How Much Do You Need To Become Financially Independent In The Netherlands (Part 2)

In the previous post on the topic “How Much Do You Need To Become Financially Independent in the Netherlands”, we looked at three scenarios (the “poverty” option, base case option and the “luxury” option). One of the main things we concluded is that taxation significantly increases the amount of required assets before you can call yourself financially independent. We assumed an average tax burden of approximately 30%. However, was this calculated correctly?  Financial-IndependanceXSmall

In this post we will evaluate the impact of Box 1, Box 2 and Box 3 taxation on the total amount of assets required to provide you with a net “base case” income of €25,000 per year (in 2016 Euros). The assumptions remain that that 4% rule applies, that you make an average rate of return on your investment (ROI) of 7% and that we encounter an average 3% inflation. Obviously, swings in the ROI and inflation affect the total amount of assets required.

For this analysis we assume 4 scenario’s (see scenario assumptions below for further details):

  • All your income falls under Box 1
  • All your income falls under Box 2
  • All your income falls under Box 3
  • Your income has a 20 – 80 percentage split between income in Box 1 and Box 3

Real Life Examples

What do these scenario’s mean in real life? Here are some examples for the four scenarios, (please do keep in mind that there are many other examples out there!):

If all your income sits in Box 1, it most likely means that you are still employed as you have income from labour, or you are unemployed and are receiving benefits or you are retired and are receiving a (government/private) pension (and/or a combination of the aforementioned). You have no special interests in (your own) companie(s) (i.e. you don’t hold any shares or are a major shareholder in a corporation, which is taxed in Box 2) and you have limited to no assets and/or receive little to no dividends (as they are taxed in Box 3).

If all your income sits in Box 2, you are not (directly) employed, receiving benefits or a pension (all box 1), you are getting all your income from dividends paid by the company you own or in which you have a substantial amount of shares (see here for details). But you have limited to no other assets (box 3).

If all your income sits in Box 3, you are not employed, are receiving benefits or a pension (all box 1), or you are receiving very little and end up not paying any taxes due to various credits. You either do not own a company or are own a substantial amount of shares in a corporation (Box 2), or when you do, the company does not pay dividends (hence no income and taxation). However, you have managed to collect a (large?) amount of assets in the form or shares, bonds, real estate, loans, etc. This scenario is most likely when you become financially independent prior to age 67 and fully live off dividends, real estate income and/or capital gains from shares/index funds.

The fourth scenario is a combination of option 1 and 3; which you could describe as you having a large amount of assets (box 3) and are also receiving income from employment and/or pensions and/or benefits. The majority of us in the Netherlands will end up in this category at one point during our lives, albeit the ratio between incomes in Box 1 and Box 3 may vary significantly depending on your personal situation.

Final_FinancialIndependenceScenario Assumptions

As there are way too many variables to consider everything, we therefore need to make certain assumptions for our 4 scenarios. We assume the following for each scenario:

Scenario 1 (this scenario is primarily used to evaluate taxation from a “normal” job compared to taxation during “financial independence”):

  • Taxation is based on 2016 rates
  • It assumes income is from labour and you receive the associated credits/benefits (i.e. “heffingskorting” and “arbeitskorting”)
  • No income from other credits/benefits or government/private pension
  • You are younger than 67 years (calculation uses a person of 35 years)
  • No special tax arrangements or benefits (e.g. no company car, you rent a house, no special life insurance or other policies, etc.), just to keep it simple.

Scenario 2 (this scenario represents living from dividend income of your own company without performing any work; it is supposed to be representing “retirement”!)

  • Taxation is based on 2016 rates
  • There is only income in Box 2 from special interests in a company (paid in dividends)

Scenario 3 (this scenario reflect financial independence by living purely on your hard earned assets)

  • Taxation is based on 2016 rates
  • No dividend income assumed (more to follow in a future post regarding dividend tax and Box 3 calculations)
  • Assumed ROI of 2%, 4% and 7% (to show taxation effects), note that the taxman assumes you get around 4% (subject to the amount of assets you have) and we assume you get 7% for our base case.

Scenario 4 (this final scenario reflects financial independence, but you still like to do some work on the side for fun, say 1 or 2 days a week, and get paid for it)

  • Taxation is based on 2016 rates
  • No dividend income assumed
  • Income is from labour and you receive the associated credits/benefits (i.e. “heffingskorting” and “arbeitskorting”)
  • No income from benefits or pension
  • You are younger than 67 years (calculation uses a person of 35 years)
  • No special tax arrangements or benefits (e.g. no company car, you rent a house, no special life insurance or other policies, etc.)
  • Assumed ROI’s of 4% and 7%.

