62 Comments

  1. Love the way you applied the concept to your portfolio and did the math, Mr. Groovy!

    There’s a good chance we’ll land in the 15% tax bracket in retirement, too, making those qualified dividends and LTCG (mostly) tax-free. There are a couple states we could end up calling home – it’s worth looking at the state tax treatment of each. Bummer that NC taxes all of it.

    Stay Groovy!
    -PoF

    • Mr. Groovy

      LOL! Thanks, PoF. I got a headache this past weekend trying to figure it all out. But all kidding aside, I really liked your post on unequal money. It was an eye-opener for me. When we started our investing careers, we just put more money into our Roths and brokerage accounts than our workplace retirement plans. Don’t ask me why we did this. We just did. And thankfully it worked out. Tax-deferred accounts are great, but their tax bite hits you at the most inopportune time–retirement! And I hear ya about researching states for more favorable tax treatment. Mrs. G already has her eye on Tennessee. Thanks for stopping by, my friend.

  2. I currently estimate the tax on my accounts at my current marginal rate. I realize it’s way conservative but this gives me both a margin of error and avoids the complex questions that are too complex for now (rates can change between now and then for example.). It’s highly unlikely you’ll be in your current bracket if you retire early since you can structure your pay outs as you have done. There are even some states that don’t tax retirement income.

    • Mr. Groovy

      Agreed. Better to be way conservative than be deluded about your true net worth. Having a comfortable margin of error in today’s environment is more important than ever. Our government is pretty ravenous and it’s always on the prowl for fresh prey (i.e., something that’s not already taxed). Thanks for stopping by, FTF. Always a pleasure.

  3. This is a very important analysis to run, no doubt, because the tax man will still get his. We’ll hopefully avoid some capital gains tax by staying in the 15% tax bracket and maybe consider living in a state that doesn’t tax retirement income. A lot of our money today is going into traditional retirement accounts that will be subject to income tax eventually though.

    • Mr. Groovy

      Agreed. It is a very important analysis. I only just started looking into this, so what I’m about to say in coming out of certain part of my anatomy. But I think as a general rule, the average person should limit his or her 401(k) balance to thirty-three percent of his or her portfolio or less. Once this threshold is reached, he or she should shift retirement contributions into Roths and brokerage accounts. I’m curious what the FI community thinks about this guideline. Thanks for stopping by, TGS.

      • I wouldn’t necessarily recommend against limiting tax deferral while working. Particularly for physicians and others in the higher tax brackets, it’s worthwhile to defer all the tax you can. For me, that’s $18,000 in a 401(k), $18,000 in a 457(b) and $6,750 in an HSA.

        If you can do that, and still put enough away in Roth and taxable to make the tax deferred investments 1/3rd of your holdings, that’s a great thing, but to do so requires a generous salary and a high savings rate.

        • Mr. Groovy

          Thanks for the clarification, PoF. While keeping tax deferred investments to 1/3rd of your holdings is preferable, it may not be feasible.

  4. Very interesting analysis. I’ve never thought about my retirement money quite that way, but it makes a lot of sense. One of the “benefits” of having multiple health conditions is that your medical expenses provide a nice deduction to counterbalance your taxes. As a result this hasn’t been a big issue for me, but in the planning stages I can see where it would be important.

    • Mr. Groovy

      Hey, Gary. I never thought about this either. Kudos to PoF. It’s not a bad exercise if you got an afternoon to kill. Thanks for stopping by, my friend. Sorry about the health conditions. But at least you can use the expenses for those health conditions to counterbalance your taxes. Every once in a while, our government gets something right.

  5. This is a good question to ask.

    Same here in Belgium: some accounts are not mine until a certain age (and some taxation at that age). Things can change fast. Just recently, they started taking an advance on what I need to pay in 2043… Talk about a trustworthy government.

    That is why I stopped a certain investment that has tax advantages, and thus disadvantages.

