What If

These are probably the most important pages on this website!

We are all used to telling our employer how many exemptions we have so they can make the proper tax deductions during the year. For most of us the first time we look at our potential taxes is in January of the following year when we get our W-2s in the mail.

We can do basically the same thing during retirement, but now that we have seen what our Personal Tax Hump looks like and realize that we can save thousands of dollars each year if we avoid those extreme marginal tax rates, we should all consider doing the opposite! Start doing your tax calculation this January, not next January, and keep asking yourself What If every time you decide to create extra taxable income!

Use the following links to examine the details of each of these
What If situation that you could be facing during your retirement.

  • You prepared properly for year end unexpected income.
    • 22.2% You received a taxable bonus or short term gains.
    • 10.2% You received some long term capital gains.
  • You did not prepare for year end gains and some of your income was LTCGs
    • 49.95% You received a taxable bonus or short term gains.
    • 37.95% You received some long term capital gains.
  • You did not prepare for year end gains and none of your income was LTCGs
    • 40.7% You received a taxable bonus or short term gains.
    • 33.7% You received some long term capital gains.
  • Break Even Detailed examples after Federal, State, and Local taxes.
  • QCD Detailed example of a Qualified Charitable Distribution.

Let's take a closer look at the Break Even Calculations
Iím not a tax accountant, so use everything on this page at your own risk!

The numbers for this first example are very specific so that the math will be easier to follow. This is an example for a single individual with an average inflation adjusted income of $54,860 over the top 35 years of their employment. Their PIA, Primary Insurance Amount, will be exactly $2,000 a month, $24,000 a year, at their normal retirement age. If they decide to start their benefits exactly 4 years early their SSB rate would be 75% or exactly $18,000 yearly. Regardless of where their money is coming from, they want their retirement lifestyle income to be $4,000 monthly, $48,000 yearly, after all taxes!

The spreadsheet supplied on this website ends at column J. This example adds columns L through N for the calculations of your personal State and Local taxes. Since there are 50 States and over 3,000 Counties, not to mention how many Cities have income taxes, the creation of these additional columns is totally up to each user! The marginal tax rate for Maryland taxable income from $3,000 to $150,000 is 4.75% plus 3% for Cecil County.

This break even calculation, after all taxes, begins by entering the larger Social Security benefit, in this example $24,000, in cell C6. You then enter a series of SWAGs (Scientific Wild Arithmetic Guesses) as the amount of other taxable income in cell C4. As you enter each SWAG, your Federal tax will be calculated in cell H19 with your After Federal Tax income in Cell H20. The numbers are carried over to column L, the Federal taxation of your Social Security is reversed, and in this example your Cecil County Maryland Tax is calculated in cell L13, which is then subtracted from the after Federal tax income from H20 giving you your after Federal, State, and Local tax Lifestyle income in cell L15. Just keep SWAGing until cell L15 is exactly your desired $48,000 after all taxes Lifestyle.

You can modify the spreadsheet to make life easier for your SWAGing. Cell C7 = L15, the current Lifestyle result based on your current SWAG in C4. C8 is the Lifestyle you want. C9 is the sum of your current 22.2% Marginal Federal Rate + 4.75% Maryland + 3% Cecil County. C10=(C8-C7)/(1-C9) is the complex calculation the additional Lifestyle you need, divided by your after marginal tax rate. C11=C4+C10 then you just add the additional needed income to your current SWAG to get a good idea for your next SWAG.

Once this is done, enter -$6,000 in cell E6 so that the Social Security income level in cell J6 reflects the earlier retirement benefit level, $18,000. Change C7=N15 to look at the What If lifestyle and C11=E4+C10 to look at the What If SWAG; Then you can start SWAGing at the amount of additional taxable income that will be necessary in cell E4 so that your after Federal, State, and Local taxes will result in the same $48,000 (cell N15) retirement lifestyle.

Lets do a quick overview of this Break Even example!

Using your Gross Social Security, L25 says you are getting 75% of your larger benefit if you retire early, L26 you will get $72,000 from Security in the first 4 years, L27 then you will start getting $6,000 a year more if you had waited, and L28 the simple division of $72,000 / $6,000 says you will Break Even in exactly 12 years! This number will ALWAYS be the same because you always get 75 cents on the dollar when you retire 4 years early.

Using your Net Government Income calculated in cells L17 thru N20, N25 says that you are only getting 58.31% of your larger after all taxes benefit, N26 you are getting $45,481 in the first 4 years which is $26,519 less because of all the taxes you are paying, N27 then you will start getting $8,129 more each year which is $2,129 higher because you pay more taxes on the lower benefit, and N28 N29 break even is only 5 years and 7 months, which is less than half the time that everyone talks about when they are using your Gross benefit instead of your Net benefit.

Taking a closer look at the changes between the larger and smaller SS benefit levels: Your SS benefit is $6,000 less; which requires $8,129 of additional taxable income; which raises the basis for the taxation of your SS benefits $5,129 ( -6000/2 + $8,129); which increases your taxable SSB $4,360 ($5,129 * 85%); which increases your taxable income by $12,489 (line 4 + line 10); which increases your Federal Taxes $1,499 ($12,489 * 12%). The remaining $630 comes from the marginal Maryland 4.75% tax rate plus 3% for Cecil County, which is calculated on only the $8,129 additional income because Maryland does not tax your Social Security benefits.

The graph of this example indicates that the early retirement Marginal Tax rates do not include the 40.7% marginal tax hump. The distance between the taller solid and dotted Gross Income 20% tick marks illustrates the amount of additional Tax Dollars that are necessary when your Tax Delayed Social Security benefits are replaced with other taxable income. In this first example both Marginal Tax lines indicates that all of the additional taxable income is being taxed at the 22.2% Marginal Tax rate.

Bottom line; if your target is a specific retirement lifestyle which will have a specific after tax cost, replacing your Tax Delayed Social Security with Taxable income will be very costly!

What happens if the Marginal Tax Hump is part of the calculation?

This second example could be for an individual earning around $60,000 who wants to retire at either 66 or 70, or an individual earning about $85,000 who wants to retire at either 63 or 67. In both cases they want a retirement Lifestyle of $58,000 after all taxes.

The solid green lines in this second example illustrate how proper planning has resulted in your Gross Income stopping near the top end of your Social Security Sweet Spot. But your early retirement Social Security benefit level does include a 40.7% Marginal Tax Hump, and in order to reach your desired after all taxes Lifestyle income level, you must pay that entire Tax Hump! Bottom line, you need to withdraw an additional $10,966 from your IRA each year to pay an additional $3,466 in taxes to make up for the $7,500 smaller Social Security benefit. This huge amount of extra taxes drops the "net" break even point to only 4 1/2 year!

What happens if you retire early and just live at your Sweet Spot?

Since both examples are at their maximum Sweet Spot, both taxes are at the top of the 12% Federal Bracket, $4,543, but the lower Social Security benefit level does require an additional $1,723 of taxable income so your State tax is $134 higher.

The bottom line is that the lower SS benefit is costing you an additional $1,723 to live on $5,911 less while paying $134 of additional income taxes. Is this what you were thinking about when you decided to start your benefits early?

I hope that this information will be helpful for your retirement plans. Just remember that the information is coming from a computer Geek who does not have any credentials for investments or taxes. While I believe that the information is correct, like anything else that you read about on the Internet, double check itís accuracy for yourself before you use it!

My best wishes for your happy and safe retirement!