The Results

For details on the taxation amounts, please see Box 1, Box 2 and Box 3 (and check the website of the Belastingdienst for the latest and greatest). Please keep in mind that taxation between box 1, 2 and 3 is not interchangeable (i.e. taxation credits cannot be switch between boxes)!

Based on our assessments, you get the following taxation amounts and effective taxation rates based on the above noted assumptions. The required amount of assets are based on the noted returns on investments (hint, you need to make sure your ROI is as high as you can!).

2016-01 HMDYN P2

Observations and Considerations

Scenarios 1 and 2 are pretty straight forward, but there is a significant impact for scenario’s 3 and 4 subject to your effective ROI and associated taxes (box 3). The explanation on the results is as follows, the lower your ROI the higher your assets needs to be, simple right? However, the higher your assets, the higher the effective taxation, which makes is increasingly more difficult to obtain the required income of €25,000 net of taxes. We therefore see these ridiculous asset amounts to become financially independent.boracay-island

So how does this work then in reality? You will have years that do better than average and years that do not. During the years you are doing better than average, your taxation is “relatively” limited (but about the same in absolute terms) and you should have some extra that year to reinvest  into (or leave in) your portfolio. During the less than average years, you may have to dip into your principle to pay for the owed taxes (or work to get some extra income). On the upside, during a large stock market/housing crash, you tax burden also gets some relieve as your assets would be worth less!

We never realized these impacts on our cash flow (and required amount of assets) and now realize that we need considerably more assets to “securely” live during our years of financial independence. Or we just need to do some work on the side for some extra income during less than average years to cover the taxes.

Another realization is that most people on their way to financial independence in the Netherlands (and blog about it) do not assess this taxation topic and are more closely looking at the wealth building stage (how and how much). However, if you don’t know the level of your taxation, how can you define your wealth goal? So we have now taken an slightly conservative approach and included assets to cover taxation during financial independence. Our final calculated number is what is used in our Cheesy Index.

Conclusion

Based on the assessment above we conclude the following:carnival-of-financial-independence

  • The Dutch tax system is complex and has a large impact on everyone trying to become financially independent. It does not matter much if you are a dividend investor (all Box 3), real estate investor (also Box 3) or investor in Index Funds or stocks (yup, Box 3 again).
  • From a taxation perspective the most “stable” and easiest to calculate would be income from Box 2.
  • Taxation in Box 3 can work in your favour, but can also hurt you in financially less successful years. The key is to maintain a ROI of more than the assumed 4% by the government (plus 2-3% inflation, so ideally an ROI of 7% and up), and you should be coming out ahead.
  • It may actually pay off to do a little bit of work on the side (say postal delivery, cleaning services, consulting, etc.) for one or two days a week to keep your overall taxation down (the Dutch government stimulates labour and low incomes with significant tax breaks/credits). But it is then debatable if you truly are financially independent, you certainly would have way more time on your hands.

 

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11 comments

  1. Nice post and blog, CF. Thank you for all these information.

    I would like to ask you a few questions. Imagine that we already got to the financial independence and all income comes from investments (box 3).

    1) In understand that investments pay taxes according to the net wealth, ok. But in addition, I guess dividends pay taxes as well. 100kEUR that provide 3% annual dividends, will pay about 1.2% in wealth tax and about 1% due to dividends (30% of 3%). In total, about 2.2%, right? Considering a 2% target inflation, the break-even return of Dutch investments is 4.2% (returns below 4.2% means that we lose purchase power!). This is shocking. Are these numbers correct?

    2) In case of crisis, taxes could send us to poverty. If we had 100kEUR in 2007, that could became 50kEUR in 2009 due to the crisis, and we would have to pay at least 1.2% annually (assuming no dividends). Therefore, even if we do not sell (no capital gains) and we do not get dividends, we would have to sell part of the investment (600 EUR) in the worst moment, not for living, but for paying taxes (!).

    3) Considering the usual Bogleheads approach, we should own part of the investment in stocks and part in bonds. Reason: they have been historically anti-correlated (perhaps this is no longer valid…). But it is quite astonishing that in Netherlands it is not worth to own bonds (or an ETF of bonds), because their estimated return is lower than 1.2% annually, and therefore we know a priori that we will lose money (a lot of money if we consider inflation!).