    • Mr. Groovy

      Hey, AT. You’re experience doesn’t surprise me. Western governments are heavily in debt and it’s getting worse. So they’ll always be tweaking the tax code in effort to eke out just a little more revenue. At some point I think they’ll shut down the Roth IRA over here. Sigh.

  6. Thanks for breaking this down, PoF post was great and got me thinking along similar lines. It’s to early for us to do the calculations, but we can keep playing the tax advantage game now and plan to be in the lowest tax bracket at retirement.

    • Mr. Groovy

      Hey, AE. I agree. The key is to save as much money as you can. If you can keep the tax-deferred portion of your portfolio below 33%, great. If you can’t, it’s not the end of the world. Tax-deferred money is still pretty much protected from the government’s ravenous maw if you’re income poor in retirement.

  7. Almost all our investments are in Roth’s and Mr. Mt’s military pension is tax free. But we would take a big tax bite if we sold our rentals, and we still have to pay taxes on the rental income. Although with 5 kids, and such low taxable income, it’s a wash at this point. =)

    • Mr. Groovy

      Hey, Ms. M. It’s good to hear that our government is still taking good care of our vets. The feds could probably do a little better with the tax credits for children, though. Sigh. Quick change of subject. I’m not rubbing it in, but it was 69% here in Charlotte today.

  8. Great point! Many investment accounts are taxed (in different ways and at different rates), which makes some of that money “not really yours.” I prefer to invest in my Roth IRA. I’m not able to max it out yet, but I like its flexibility. I also don’t know what taxes are going to look like when I’m ready to withdraw those funds, so I prefer dealing with the devil I know and paying taxes upfront.

    Unfortunately Mr. Picky Pincher’s job just switched their HSA to an FSA, so we have to re-learn the rules for that type of account. Now that we’re homeowners I’m looking for different ways to decrease our taxable income. I hate that we went up an income bracket this past year, so that means we’re taxed at a higher rate, which totally sucks.

    Once we pay off our debt we’ll start to heavily invest. I’m leaning more towards index funds and real estate for our passive income.

    • Mr. Groovy

      Sorry to hear about Mr. PP’s HSA. I love the HSA. My company finally gave us that option three years ago. If I had it 20 years ago I’d really be set. Roths too are great if you can forego the immediate tax savings. Mrs. G and I gave real estate a try for a couple of years and decided it wasn’t for us. I think being a landlord is more about managing people than managing property. My supervisor at my government job was heavily into real estate and loved it. He was a great reader of people and loved dealing with problems big and small. Keep me posted on your real estate adventures. I’m curious to see how you find it.

    • Bummer on the switch from an HSA to a FSA.

      FSAs (Flexible Savings Accounts) are not nearly as advantageous as HSAs. If you don’t use up your FSA each year, you will lose all the funds. Therefore, they cannot be used as an investment vehicle like HSAs.

      • Mr. Groovy

        Exactly, Live Free. I love the HSA. I’ve had it for 3 years now and I have over $13K in my account. If I had it my whole working life I’d easily have $100K in it. Sigh.

  9. This is a nice exercise to see all your accounts from the viewpoint of taxes. Over time it looks like ours will change a bit like yours because of capital gains taxes, Roth IRA laddering, and moving things around in the future. It’s good to keep this in mind as you get close to retirement! I’m not keen on the government owning any of my money, but something we have to work with. Hopefully the tax code will still be favorable to early retirees when we get there!

    • Mr. Groovy

      I kind of knew there were tax ramifications to my portfolio, but they were always in the back of my mind. I think everyone should try this exercise at least once to see where they stand. When I began it, I was a little worried. I don’t like the idea of the government owning any of my money as well. But when I was done, I saw that the government’s cut was relatively small. It was also nice to see that I had some control over my tax exposure by timing capital gains and limiting withdrawals. But, man, did my head hurt. So many variables. And in 10 years, when we start to collect Social Security, it will be even more complicated. I have my fingers crossed. I think the tax code will remain favorable to early retirees, providing they have a low income. Thanks for stopping by, SS. I really appreciate your thoughts.

