OurNextLife.com // Optimizing Our Early Retirement Income // Taxes and ACA vs Actual Cashflow

Optimizing Our Retirement Income // ACA and Taxes Vs Actual Cashflow

If you’re been reading here for a while, you may have sensed that we’re borderline obsessed with ensuring that we always have access to affordable health care, especially in the years between leaving our jobs and qualifying for Medicare. As lots of knowledgeable readers have shared, health care is nowhere near “affordable” for anyone earning in the higher five figures and up, and we care about keeping those costs down so much that we’re willing to shape our retirement income around controlling our health care costs. In other words: We’re willing to live on less than we can technically afford in order to gain some level of certainty on health care costs. This and keeping our house cold are our weirdo areas.

Spoiler alert: This is not a post about health care.

I bring up health care only because it plays into a larger issue that we’ve struggled to get our heads around, which we’ll call our optimal retirement income: a level at which we get a big Obamacare/ACA subsidy on our health insurance, we pay low taxes and we enjoy a comfortable standard of living. While some of this optimization may be more straightforward for investors who focus entirely on dividend investing, as opposed to our index fund and rental income strategy, anyone with multiple streams of passive income will have to confront this math at some point.

While looking at the ACA subsidy levels is a good place to start, unfortunately it’s only part of the equation, because income as defined by the taxman and retirement cashflow are not necessarily the same thing. (Shoutout to Justin at Root of Good for writing such a great ACA subsidy post that I link to again and again!)

What this post is really about: The income vs. cashflow discrepancy in retirement

To figure out our optimal retirement income, we have to look at both income and cashflow, how they’re each calculated, and how they each impact our taxes, ACA subsidy and overall quality of life. Let’s dive in!

This post gets into taxes and income, so all the usual caveats apply: We’re not financial planners or tax professionals. Consult the pros regarding your own situation, and know that we offer this to spur thinking, not to serve as financial advice. You’re grownups — you know the deal. :-)

OurNextLife.com // Optimizing Retirement Income -- Obamacare/ACA and Taxes versus Actual Cashflow

Everything in this post comes back to the chart below. Don’t worry, we’ll zoom in and break it down.


The big picture point, which you can get at a glance from the different colored bars, is that sources of income may have a different impact on our cashflow than they do on our taxes, and they may have a different impact over time. In our quest to find our optimal number, we have to factor all of this in.

Optimizing Income for Taxes and ACA

The ACA subsidy limits correlate loosely to tax brackets, so we’re going to short hand “taxes and ACA” to just “ACA.” Basically, if we can get a big subsidy, then we’ll also be in a very low tax bracket. (Which we’re only okay with because we’ve paid a lot of taxes so far — we think of it as paying it forward.)

Because we don’t share our numbers, we’re talking about all of this conceptually, which may be easier anyway, since it won’t unintentionally anchor you to the targets we’re aiming for. Instead, you can apply your own circumstances.

The technical paragraph: The ACA subsidies are based off the modified adjusted gross income (MAGI) reported on your tax return for the year in which you receive the health benefit (meaning: if we receive a subsidy now in 2016, we’ll make sure everything is square when we file our 2016 tax return next year). The downside is that you have to guess, and if you guess too low, you could end up having to repay part of that subsidy on your next tax return. The upside for early retirees is that we have a lot more freedom than regular workers to reverse engineer our income to fit into the constraints we wish to fit. Unless you’re still making IRA or HSA contributions in retirement, which you can subtract when calculating AGI and then MAGI, MAGI in retirement will probably be pretty close to your full gross income. You don’t get to take out either the standard deduction or itemized deductions to determine your ACA subsidy eligibility, and if you claimed student loan interest in calculating your AGI, for example, you have to add it back in to find your MAGI. Not cool, I know, but then maybe that’s another incentive to pay that loan off ASAP.

So thinking about all of that, we know we have to fit all of our income streams into our MAGI and still stay under a certain limit for ACA and tax purposes. The black bar in the chart below represents the current subsidy limit that we’re eyeing. We know it could change, but we have to plan around something.