    Finally, I would like to say that Netherlands is an amazing country, having several wonderful characteristics… but taxation is not one of them 🙂

    1. Hey Daninave,
      Thanks for the comment and sorry for the delayed reply. In the midst of moving….. a very time consuming hobby 😉

      As your points:
      Point 1: you can correct the wealth tax with already paid dividend tax. So no double taxation here (fortunately). Ultimately, you only pay the value of the wealth tax (say 1.2%, but is subject to your total wealth and tax free allowance), so in onder to stay ahead of the game, you would have to make at least 3.2% ROI (1.2% for taxes and 2.0% for inflation). In short, you have to aim for about 7-7.5% (average) in ROI to be able to become financially independent.
      Point 2: Correct, you would be on the hook for taxes on that €50K (actually €25K as the first €25K is tax exempt). Could be a bad year in case of a crisis: triple hit (expenses, taxes and losses)
      Point 3: Bonds are not very interesting as you point out. Real estate (either physical or REIT) is potentially a better option to balance the portfolio. Alternatively, crow funding is averaging us also about 7-8% at this time (no write-offs yet). We actually don’t own any bonds (government or commercial) due to the poor ROI and dropping interest rates, but this may change in the future as we keep adjusting our porfolio.

      And yes, you have two very good points. The Netherlands is a great place to live, but the taxation is horrible (as in pretty high).

  2. If you want to live the life for really low tax, consider Mauritius. I think it’s pretty much tax free on your starting wealth that you move there with. 🙂

    I think it’s important to always do something more than just receive investment income. Working in some sense (particularly a paid hobby/love) can be really fulfilling, give you the drive in life. So many times in life, you see people retire and then not have any goals to motivate them except ticking off another country. Look at Warren Buffett, he’s 85, one of the richest people in the world, yet jointly runs one of the biggest companies in the world.

    In Australia the tax laws are very generous for older people, you can have all of your investments in a retirement account and it’s free. On top of that, you can have some money out of the retirement account and, as a couple, earn $36,400AUD between them tax free. It probably won’t be as generous by the time I (currently 24) get to 65/70/whatever retirement age is in 40 years.

    Tristan

    1. Mauritius, really, I’m in! Now I just need to convince Mrs. CF to settle in the Indian Ocean 😉

      Good point on the “life after financial independence”, we have some real estate that we still need to manage by that time. During financial independence this portfolio/work may increase or change into a B&B type effort. Work half the year, work the other half and meet many fun people. Not sure yet what will happen.

      Great to see that the Australian tax laws are similar to the Canadian in terms of retirements accounts. We do have retirement accounts and they are also tax sheltered, but there are very few you can actively manage yourself (or are even allowed to) nor can you withdraw early. Most are managed by large pension funds. Still, we will likely get some money from these accounts once we turn 67 or 70, will be a nice safety net.

      Have yourself a great weekend!

  3. Hello CF,

    Nice article about our taxes in The Netherlands. After reading it, it struck me again how complicated our tax system is.
    Your conclusion that you also need to take the tax burden into account when calculating you FI date is correct!
    I made some quick calculations last year and it opened my eyes.

    Keep up the good work!

    Cheers,

    Pollie

    1. Thanks Pollie, hope it helped you a bit as well. Think the tax issue is understated. There will be a couple more of these posts as there are a few other taxation topics I would like to review.

  4. Mr. Tako raises a good question but the reasons you mentioned are great one to why you should live in Netherlands still. It’s a great idea to run these analysis/assumptions to see the tax implication when you’re financially independent.

  5. Let me ask a question from left field – Have you ever considered not living in the Netherlands? What are the tax implications of it? If, say for example, you establish residency in another country, do you still have to pay taxes in the Netherlands? Many countries have special rules about this.

    1. Funny you mentioned this, we actually immigrated back to the Netherlands last year 😉 Yes, we could move to other countries to lower the burden, and may even do so, but we would like Miss CF to grow up around her family. She is already enjoying being with the grandparents and her cousins, so we think it is the right thing to do for now.

  6. This is an approach I did not yet take: figure out tax implications of FIRE! A good sugestion, when our date is near, I need to look into that for my Belgian situation.
    AT

    1. Hey AT,
      I would hardly recommend you do, preferably sooner rather than later as it could significantly affect your FIRE strategy. What I did not mention in the article, is that in our case the Tax burden gradually increases over the years. Which is going to affect our savings rate (yearend taxes end up in the expense section of our budget). This additional burden is currently not incorporated into the strategy and budget.
      As we are unfamiliar with Belgian taxes, it’s hard to identify the impacts, but there undoubtedly will be some.
      Good luck with the research.

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