The Lovely Low Taxes of Early Retirement

A sand island at the local lake, part of a recent “workday” with my boy.

Despite the occasional complaints voiced by those who feel they are Taxed Enough Already, I’m always pleasantly surprised at the low tax rates that US residents pay (myself included).

I guess it all depends on your frame of reference: the Canada that I left in the late 1990s had a marginal income tax rate of about 50% at the time, which kicked in at an income of about $60,000. I had almost reached the top tax bracket just two years out of school, which I found was a disincentive against going on to earn a much higher income. Since then, Canada’s tax rates have dropped drastically, leaving them much more competitive with the US.

But for this article, let’s see exactly how good or bad the situation really is, using the Money Mustache family as a case study.

Looking at my recently-filed tax documents, it looks like we had about $72,000 of income for the 2011 tax year. That’s a mix of the rental house income, dividends, a few carpentry projects for me, a bit too much part-time work for Mrs. MM as she helped some people through an unexpected crunch, a bit of blog income and some capital gains. It was an unexpectedly flush year, and we’ll do our best to earn less in 2012, lest the Internet Retirement Police start hassling us again about being “not really retired”.

Countering this rather large income was the $1000 child tax credit, tuition credits for little MM’s preschool, and of course the wonderful $11,600 standard deduction for two people married filing jointly.

When you add it all up, our Federal taxes (including social security and medicare) were $4884, with an additional $2211 of State tax for Colorado. So $7095, or just under 10% of the income went to the tax man.

That’s pretty reasonable, considering that it was such a bumper year of income. I’ve got Turbo Tax open in the other window right now, so let’s see what happens if I delete all the extra income and keep only enough to pay for our regular spending of $27,000. To provide a nice safety margin, I’ll scale everything so it adds up to about $30 grand. Here’s how I’ve got it split up:

Wages and Salaries: $19,000
Taxable Interest: $59
Ordinary Dividends: $373
Capital Gains: $5190
Business Income (Schedule K-1): $5501

Total:  $30,123

Now let’s pull the lever and see exactly what we would owe on this level of income:

Federal Tax: $654 (mostly self-employment tax)
… then subtract the $1000 Child Tax Credit to get:

Net Federal Tax: -346
Net Colorado Tax: $208

Total tax: Negative One Hundred and Thirty Eight Dollars.

Wow. That’s a pretty affordable tax bill, considering it’s on over $30,000 of income, still a relative shitload compared to what one needs to live a happy life in this country!

This is of course an arbitrary income mix caused by me hastily deleting things at random from my own tax return. But at least I have some wage, dividend, capital gains, real estate and business income like a normal early retiree might have. Let’s change it again to see what the situation would be for someone living entirely off of dividends:

Dividend Income: $30,123

Running it through Turbotax again, I get….

Federal Tax $0 (but apparently lazy people with no regular income do not get the $1000 Child Tax Credit, so no refund this time)
Net Federal Tax: $0
Net Colorado Tax: $322

Total tax: $322

This is an interesting result: the first case of regular income, even with the dreaded 13.3% “self-employment tax” comprised of medicare and social security contributions, is actually more tax-efficient than the dividend earner’s setup.

People using rental real estate as their source of passive retirement income will have it even better: The depreciation allowance effectively shields 30-50% of your rental income from taxes during the early years of owning a rental property. This benefit slowly fades away over a 30-year period and only then will you pay full income taxes on the rental income. I’m getting this benefit on my own tax return, but I excluded its effects from this article, to avoid confusing the issue and to allow an apples-to-apples comparison.

But in any of the above cases, the income taxes paid by a family like mine living  on a retirement-level income are still approximately zero. This is why I rarely mention taxes when calculating things like the safe withdrawal rate. The unfortunate folks who do their retirement planning with the “you’ll need 90% of your peak career income to sustain you in retirement” financial advisers will indeed need to plan for taxes. But we Mustachians will fortunately slip nicely under Uncle Sam’s radar.

Of course, many of us will accidentally earn more than we need even in retirement, and we’ll end up paying thousands in taxes each year because of it, just like I did this year. That’s a happy compromise as well, as long as you’re not an anti-tax activist. I’m aware that I’m using the many resources provided by this country, so I don’t mind paying taxes for them. But since my entire lifestyle fits within the Zero tax bracket, I am only paying tax on the surplus income.

That makes me feel like the whole situation is entirely under my control. I can continue the current course, which works well for me. If I later decide I hate the government, I can strategically earn less money so I pay negative taxes as described above.

If I still like earning lots of money in order to maximize my power to do good in the world, but insist on paying no income taxes, I can even structure my work into the form of a charitable trust or nonprofit. This entity would pay me just enough money to get by without paying taxes, and it would donate 100% of its remaining income, tax-free, to scholarships for underprivileged kids, or schools and health care for African villages, or even Face Punching machines to be installed in shopping mall parking lots.