  10. OMG!! I totally never thought of it this way and missed PoF’s post on it. This is having me rethink my strategy.p – I want all the money to be MINE!! I have both a Traditional and Roth 401k at work. I used to split continuations then last year switched to all Traditional thinking it would save my taxable income and later I would convert it. But now I think I will switch to all Roth. I can keep what’s in the Traditional for the years I am past 60. I should have plenty to cover me in my Roth until then…especially with FI and that little 4% rule…I may never have to touch the trad anyway! Great post – mind blown.

      • Mr. Groovy

        Couldn’t agree more, Wes. PoF nailed it with his unequal money post. So glad I found it. The concept definitely wasn’t on my radar.

    • Mr. Groovy

      Haha! I love your rebellious spirit, Miss M. Obviously, Roths, savings, and brokerage accounts give you the best shot at keeping your tax exposure manageable. So if you can go all Roth, it something to seriously consider. Your ultimate nest egg will be smaller, but it will be ALL YOURS!

  11. Not sure how I missed that PoF post, but thank you for this one. I’m suddenly nervous about my allocation, although I do live in WA which has no state income tax, so that should ease the blow a bit.

    Still shaking my head though – how have I never looked at money through this lens before??

    • Mr. Groovy

      “Still shaking my head though – how have I never looked at money through this lens before??”

      You and me both, Ty. It seems so obvious now. PoF definitely deserves a pat on the back for this one.

  12. There is some great software from LifeYield (https://www.lifeyield.com/) that can help you harvest and rebalance in a tax efficient manner. They have the world class capability in the space, but you’ll likely need to find one of the advisors they work with to get access. I can vouch for the principals and one of the founders is the son of a Nobel economist and brilliant.

    Great piece and well dissected!

    • Mr. Groovy

      Thanks for the your kind words, Ian. And thank for the tip. Hopefully more financial advisers will make this kind of analysis standard practice for their clients. There are just too many moving parts for the average person to minimize the government’s claim on his or her portfolio. We really need the professionals to step up and fill this void.

  13. Excellent calculation! I think this is a good way to look at your portfolio, with the future in sight. I like the hands on calculation applied from PoF’s post. Thanks for burning an afternoon to show us how it’s done! Now I’ve got to find some time to look at my portfolio this way.

    • Mr. Groovy

      Thank you, Kraken. I just hope I got the calculations right. I was even going to provide another table with our projected Social Security benefits factored in. But my mind was fried. Perhaps I’ll revisit this topic in six months and deal with Social Security. What fun! I can’t wait!

  14. Nice analysis! The real value of course is when you compare this to actual $$ and the future value of all of these accounts a they keep growing. The actual relative % of government ownership will change based on your variable tax rate (based on the quantity of the investments you full out during retirement). A long way of saying that you can effectively significantly lessen the “government burden” based on how you withdrawal the money! Given that I am 32 I have done a similar analysis (thanks PoF! and FIG!) and the actual “government ownership” ranges between 4%-31% depending on how I would withdrawal the money. Great exercise for all of us nerds!

    • Mr. Groovy

      Haha! This is definitely a nerdy exercise. Excellent point about how government ownership is affected by withdrawal rates. And as long as you’re conscious of this variable, you should be able to take advantage of it. Thanks for stopping by, MM.

  15. I have very little in traditional myself, but let’s not kid ourselves, if the government needs revenue because the RMD withdrawal well dries up, they will find a way to tax the Roth’s or tax the taxable accounts more.

    Maybe I’m just cynical. 😀

    • Mr. Groovy

      Not cynical at all, my friend. That $19 trillion and growing debt looms large. My suspicion is that they’ll do away with the Roth or cap the contributions to it before they start to tax it. We’ll see, of course. The next couple of decades should be interesting.

