Big Tax Savings due to Early Retirement

tax-keyboardNow that I’m retired, lots of things have changed, of course. One of them I have been expecting is the taxes I will pay.

Not only am I earning about one-third of my former income each year, but I’m not doing it from earned income.

On the tax-paying side, I won’t have a job deducting income taxes for me, so there are implications there as well.

To get a head start on all of this I sent a note to my CPA in December. I asked her about a few of the issues I thought might appear.

In the note I also asked about 529 plans. I covered that issue in What to Do When You Save Too Much for College.

Let’s get the conversation going. Here’s my initial email to her:

Hi, Wendy. I hope this email finds you well.

I have had a couple life issues over the past few months (both good!) and want to get some end-of-the-year direction to make the most of our tax return in the spring.

First of all, I retired in August! I will have a substantial income for 2016 (similar to past years) but in 2017 my income will drop to about $100k. Sources will be my rental units, interest and dividends, and my websites.

Given this, are there any implications for 2016? Probably not, but I’m sure there will be for 2017 (like will I need to make quarterly tax payments?). I’ll need any thoughts on taxes for 2017 before the beginning of the year.

I think that’s it for now. Let me know if you have questions and I’ll get back to you asap.



She responded:


Congratulations on your retirement! 🙂

To answer your questions:

For 2016 I wouldn’t anticipate your tax return being much different than in previous years.

Your refund will probably be less…given you only had one employer and there won’t be excess Soc Sec withholdings. This amounted to $4581 last year.

Otherwise, there shouldn’t be much difference as you’ve always had ample withholding to cover your tax liability.

For 2017 you will need to make quarterly estimated payments. In order to give you a projection for this I will need to know the following:

1. Rental income – can we assume same as last year?
2. Interest and dividends
3. An estimate of income/expenses for your website business
4. An estimate of charitable contributions

I can take a look at this before year end or you can give these to me when we prepare your tax return.

Once I get an idea of estimates needed you can decide if you want to carry forward any portion of your refund to cover those.

Let me know if you have additional questions.


My response:

Thanks, Wendy.

Here’s an estimate of what I think I’ll earn in 2017:

1. Rental income should be about the same as 2015 and 2016
2. Website income after expenses of about $5,000
3. Interest around $10,000
4. Dividends around $10,000

I think our charitable contributions will be low in 2017. We contributed $25,000 in mutual funds to a Donor Advised Fund this year so we can deduct it on our taxes for 2016 (as income is high). We will only disperse about $5,000 of that $25k this year, then disperse the rest next year. But since we will have taken the deduction for it all in 2016, there won’t be much (if any) in 2017.



Then she came back with the good news:


I’ve finished the tax projection for 2017…these are estimates only based on the information provided.

Federal tax = $2322 – projection sheet attached. Because you would fall into the 15% tax bracket there is 0% tax on qualified dividends.

There are variables here…

1. Education credits would be available since your income will be under the threshold for phase out.

2. The credit would depend on the amount of basis reported on the 1099-Q issued by the 529/ESA.

3. The maximum amount of credit is $2500/student, per year (maximum 4 years).

4. Depending on amount of the Education credit, your tax would be reduced…possibly to $0.

Colorado tax = approx. $50. The tax would be about $1165 but you get a credit for taxes paid to another state so that would reduce your tax almost nothing.

Michigan tax = approx. $1120

Please let me know if you have any additional questions.


My response:

That sounds awesome! After so many years of paying so much in taxes, I like this! 🙂

A couple questions:

1. I have roughly $500k in mutual funds in a brokerage account. I’ve accumulated them over the past 10 years and they have substantial capital gains. Are you saying I could sell them and pay zero in capital gains tax?

2. Can you explain how the education credit works in association with the 529 report?


She responded:

Only if your total income falls within the 15% tax bracket will you be eligible for the 0% capital gains rate.

Once you hit the 25% – 36% brackets, you will pay 15% in capital gains tax. And if/when you fall into the 39% bracket you will pay 20% capital gains tax.

State tax is a flat rate, you will pay this tax on any amount of capital gain.

The money you have contributed to the education account is considered your basis.

The education credit is calculated on the amount of basis used to pay for the education expenses.

Any gains within the account are not included when calculating the credit.

For example:

You contributed $2000 to the account, it has grown to $2500 and you withdraw all of it.

The education credit is calculated on the $2000 contribution (basis).

The credit is called the American Opportunity Credit. You qualify for the full credit if you pay at least $4000 out of pocket (this would be 529 basis….or cash you use).

The credit is split between what’s called a nonrefundable credit and a refundable credit.

The nonrefundable part is $1500 and is entered on line 48. If your tax (line 42) is less than $1500, then this part of the credit is limited to the amount of Line 42.

The refundable part is $1000 and is entered on Line 75.


Wow! Lots of good news here! Let me go through some of it:

  • As a high income earner, I have paid a fortune in income taxes through the years. Running a report on Quicken shows that I’ve paid over $800k in taxes (federal and state income taxes, Soc Sec tax, Medicare tax) in the past 10 years alone. In case you’re wondering, I have a professional doing my taxes so I know I’m not paying more than I need to. I’m not moaning about paying my fair share and certainly I earned a lot to pay that much. That said, that’s a HUGE amount of money. To now have to pay next to nothing is awesome!!!!
  • Because of my high income we were phased out of about every possible deduction/credit there was. Now to have the chance to get one is great!!! It’s about time.
  • The capital gains idea was given to me by ESI Money reader Glen in this comment and this one. My thinking is that I can sell most of the $500k or so in my Vanguard brokerage account. It’s mostly in their Total Stock Market Index Fund (Admiral shares). I’m thinking of converting that money into a dividend-generating fund. Right now I earn about $10k in annual dividends from this money or about 2%. If I could get it to 3% that’s another $5k. 4% is an extra $10k. Or I could buy a REIT fund. Or invest in more real estate. Any suggestions for how to turn this money from growth to income? (I have enough growth funds in my retirement accounts).

So overall, GREAT news all the way around! This certainly helps my retirement budget as well since I almost eliminate my largest expense.

I had a reader tell me that expenses in retirement would be far lower than I would expect and I’m starting to see this to be true. More on this topic to come!


photo credit: investmentzen Tax Keyboard Button via photopin (license)


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