Within that limit, the two things that must fit are the two income sources we can’t avoid: our net rental income (rent received minus depreciation, mortgage interest, insurance and maintenance — determined on its own schedule within the tax return) and the dividends on all of our taxable accounts, which we’re taxed on whether we actually take those dividends out or reinvest them. But we also hope to have ample room within the limit to take some capital gains from shares we’ll sell, to earn a little income from fun work and, in years with bad dividends or market gains, to convert a few dollars from our 401(k)s into a backdoor Roth.

One big change for us in retirement will be how we treat dividends. We’ve always reinvested them, but because we’ll be paying the taxes on those dividends anyway, we might as well use those dollars to support our lifestyle instead of us paying more tax for more capital gains because we sold more shares while reinvesting dividends. That feels a little like double taxation, which doesn’t fit with a good tax optimization strategy.

Also notable in the “income” calculation is that “rental income” doesn’t necessarily equate to “rental cashflow,” because most of that money goes to pay the rental mortgage for another decade-plus, and cost basis (what we paid for the shares we’re selling) isn’t taxable, meaning our taxable income is skewed compared to our actual cashflow on at least those two measures (too high on rental income, too low on cost basis).

So based on the ACA subsidy limit we’re eyeing, we do have one number (our maximum taxable income), but it’s not THE number, the number we’ll actually live on. To calculate that, we have to go another step, from income to cashflow.

Optimizing Cashflow in Early Early Retirement

We will often talk about our “income in retirement,” when what we really mean is our cashflow in early retirement. As this chart represents proportionally, more or less, the biggest chunk of our retirement cashflow, at least in the first 10 years or so of early retirement, isn’t income at all: cost basis. Really we’ll just be getting back what we put into our investments, with some percentage of growth taxed as capital gains. But at least in the early years of our early retirement, those gains will be a small percentage and the cost basis itself will be a bigger percent.


Rental income will also be a smaller share of our cashflow than it looks like in our taxable income breakdown because the income calculation doesn’t factor in the full cost of mortgage payments, which eat up most of the rent.

Finding THE Optimal Number

Lots of people determine their retirement cashflow number by using the 4 percent rule, and that’s certainly a valid way to go, assuming your funds are all accessible when you need them, and not locked up as tax-deferred funds you can’t touch without penalty until age 59 1/2. (In our case, we think the math is more complicated, and have done extensive number crunching to figure out how much we need for phase one of our early retirement, before we turn 60. Plus we just sleep better at night knowing we’ll be mostly leaving alone our tax-deferred funds until our later years.) But even without the easy 4 percent rule to help, we still know roughly what we can safely spend in phase one of retirement, and we can plug that into this formula:

OurNextLife.com // Finding Your Optimal Early Retirement Income -- maximizing ACA subsidies, minimizing taxes and ensuring you don't go broke!

At a basic level, you want to ensure that everything you plan to live on — the “income,” the cost basis of the investments you plan to sell and any adjustments you need to account for — all fit within what you can comfortably afford to spend each year without running out of money. You can certainly go deeper than this, and do some projections like these, but you’ll have to make some guesses about likely interest rates and when the market might tank, which is beyond the scope of this or any post.

Optimizing Cashflow in Late Early Retirement

Just for fun, let’s take a look at our late early retirement (approximately age 50 to age 60).


Though a ton could change between when we pull the ripcord and then, we expect to see two main shifts: 1. the rental property will be paid off, so the rent will be actual cashflow for us, and 2. we’d ideally see a higher proportion of capital gains and lower cost basis in the mix because our investments will have had more time to grow. The second factor is highly market-dependent, because how many shares are left to sit and grow depends on how much we have to sell in our early years. The proportions in this chart are what we would hope to see!

Recap of Income vs Cashflow

We’re 1600 words in and almost there! Recapping the whole idea, we see that “income” in retirement will be smaller than cashflow for anyone whose retirement plan includes selling shares of stock or bonds, but also that income doesn’t fully account for every aspect of cashflow, namely cost basis. Also, over time, the proportion of different cashflow or income streams can change based on market conditions and other factors like paying off mortgages. Fun!


Once We Get to “Traditional” Retirement Age

Because we’re building our income and cashflow to fit around ACA limits, we know that we’ll have a bit of a Rube Goldberg system in place. The good news: We can cut it all out once we reach Medicare eligibility at age 65.


