4% rule and tax?

[albireo13]

I've been reading about the 4% withdrawal rule of retirement savings.
My question is about tax assumptions ....

If savings are mostly in tax-deferred plans (401Ks, IRAs,etc) the 4% drawn will be taxed. Thus, your income estimates should factor in that tax loss.

Am I interpreting this correctly?

Thx

[pb4uski]

The 4% "rule" is focused on withdrawals....it does not care a bit whether the withdrawal is spent on taxes or food or geisha girls.

So if you expect taxes of 10% and withdraw 4%, then you have 3.6% to spend after taxes on food and geisha girls or whatever.

You can get a good idea of the tax implications by dioing a pro forma tax return with the tax-deferred withdrawals using Taxcaster or Turbotax... my effective tax rate on withdrawals over the last few years has been less than 10%

[audreyh1]

Quote:

Originally Posted by albireo13 I've been reading about the 4% withdrawal rule of retirement savings. My question is about tax assumptions .... If savings are mostly in tax-deferred plans (401Ks, IRAs,etc) the 4% drawn will be taxed. Thus, your income estimates should factor in that tax loss. Am I interpreting this correctly? Thx

Yes. You need to estimate what your tax situation will be so that you can subtract taxes from withdrawal and know the funds available for spending.

[RunningBum]

Yes, one way or another you have to account for the income tax on the tax deferred account. How you do that is up to you, but $1M in a 401K/tIRA is different from $1M in a Roth IRA, which is different from $1M in a regular investment account, so naturally you have to deal with the tax expense or the reduced after tax income.

[jebmke]

Yes, taxes are an expense. I include them in my expense budget every year. Theoretically, the 4% also includes mutual fund expenses and any other administrative cost of a defined contribution plan.

[OnTheBeach]

I believe that the 4% rule is based on net assets, which would be your net worth after taxes. If you have 1 million dollars and you estimate that it will be subject to 20% of federal and state taxes - then you have $800,000 net worth - and the 4% rule would allow you to live on $32,000. You can withdraw $40,000 per year and pay $8,000 in taxes.

[pb4uski]

No, OnTheBeach.... the 4% rule doesn't consider the tax attributes of the retirement investments.

So in the scenario you describe you would withdraw $40,000.

If that $40,000 withdrawal was taxable then you would pay the relevant tax and could live on the rest.... see post #2 above.

[OnTheBeach]

I was trying to illustrate that a person can't spend the 4% because of potential tax liabilities. When I calculate my net worth, I always calculate it "after tax", so my expenses/net worth is accurate.

[Blue Collar Guy]

When I had a million bucks, I threw in 700k in the portfolio box, thats how I figured how much i could spend on me. Now I throw in 70 % of the new number every Christmas week. That gives me the "ish " on what type of dough I can blow om myself if I wanted.

[pb4uski]

Quote:

Originally Posted by OnTheBeach I was trying to illustrate that a person can't spend the 4% because of potential tax liabilities. When I calculate my net worth, I always calculate it "after tax", so my expenses/net worth is accurate.

Fine if you want to do it that way... many people do.... but the question was on how the 4% rule worked with respect to taxes.

Quote:

... The study did not adjust for taxes or transaction costs. An investor’s own experience would differ depending on how much of his assets were in tax-deferred accounts, and the extent to which transaction costs could be held to a minimum using low-cost index funds.

[Jerry1]

4% rule is a good rule of thumb, but yes, you need to take your taxes into account. Once you've moved to a more robust planning framework, get a good planning tool that accounts for taxes. I use a tool that I get free with my Fidelity account but there are many. That way, you can see in your modeling, how taxes impact your overall expenses. The tool I use recognizes that my taxes change as I move into using social security for my expenses versus my withdrawals from a tax deferred account. It also inflates various expenses differently (health care likely to increase faster than food - for example).