The world becomes a blank slate to be used for your own enjoyment. It’s  just another example of the freedom you get in early retirement. And it’s just another example of why I don’t accept complaints about taxes around here*. Save your money, build your ‘stash, and then the ball is entirely in your court .. for life!

* politically-charged complaint attempts deleted from the comments section of this article so far: 18

  • ELF May 19, 2014, 6:24 am

    Reading this post and comments, I am half tempted to try living in the US for a while. As a Brit currently living in France I have to keep my income below 32000€ (about US $45000) otherwise my tax rate almost doubles (on all my income) and I am already paying over 30% on all revenue (nothing is deductible)! So if I earn 33000€ my post-tax income is less than if I earn 20000€ – how’s that for a disincentive.

    A carpenter here is classed as an “Artisan” and pays 60%!

    • ELF May 19, 2014, 6:34 am

      I should have added that despite the tax rates, I love France and feel living here is worth the cost of the taxes. I chose high taxes when I moved here, so I get the most from the French way of life and get by by being frugal on other less necessary expenses.

  • Israeli Semi-Mustachian November 7, 2014, 10:03 am

    A little late to the discussion, I know, but I want to ask something: If you live off unearned income (dividends, capital gains, and so on), are not paying into Social Security, and have not earned enough Social Security credits, doesn’t that mean you won’t qualify for Social Security benefits?

    • moo-stash January 17, 2015, 10:21 am

      To qualify for Social Security benefits you need only 40 credits, which is 10 years of paying into Social Security. MMM and MrsMM did have careers before the blog and probably have already amassed their 40 credits no problem.

      • Israeli Semi-Mustachian January 18, 2015, 12:46 am

        Thanks, moo-stash.

        Since I posted that comment, I did realize that.

        For the record, and for anyone else who reads this, we are referring to Social Security retirement benefits. You might not need 40 credits (aka quarters) for other Social Security benefits.

  • Dawgman December 27, 2014, 8:03 am

    I have been skimming through the MMM site/articles for the last year and really enjoy and admire the retirement philosophy. While I appreciate the frugality approach by most who comment on the various articles, I do believe the over all strategies and philosophy are relative and can be applied to various retirement incomes. Like many Americans, we all prefer to pay less taxes and employ strategies (legally) that will allow us to keep more $$ for ourselves in both our working years and our retirement years. So here goes my question… what creative tax saving strategies would a higher retirement income producer (assume $150K – $250K/yr generated from various assets such as retirement accounts, non-retirement accounts, & real estate? I realize this is a good problem to have, but none the less, employing and planning for such strategies helps all of us refine our number as has been reflective in some of the income examples provided (most under $75K/yr). Obviously, certain strategies which apply to all retirement income classes still apply… moving to a more tax efficient state, taking advantage of more tax efficient investments (i.e. real estate), elimination of payroll taxes, strategic rollovers of IRAs into Roth IRAs. There are some of us who have been extremely fortunate to make certain incomes, live below our means, have little/no debt, and save/invest with the intent of generating a certain higher level of income in our retirement years, yet still subscribe to the overall MMM philosophy. I would love to hear how people in this category might be reducing their tax burden?

  • DavidB April 14, 2015, 7:55 am

    Wow… I can’t believe how low your taxes are! I’m up in Ottawa (which you seem to be familiar with), and I end up paying more in taxes than most people earn in a year. I also can’t believe you’re paying only $25 a month for electricity! My bills this winter were $400 per month for heating oil and $200 per month for electricity. Perhaps I need to move down south where taxes are lower and the weather is warmer!!

  • Igor April 14, 2015, 6:33 pm

    I just found this site and read a few posts, including this one (“The Lovely Low Taxes of Early Retirement”).

    While it definitely is an excellent, original and thought provoking blog, I can’t help making the following comment.

    In this post you wrote that your 2011 income was $72,000 with standard deduction of $11,600. Also, with your family of 3, you should’ve claimed 3 exemptions. Therefore, your taxable federal income must have been $49,300. According to the 2011 federal income tax rates (https://www.libertytax.com/help-with-taxes-and-forms/irs-tax-forms-publications/2011-federal-income-tax-rates), for married filing jointly status the federal income tax alone on 49,300 should have been $6,545
    ($1,700.00 + 15% of amount over 17,000 for 17,000 – 69,000 taxable income range). And you also had to pay some self-employment, social security and medicare taxes. So how could it then be that “When you add it all up, our Federal taxes (including social security and medicare) were $4884”? Perhaps, you claimed some additional deductions on your 1040?

    • Mr. Money Mustache April 15, 2015, 6:18 pm

      Hey Igor – all data was from TurboTax, so I didn’t look into the details of it. But remember that much of my income is from capital gains, dividends, and rental house income (very large deduction due to depreciation). These tax at lower rates than standard employment income. That may affect your calculations.