  16. We’re hoping we can tuck our savings away and it will grow enough that the taxes will be irrelevant. If we withdraw less than 4% (ideally 0% for the first decade at least. We’ll make enough for our expenses but stop saving extra) then there’s a good chance that we’ll die with more than we have when we stop saving.
    The best laid plans… well, one can hope, right?

    • Mr. Groovy

      I love it, Julie. If you can withdraw 0% for the first decade of your retirement, I don’t see how any conceivable government ownership of your portfolio will hurt you. That’s freakin’ fantastic.

  17. Very interesting perspective. Currently, my goal is to defer taxes. So, we try to max out our 401k contributions.

    Investing in real estate is a good alternative. If one purchases a property for $100K and it appreciates to $200k in a 20 year period and the individual dies and the kid gets the property, the cost basis for the property would be reset to $200k for the kid. Thus no capital gain taxes.

    Now, the property would however become part of the estate and would be subject to estate taxes which is non existent for assets below ~$5M in value.

    • Mr. Groovy

      Looks like real estate would resolve most of the government’s ownership issue. And great point about the stepped up cost basis for your children. That’s a great way to mitigate the government’s tax bite. Thanks for stopping by, Michael. I really appreciate your perspective. It will definitely give people hope.

  18. Great analysis, and an important thought. Most of our investments are in brokerage and IRA. Or they are in real estate, which is harder to nail down the worth. We get taxed on profit but can claim depreciation and mileage when Jon does repairs, etc. I guess we need to do some math.

    • Mr. Groovy

      As long as one can stomach being a landlord, I think real estate would be a nice addition to one’s portfolio. As you and Michael point out, its peculiar tax advantages can definitely reduce the government’s overall claim on your portfolio. And more importantly, it’s a stream of income that is never going away. How handy will that be if the feds are forced to reduce Social Security and Medicare benefits in the future! Thanks for stopping by, Emily. I’m curious to see where you and Jon stand vis a vis the taxman. Let us know when you find out. Cheers.

    • Mr. Groovy

      LOL! A similar thing happened to Mrs. G and me. When we started investing we put a majority of our money into Roths and a brokerage account. Don’t ask me why we did this. We didn’t start loading up on our 401(k) and 403(b) until four or five years ago. Again, we have less than 1/3rd of our portfolio in tax-deferred accounts because of dumb luck.

  19. This post reminds me why I put as much into a Roth as I can. My wife & I need to start putting money away into an HSA as well, but, haven’t quite made it there yet.

    • Mr. Groovy

      Hey, Josh. HSAs are great, especially if you’re young and healthy. I wish I had access to one when I was younger. With just a little forethought and effort I could have easily put $500 a year into an HSA. Had I done that for 30 years, I would easily have $50K available to supplement Medicare. Meh.

  20. I continue to be confused by Roths and Traditional IRA’s. I have both – accidentally. I opened the Roth and my dad yelled at me and was all like “WRONG! Never have faith in future tax breaks!” So now my money is mostly in a traditional IRA. Which is better… money taxed on the way in, or on the way out?! Presumably I am in a higher tax bracket now. So confusing!

    • Mr. Groovy

      I can’t say your dad is wrong. Government at all levels is deeply in debt and will therefore always be looking for new things to tax. How long will it be before the government turns its covetous gaze upon Roth IRAs? It’s such a damn juicy target! But then again, the American people can only take so much. Start taxing Roth IRAs and the Whiskey Rebellion might look like a game of tiddlywinks in comparison. If I were a betting man, I would say Roth IRAs are safe. A country that put Donald Trump in office is itching for a fight, and the politicians know this.

  21. Oh gosh…why did you need to break it down like this. I must’ve missed that post by PoF. This does not make me feel good about our progress. Thanks for opening up my eyes to this. We will definitely incorporate this kind of thinking into our future financial steps.