Medicare does make some adjustments for income, but the different limit levels are far less punitive for high earners, so once we both hit 65, we plan to cut loose a little more. At the very least, we won’t have to be so careful about constantly engineering our income to stay within the bounds of the ACA box. Or — who knows? — maybe everything will change in the next 25-30 years! And if that happens, then we’ll have another monster post on our new calculations and plans. :-)

Your Turn!

Is anybody else thinking about the income vs. cashflow discrepancy? Have you factored what you expect to live on each year and how that equates to income, which in turn affects your subsidy eligibility? Anything we missed in this post? Any thoughts we spurred? Let’s get into it in the comments!

57 thoughts on “Optimizing Our Retirement Income // ACA and Taxes Vs Actual Cashflow

  1. We haven’t started planning this far ahead, but (as always) you have me thinking – mostly about creating passive income streams so I actually need to solve this problem one day

    Did you define “fun work”? I am assuming that is blogging because you have so much fun reading our comments ;)


    1. Glad to get you thinking! :-) We think of fun work as very part-time stuff that gives some benefit — helping a friend, earning us free ski passes, fulfilling some creative need, etc. We actually haven’t made a penny from the blog because we don’t like ads, and we aren’t open to sponsored posts… so jury is still out if blogging will ever fit into the fun work category! But we plan to keep blogging for the long haul either way. :-)


  2. Good post – makes sense how you are thinking of things. I thought hard about how to try to manage income in 2016 so I could help my tax situation, but I can already tell it’s not going to work. I worked 1 quarter and have a lot of stock options that need to be exercised. Those blow your income sky high.


    1. Like you, we expect to finish up at a partial year point ( end of Q2, 2018) and will have a nightmare projecting for the first year of FIRE as it pertains to tax situation. It will be a mess and hopefully will settle down into something we can plan around. Trying to project what we will have in terms of capital gains on our investments has been hurting our brain for the past few weeks. Stock options exercise also complicate things for us in that first year. A nice problem to have, don’t get me wrong, but a problem.


      1. You both point out exactly the reason why we’re hoping to be able to quit by end of 2017, and not stay a little into 2018 — the tax and ACA calculations are something we’d rather dodge altogether!


    2. Yeah, I think the first year has got to be tough, especially if you have a partial year of work! And thanks — you just made me happy for the first time that we don’t have stock options. Haha. This is why we’re working so hard to wrap things up in 2017 with no work spillover into 2018!

      Liked by 1 person

  3. Great post. I have thought a lot about the cash basis v. income issue, although I haven’t sat down to try to figure it out. Do you know how to determine how much of your withdrawal will come out as basis and how much will be capital gains? I am sure there is a formula but I won’t need it for several years so have not bothered to research it yet!


    1. Thanks! I haven’t seen a good formula for projecting that. We’ve built an Excel sheet with different scenarios, but it’s very rough, and builds off of what Vanguard calls our current basis vs. gains ratio, which is ever-shifting. For our first year or two, we’re just assuming that we’ll have 5-6% more gains than we currently have, but we know we have to keep things flexible, as this will change literally every day!


  4. I love have thorough you are about researching each angle of early retirement. The rules of thumb (like 4%) are familiar but can leave out a lot of details that are really good to consider. Thanks for sharing your thoughts on this. It does seem hard to plan the healthcare piece, since that could easily change.


    1. Thanks, Kalie! As you can tell, I’m a bit obsessive about these details for our own plan, so I figure I might as well share the thinking if it can help others! :-) And yeah, health care is probably going to replace work as our leading stresser in retirement. But at least we’ll know that going in, and can brace ourselves!


  5. If I stick to index fund investing only, then the only income I’ll be able to manage is capital gains and Roth conversion ladder (if it still exists). I’m still pretty far away from FIRE so I don’t give it that much thought. I can almost guarantee things will change in the next 7-10 years when I hopefully become FIRE. On reddit I’ve seen some FI individuals talking about decent healthcare options they use which they’ve bought since they don’t qualify for ACA as well.


    1. You seem pretty good at containing your costs, so I think managing your capital gains still gives you a lot of leverage. But you’re for sure right that tons could and will change. That’s a big reason why we want to spend less than we can afford, because we want that cushion to weather and weird changes that force any of our costs to rise dramatically!