My next step prior to fully retiring is to sit down with a planner an do a bit more sophisticated cash flow analysis so I can best plan which accounts to use when. Basically, I want to ride the 15% tax bracket and anything I don't use, shift over to a ROTH.

[tb001]

Probably a dim question, but are there any easy rules of thumb to use on tax rates for different investment types? I've been working up a detailed budget in the hopes that we can RE, but I'm confused about how much to include for taxes. 80% of assets are in regular investment accts, not 401ks etc. We're in a high tax state and high tax bracket now, but I'm not sure how that changes as we start dipping into savings.

[Koolau]

Another reason I've never been too slavish about using the "4% rule." Any way that recognizes the taxes (either discounting your taxable stash or calling the tax taken from every withdrawal an "expense") will get you where you need to be. It can get complicated and there are tricks to play to lower the taxes (take some from qualified sources - 401(k) tIRA, etc. and some from, say cash in your cash bucket, already taxed money such as outside mutual funds, tax-loss harvest, etc. etc.) Point is you probably "should" (maybe too strong a word) recognize that most tIRA and 401(k), etc. balances are of less value (for most of us) than cash under the mattress, already taxed money, etc. It's all in the accounting and the intricate games the convoluted tax system forces us to play (if we wish to spend more on geisha girls, booze, etc. - or just wasting it, heh, heh.) How you account is up to you, but the 4% rule can be applied any way you want as long as you do account for the taxes. Sorry if this isn't the easy answer OP was looking for.

By the way, this is one reason I've become an advocate (too late for me) for not overloading on qualified money during your w*rking years. Emphasize Roths and other tax-already-paid vehicles unless you're situation is favorable to shielding now to pay later. Eventually RMDs will rear their ugly rear and leave far fewer tax options - so plan ahead. In any case, it's impossible to play it perfectly. After all, they can change the rules after you've already started playing, so YMMV.

YMMV

[bingybear]

Quote:

Originally Posted by tb001 Probably a dim question, but are there any easy rules of thumb to use on tax rates for different investment types? I've been working up a detailed budget in the hopes that we can RE, but I'm confused about how much to include for taxes. 80% of assets are in regular investment accts, not 401ks etc. We're in a high tax state and high tax bracket now, but I'm not sure how that changes as we start dipping into savings.

I think I'm about 55% after tax, 3.5% Roth, 1.5% annuity and 40% TIRA. For the last couple years predicting taxes has been reasonable accurate for me. The catch is you have to understand what you are invested in. Active MF can kill the planning as distributions are somewhat variable. They can drop a big distribution that will kill your planning.

Looking a typical distributions from the ETFs in my taxable accounts I estimate the distributions and type (LTCG, Q-Divy (holding period is part of this), nonQ divy and STCG.

I stack this up and just use the basic rules for taxes -- normal income first, Qdivy and LTCG next. I can tell approximate headroom for the 15% bracket. In December I validate and roth covert to the top of the 15% bracket.

So modeling. Do the estimates as above, assume they are right and then add you roth conversion if desired. I ignore taxable basis in my TIRA for planning.
The wild card.. what do you use for taxable performance from year to year.

I also harvest losses and presently am sitting on about 90k of losses to offset selling gains or 3k of income (which is what I typically do).

I'm not pulling from qualified accounts yet, so they don't play in near term taxes other then conversions effects

[pb4uski]

Quote:

Originally Posted by tb001 Probably a dim question, but are there any easy rules of thumb to use on tax rates for different investment types? I've been working up a detailed budget in the hopes that we can RE, but I'm confused about how much to include for taxes. 80% of assets are in regular investment accts, not 401ks etc. We're in a high tax state and high tax bracket now, but I'm not sure how that changes as we start dipping into savings.

Suggest that you do a pro forma tax return using Taxcaster or TurboTax as if you were retired ... eliminate earning and make any other applicable adjustments to see what your taxes will be. If you use TurboTax you can cover off both federal and state.