    Mrs. Mad Money Monster

    • Mr. Groovy

      Agreed Mrs. MMM. Saving is still a lot better than not saving. So tax-deferred accounts aren’t total villains. They’re just, as you commented, something to keep in the back of your mind. If you can manage to put more savings into a Roth or a brokerage account, great. If you can’t, not the end of the world. PoF’s post was a real eye-opener. Glad I caught it too.

  22. I caught PoF’s article, and agree with you that it was original. Great “add” by applying the math to your $$.

    Unfortunately, I didn’t have a Roth in my 401(k) for my first ~20 years, so I’m over-weight on Traditional IRA. Trying to make up for it now, but hurts contributing to a Roth while in a high tax bracket. Ah well, regardless, great way to look at your portfolio!

    Tax Diversification. Important stuff!

    • Mr. Groovy

      I love your spirit, Fritz. And something tells me that despite your portfolio being heavily weighted with Traditional IRA money, you’ll handle this retirement thingy with tremendous aplomb. Tax diversification surely complicates retirement planning. The real complication as you’ve so eloquently expressed before, however, is healthcare. The next couple of decades should be interesting, my friend. Thanks for stopping by.

  23. When are they going to really up the IRA contribution totals for the year? This $500 every year or two is not sufficient. I would rather this go up than the 401(k). Great presentation of the data.

    • Mr. Groovy

      Excellent question, Brian. Mrs G has been saying that for years. Why is the IRA allowance so much smaller than the 401(k) allowance? The IRA allowance, including the catch provision, is less than a third of the 401(k) allowance–and that’s not even taking account of the company match. Hello! McFly! We supposedly have a savings crisis in this country.

      • Exactly. Forget about employer-sponsored retirement accounts (401k, 457b, etc.). Just give everyone an “Individual Retirement Account”, allow pre-tax contributions to some high level like 50K per year, and maybe we could reduce the need for social security.

        • Mr. Groovy

          Love the cut of your jib, Live Free. I don’t get it. Does our government want us to be dependent serfs?

  24. Running through my math it looks like the government can tax 60% of our portfolio while 40% of our portfolio has already paid taxes 🙂

    Hopefully being in the 15% tax bracket that means that we own 91% while the government owns 9%. My math may be shaky but it’s a little early in the morning for me 🙂

    Great post btw…really enjoyed reading it and really got me thinking!!!

    • Mr. Groovy

      Thanks, MSM. Agreed. It’s a nice exercise to run your portfolio through. I think as long as you’re in the 15% tax bracket or lower, you’re in good shape. What really complicates matters is when Social Security is thrown into the mix. My analysis didn’t go there. Perhaps I’ll do a follow up post and see how Social Security affects my portfolio ownership. I gut feeling is that the government will own more of my portfolio, but not a devastating amount. We’ll see. Thanks for stopping by, my friend.

  25. Good approach to knowing the true ownership costs. What I do is that I simply “deduct” a fixed percentage of my pre-tax assets based on estimated tax bracket in financial tracking spreadsheet so the government portion is already considered. Also, for MFJ status, you can shield upto $90K of dividends and capital gains practically federal tax free. That’s a lot of dough and if you are pushing beyond that figure, you must have a massive portfolio. Then, you ought to pay!

    • Mr. Groovy

      Thank you, TFR. It was a fun exercise. And great point about MFJ status. The capital gain loophole is awesome if you’re in the 15% tax bracket or less. Top of the 15% tax bracket ($75,300) minus your AGI equals the tax-free capital gains spread. Next year, Mrs. G and I will have an AGI of approximately $10K. This means we could have a capital gain up to $65K and owe zero federal taxes on that gain. Pretty groovy.

  26. Have you read “The Power of Zero” by David McKnight? I would highly recommend it. The book details strategies to get into the 0% tax bracket in retirement, including how to deal with social security payments. Getting to the 0% tax bracket isn’t feasible for everyone, but the concepts on how to lower your tax liability are super interesting.

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