  6. We haven’t planned that far ahead – oh who am I kidding, of course we have at least 3 versions on different spreadsheets regarding that… :)

    Our biggest takeaway is that to remain in the good graces of subsidies and what not, we’ll just have to manage our withdrawal rate and big purchases and keep a good eye on it so that if we get close to the break point one year, we can minimize any big withdrawals/asset sales etc… to stay under the limit.

    However, if Mrs. SSC can parlay this theoretical teaching gig into another teaching gig (hopefully out west) that would cover our health care worries and we now have that much more of a cushion in our retirement planning. Plus, there’s the whole thought of “what’s the future going to hold” for instance Mrs. SSC threw out the idea that I could go get a PhD in geology, for no other reason than because I would want to. If it is like grad school last time I went, I could get a small stipend, ~$20k/yr and get to study geology more and have a ton of freedom (it’s still a lot of hard work, but it would be fun). If I went that route, I could also parlay that into a post-doc somewhere for another stipend, wich just gives us more health care and more of a cushion against spending our investments.

    The main point is that, that scenario has never entered into our retirement planning whatsoever, and neither has Mrs. SSC’s teaching. her teaching scenario is WAY more likely than me going back to school. The future changes so rapidly, that at least we have different scenarios we’ve thought about and how they could influence our spending and tax situations.


    1. OF COURSE you guys have multiple scenarios mapped out. :-) I would expect no less! The implications of teaching (and maybe your PhD program) on your situation seem potentially huge! I hope you get some clarity on that stuff soon. And while we have no specific vision of what we might do, we are toying with options that could give us health insurance. Honestly, I’d be willing to do a fun job just for the insurance, even with no pay! :-) And, as ever, YES, it could all change at any time. But we’re with you guys — it still makes sense to map out different scenarios. I feel better able to roll with the punches when I’ve at least thought through the implications of different things!

      Liked by 1 person

  7. This is where I fail as a PF blogger. I know the numbers for things like Roth vs. Traditional (go traditional!), but then I’m like: Roth 401k? I can do that? (yay Roth!) – so…. no, I haven’t gone far enough into calculating the income vs. cashflow conundrum. (maybe, thanks to my heavy “feeling” influence on my finances… it will mostly end up in Roths anyway and I won’t have to worry about things like capital gains or dividends as much…?)


    1. We’ve been priced out of Roths for a while, so our failing is the opposite — we don’t think enough about Roth! (I know, a nice problem to have — I’m not complaining! I really do think tax shelters should be for people who need them, not those who could afford to retire regardless, so I’m good with the income caps.) But yeah, if you care about ACA coverage, as I suspect you guys will one day, it’s worth crunching this stuff out. How big a subsidy you get can impact the budget more than any other factor, so we don’t feel like we can overlook this stuff. But we’re also closer than you guys are, so you’re not late. Just food for future thought! :-)


  8. I think we are both in the same phase of planning (2020 I hope). You mention taxes on dividends but from all the numbers I am crunching if you have to pay taxes on dividends you have already fallen off the subsidy cliff, I’m using the tax caster app. I have gone to healthcare.gov to price healthcare and have come up with the game plan that I’m either going travel abroad a few years and insure outside the U.S. While maximizing Roth conversions up to the 15% bracket or stil maximize up to the 15% bracket and buy a bronze plan for about $500 a month for my wife and I while still living in the U.S. while we are young and should not have any major health issues. This will allow us to convert some major coinage to a tax free nest egg so we can have some pretty low income for collecting some subsidy healthcare in the years up to Medicare.


    1. So exciting that you’re getting closer to ER! I can’t speak for your situation, but our taxable dividends definitely don’t put us anywhere near the subsidy limits — but we’re index investors, not dividend investors, so our dividends are significantly lower than those who invest specifically to maximize dividends. And of course some of the eligibility levels vary by state. So we all have to do our own math on this stuff. But for most people planning to live modestly, there should be plenty of room in a subsidy cap for dividends — maybe you guys are planning for a more baller retirement? ;-) Also, I’m sure you know this, but only the silver plans are subsidized, so it’s worth checking again in future years with different projections to see if you can get a better rate than $500 a month for bronze or, worse, having to leave the country!


