reduce MAGI?


    1. Mister DS,

      You are absolutely right and I am wrong. As noted, I looked at our most recent tax return to get our MAGI. We did not have to add back deductions for my wife’s 401(k) contribution or our HSA contribution. I suppose I just assumed that IRAs are treated the same, but after double checking I’ve found this is one of the many quarks of our tax code. IRA deductions are added back to AGI when calculating MAGI.

      I will amend the post. Thank you for catching my error.


  10. Hi – thanks for this post! I see a lot of comments about MAGI and ACA subsidy cliff …you wrote, “ The capital gains do count toward MAGI.” So I see that MAGI is part of ACA subsidy eligibility and I know it is also used for savers tax credit. And it sounds like from comments that a Trad IRA contribution doesn’t reduce your MAGI?
    Is there anything else MAGI is used to calculate or determine eligibility?

    1. Stephan,

      This is a pretty good summary.

      Basically, what I messed up that readers have pointed out in the comments (and I’ve since corrected in the text) is that the amount you contribute to your traditional IRA is added back to AGI when calculating MAGI. 401(k) and HSA contributions are not added back, so I just assumed traditional IRA contributions were treated the same and didn’t bother to check. With the correction, my numbers were off. The larger points still stand. But the ACA subsidies are not as favorable as I initially reported.


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