  • Craig in Cary August 17, 2015, 6:27 pm

    One thing that MMM didn’t spell out in this article is that if you sell stocks (or other funds) that areNOT in an IRa or 401k, you will pay capital gains. The part not clarified is that the 15% tax on long-term capital gains applies only to the GAINS, not the whole amount sold and withdrawn.

    So, if you sell $20K of Apple stock that you’ve held since 1987, pretty much all of it is gains (you actually paid about $100 or less for it…probably less, actually!).

    But if you sell $20K of some other holding that you’ve only had a couple of years, your taxable amount is likely far, far less, because maybe $3000 or so of that $20K is gains. The other $17K won’t be taxed. Call it the downside of ridiculous run-ups like Apple’s, if you want. :-)

    Just something to keep in mind when planning your withdrawals…hope this helps someone!,

    • EarlyExodus September 23, 2015, 1:14 am

      This is a good point for holders of individual stocks, but also a stronger reason to use robo-advisors such as Betterment for a taxable account. Their tax-loss harvesting does those calculations for you and sells underperforming stocks first when making withdrawals. This will allow you to make withdrawals during retirement with a lower tax liability.

      MMM wrote a great synopsis of Betterment here:

  • EarlyExodus September 23, 2015, 1:07 am

    How does a negative Federal tax get handled for self-employed individual income earners (such as the -$346 in the scenario presented above). Does it carry over into future years?

    For example, my federal taxes are automatically taken from my paychecks, so if the government ends up owing me money at the end of the year, they cut me a refund check. But what about for self-employed folks that don’t have regular taxes taken out. What happens at the end of the year if their federal taxes are negative? Does the government still cut a check (i.e. $346), roll that negative figure to next year, or does the IRS just adjust it to ‘zero’ taxes owed and treat the next year anew?

    • Glen June 21, 2016, 7:20 pm

      Some credits are refundable and some are non-refundable. If you add a $2000 non-refundable credit to a $1000 self-employment tax, your result would be $0. But if it was a refundable credit (such as the EITC or additional child tax credit, IIRC) then you would get a $1000 “refund.” Any tax prep software will calculate this for you easily, but you might need the deluxe package if you have your own business. You can choose to apply your refund to your next year’s taxes if you like giving interest free loans to the government, but you are not required to.

  • Cindy March 10, 2017, 2:36 pm

    I’m trying to be hardcore and read all the articles from the beginning.

    This was the first time I just could not resist commenting. Anyone from the US, please stop complaining about taxes. Try living and working in Belgium where I’m from, we start with an income tax of 25% from €0 to €8710! It goes up from there to 50%. Do you hear me complaining? NO! I just keep my focus on the goal of early retirement and sure I will get there :-)


    • Larry July 5, 2017, 6:04 pm

      Cindy…. my guess is that in Belgium, you pay what seem to be high income and VAT, but that it includes things like health-care or health insurance for your family, maybe child credits, maybe free college education, beautiful cities and countryside, a safety net for the unemployed and a pension that allows you actually live above a subsistence level when you retire, (possibly at 55 or 60?). These things are all not included for most Americans… and they cost thousands of dollars per year on top of what are already not exactly “low” income tax rates in the U.S. If you add these expenses on top of our lower income tax rate, we would come up with easily a 50% rate. And for the 50% what are we getting? Endless wars, a bloated military machine, overseas military bases in 70 countries and the top 15% high-earners garnering more than half the U.S. assets and income. Oh, and two weeks of vacation!

  • Todd June 14, 2017, 2:38 pm

    I don’t want to pay high taxes (or none at all), but what’s not clear to me is in order to lower my taxable bracket, would it make sense to retire at the end of the year, so that next year’s tax season i can say that i’ve only earned income from dividends and capital gains. Whats the best procedure for declaring “I’m Retired”, and withdraw 4% for the year?

  • Keren July 4, 2017, 11:22 pm

    In Israel it is very different. Capital gains tax is 25% (or 15% for bonds). You can’t (to the best of my knowledge) have your capital gains taxed as income. As for rental, you pay no tax for up to 5K ILS, and above that you pay tax (not sure if it’s income tax or what. The government does not want people to invest in real estate, so it is very costly to own more than one unit, and even if you sell the place at a profit, you will pay dearly (I think it’s 25% of the appreciation). In 2018 I will sit down with a tax advisor accountant and see if maybe there are more efficient ways to pay tax for my earnings. In the meantime I’m doing well so no complaints here. I hope you USA citizens know how easy you have it!

    • Keren July 4, 2017, 11:25 pm

      *clarification: in Israel, for rental income, you pay no tax up to 5K ILS per month. So that’s 60K ILS per year.

  • AGQ1225@mrmoneymustache December 5, 2017, 3:56 pm

    Hi MMM,

    A couple questions:

    What’s your take on the upcoming tax reform? How do you think it will affect the average Joe, and if you had it your way, what would your suggestion be to the government on handling taxes? Do you think Capital Gains SHOULD be taxed at different rates than income?



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