  9. It would cost me $500 because I would have income over $90k, due to conversions. But when I ratchet conversions back I will optimize the subsidy limits and definitely go for a better plan. We are definitely leaning to a more extravagant retirement. I hope to have to order extra pages for my passport.

    We do all this planning and the one thing that is for sure is that everything is subject to change. I just try to lean towards getting as much of my assets to the already taxed side because I don’t believe it will be any better as far taxes go in the future.

    I ran some rough numbers on tax caster and you can have $28600 of income and $74000 dividends and owe $0 taxes. Just don’t charge too much for rent and you will be fine!πŸ€‘


    1. Okay, so yeah, you guys are planning on a bit spendier of an early retirement than we are. :-) And that’s great! No judgment here. We’d love to have more to spend, but are just too impatient to quit working! It also seems like your conversions are going to cost you a significant amount in terms of potential ACA subsidy. Since you’re still a few years out, can you shift any of your investments now into taxable vehicles, to avoid having to take the conversions later? If you’re over the ACA cap regardless because of dividends, then it may work out better to stay the course, but worth knowing. (We’re only planning to do tiny conversions for this reason — and because we want to keep our age 60+ nest egg super robust. Who knows what the future holds?!) And we’ve seen those numbers before re: taxes — suffice to say we’ll be well under that because the ACA cliffs are not as generous as the tax threshold! :-)


  10. I have done a lot of calculations on the ACA and Roth conversation tax optimization for our FIRE plan. We also have a rental and taxable account stream in the early years. The Roth conversion is important to us mainly for college funding for our child, but it is the end of the world if that doesn’t work out. We have settle on (until things change again) targeting the 250% FPL threshold for the ACA subsidy. This should allow for around $35,000 income from rental, business income, dividends and capital gains. Everything left can be converted to Roth or imaginary income reinvested into our portfolio. Anyway, I enjoy messing with these scenarios to see what will happen if I change just one thing!


    1. I love that the PF blogland lets us all admit to our nerdiest tendencies — no shame in enjoying changing the assumptions in your retirement projections! We do the same thing. Haha. It seems like you guys have a pretty good path mapped out, aiming at 250% FPL, and your conversion plan. At least we should know after the fall election which party gets to call the shots for the next four years, so we can have some sense whether ACA will stick around or go the way of the dodo. :-)

      Liked by 1 person

  11. Always enjoy the charts and graphs. While 4 years away our rental income will currently bear/bare the hard labor of our FI. Our major milestone of paying off the rental should happen later this year and we may pivot into more taxable investments in the next 3.5 years, since we are very heavy on real estate especially as it will relate to cash flow in the future. I still need to workout my newly created spreadsheet with the house/rental income/taxes/depreciation/etc to get more specific.


    1. Thanks! The chart posts are the most time-consuming ones, but I love them. :-) We certainly wish we had focused more on rental income before the real estate market rebounded so strongly! I think you guys will be in good shape with most of your cashflow coming from rental income, though diversification is never a bad thing. And focusing more on taxable investments gives you more flexibility to increase your income if you need more cash for some emergency, while rental income is essentially fixed. I’m sure you’re thinking about all of this stuff. :-) But having a solid rental income foundation is something lots of people wish they had!


  12. Agree with focusing on cash flow not just income. And yes I have done the cash flow but probably not as detailed as this. Our retirement income is all tax free. At the moment the private health care we pay is no longer subsidied because of my income, so I kinda think anything extra in the future would be a bonus. And hopefully the income tax brackets will increase with inflation but that is not guaranteed. Have you got a list all your assumptions? That is what I’m working on ATM eg upgrade car for $x every y years, we may lend kids money but not give handouts etc.


    1. That’s incredible that all of your retirement income is tax-free! I honestly don’t mind paying taxes, but I am hugely in favor making things more predictable. I’m sure you sense a lot of anxiety around health care from us and other American FIRE bloggers who feel like we’re all aiming for a moving target! The list of assumptions would be great to share — good idea!

      Liked by 1 person

  13. To be honest, I hadn’t even considered how tricky these calculations can get when you factor in various inconsistent income stream.

    I definitely want to learn more about how different levels of income can be taxed in retirement.


    1. It’s good stuff to think about because it impacts so much of your planning. But of course the ACA could change or disappear (we’ll know more after the upcoming election) and then we’ll have to find a new plan. :-)


  14. I really love when y’all write about this. It’s complicated, but seems achievable. I particularly like that you acknowledge that Medicare and ACA requirements may change. Variables are not within our control, but how we approach them is.


    1. Thanks, ZJ! I’m glad it’s helpful! I definitely think it’s achievable — lots of bloggers who are already retired can attest to that. As to whether it’s achievable in a high cost of living place… stay tuned. ;-) But absolutely everything *could* change, as you said, and so we never want to get too comfortable thinking something is settled for good.


  15. Wow! Such great detail in your analysis! I would think it would be difficult trying to figure out exactly where you may land, especially considering the fact that Obamacare is set up in a ladder fashion, and many of these current subsidy/tax brackets are slated to change over the coming years. The upside to your equation is the simple fact that you managed to arrive at a perfect simulation on where you might stand in early retirement, which is impressive to say the least. Your charts give a real snapshot into the reality of your income vs. cash flow discrepancy as you work through a solution, and I wish you the best of luck in trying to piece together this puzzle.

    Clearly, we aren’t nearly as far ahead with this as you are, but we appreciate all that you are teaching us with your tremendous analysis! – Mrs. FE


    1. “Piecing together a puzzle” is a good way to put it. It’s definitely hard to try to game out what our income will be, versus our cash flow, but we wanted to share this info to show that the two are not necessarily the same thing. :-)

      Liked by 1 person

  16. Interesting post. I find this thought process interesting and also like reading ROG posts that explain the “subsidy cliffs” and GCC posts showing how they are able to pay no taxes in retirement.

    However, while I find this interesting and will incorporate some of the bigger items like avoiding the subsidy cliff, I otherwise spend little to no time thinking about this stuff. I figure that we are planning on a relatively low cost of living which will be very tax friendly anyway. If we are making substantial money in retirement, it is b/c we have found something interesting and motivating enough for us to do it and so if it screws up our tax planning, then it is b/c we have made too much money which is a pretty OK problem to have in my book. Just my $.02.


    1. I think that mindset makes total sense on the tax front. If you earn a little more, or even if you jump into a higher tax bracket, tax rates are marginal, so you only pay a little bit more. But, the ACA is different. Earning literally a dollar over a cliff limit could cost you thousands of dollars in subsidies. So it’s worth at least being aware, or preferably doing some thinking about what optimization looks like for your own situation. If something came along that was offering a huge windfall, we wouldn’t turn that down, since the gains would be big enough to offset the loss of the subsidies. But we’d definitely turn down something small where it’s value was enough to cost us the subsidies but not offset itself. This is only common sense, but it takes a bit of a mindset shift since the ACA is really built around these cliffs.


  17. You might be interested in one of my more recent post. It’s about IRC Reg 72(t).
    Goes a little into distributions from an IRA without paying the 10% early distribution for people under 59.5. As the tax brackets gradually increase for inflation, this may be something for down the road to have in your pocket.


  18. Holy Cow, I have been trying to get my mind around ACA and how i could use it in the future. You have confirmed my fears that it could get complicated and expensive if you don’t plan right. I’m also realizing that my future pension may alone push me over into not qualifying for a subsidy and paying the huge amount for coverage. I have an opportunity with my employer if i reach a certain level of seniority (years of service) they will allow me to buy health insurance at my current premium rates until I reach age 65. This is a huge benefit. The problem is, I know i will have enough money saved well before that milestone of years of service. I try and imagine hanging out at work not for the money but for the health insurance. How strange. It seems to me that one has to have either enough money saved that the high premiums of ACA don’t matter or withdraw so little money (income) so that one qualifies for a subsidy. I’m really hopeful that the ACA will eventually improve and the premiums will become more affordable, but all indications are opposite at this point.

    Love your Blog…This community has evolved.


    1. Thanks for reading! :-) Yeah, the ACA is complex, and things like pensions or rental income CAN push you over the limits if you aren’t smart about it. So it’s good to know what the rules and limits are for your own situation! And yeah, that would be strange to work just for the health insurance, but we’ve for sure heard stranger. ;-)


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