After tax portfolio value

[audreyh1]

Audrey:

A few questions, if you don't mind.

If you end up with more money after tax than you actually spend, where does it go? You still withdraw it, but do you include it as part of next year's portfolio?

What would you do if your tax bill increased your spending to be more than your safe withdrawal rate you established for the year?

How do you calculate your safe withdrawal rate each year? Is it a percentage of your portfolio?

No I don't. Once it's withdrawn, it stays withdrawn. It could be spent the next year. It could be used on a splurge within the next few years. I have very strong feelings about this. To me, the annual money withdrawn is money with which I've "won the game". I don't need to risk that money in the stock or intermediate bond markets any longer. If I invest it, it's outside the retirement portfolio and in short-term investments.

So when I rebalance, it's with the funds left over in the retirement fund after my withdrawal. And my annual withdrawal is only calculated on the funds in the portfolio.

Yes, my annual withdrawal is a fixed % of remaining portfolio (Dec 31 value each year), so my withdrawal amount varies in dollar terms from year to year. After a bad market year, I take a "pay cut". After a good market year, I get a "raise".

Quite a few folks do return unspent funds to their retirement portfolio for long term investment in the interest of having a larger retirement portfolio later. That is not my goal. In fact, we hope not to leave "too much" when we go. We'd rather spend it now while we can. And I chose my safe withdrawal rate to be something that I think means we're not very likely to zero in our lifetimes. As we get older, I'll probably increase it.

My tax bill from the retirement fund has NEVER exceeded my annual "safe" withdrawal - not even close. And I never expect it to. Worst case ever has been almost 1% of portfolio value - that's very high. Best case 0.2% after a bad market year. I have to live with whatever after-tax funds I get each year. So far it has never dropped below my annual budget. If it ever did, I'd just have to draw some on those funds I had left over from last year!!!

 

[audreyh1]

Don't forget the highest LTCG rate isn't 15%, it's 20%. Then there's another 3.8% surtax above a certain amount (can't remember what it is off the top of my head) which makes the effective top rate 23.8%.

I see a lot of folks using 15% as the LTCG rate, but just be aware it can be as high as 23.8%

That's right. Once total income reaches $250,000, you are looking at the 3.8% NIIT (net investment income tax) on capital gains and qualified dividends which essentially bumps the capital gains tax rate up to 18.8%. Once income crosses approx $450K, capital gains above that level will be taxed at 20% (plus the NIIT on top of that for a total of 23.8%).

And really high cap gains/qualified dividend income also tends to trigger some AMT especially if your ordinary income is very low.

So to avoid those, total annual income (not including IRA withdrawals) needs to stay below $250,000 for married filing jointly.

 

[David1961]

No I don't. Once it's withdrawn, it stays withdrawn. It could be spent the next year. It could be used on a splurge within the next few years. I have very strong feelings about this. To me, the annual money withdrawn is money with which I've "won the game". I don't need to risk that money in the stock or intermediate bond markets any longer. If I invest it, it's outside the retirement portfolio and in short-term investments.

So when I rebalance, it's with the funds left over in the retirement fund after my withdrawal. And my annual withdrawal is only calculated on the funds in the portfolio.

Yes, my annual withdrawal is a fixed % of remaining portfolio (Dec 31 value each year), so my withdrawal amount varies in dollar terms from year to year. After a bad market year, I take a "pay cut". After a good market year, I get a "raise".

Quite a few folks do return unspent funds to their retirement portfolio for long term investment in the interest of having a larger retirement portfolio later. That is not my goal. In fact, we hope not to leave "too much" when we go. We'd rather spend it now while we can. And I chose my safe withdrawal rate to be something that I think means we're not very likely to zero in our lifetimes. As we get older, I'll probably increase it.

My tax bill from the retirement fund has NEVER exceeded my annual "safe" withdrawal - not even close. And I never expect it to. Worst case ever has been almost 1% of portfolio value - that's very high. Best case 0.2% after a bad market year. I have to live with whatever after-tax funds I get each year. So far it has never dropped below my annual budget. If it ever did, I'd just have to draw some on those funds I had left over from last year!!!

Thank you for elaborating. I like your thought process, especially the part about the money you withdraw is money with which you have "won the game", and there is no need to risk it anymore.

 

[6miths]

No.

The only consideration I give to the value of my portfolio is whether it will stay above 0 while I stay above ground.

+1

It gets way too hard. If I die the day before I start to withdraw then my heirs will be looking at a big hit. Too bad, so sad...! If I live to 95 then the taxes will be very modest.

 

[Meadbh]

+1

It gets way too hard. If I die the day before I start to withdraw then my heirs will be looking at a big hit. Too bad, so sad...! If I live to 95 then the taxes will be very modest.

My will includes charitable donations and bequests to loved ones. It includes a clause that specifies a charitable donation off the top that minimizes taxes on the estate, with an upper limit.

Of course, if I spend it all, that's moot!

 

[daylatedollarshort]

Taxes are an expense item built into our retirement plan and annual retirement budget. If we had more in after tax accounts now, sure our taxes would likely be lower. But we already did the calculations on that years ago and chose to put the money in retirement accounts and pay lower taxes in the contribution and compounding years when we were in what we thought would be our peak earning / highest tax bracket years.

 

[pb4uski]

.....I could have $1 million in a regular acct where all withdrawals will be taxed at 15% due to everything being LTCG giving me an after tax portfolio value of $850,000. ...

It is virtually impossible that a taxable account would have zero basis which is what your sentence above suggests. The after tax value would be the value - unrealized gain * the tax rate. So if let's say the basis was 50% then the after tax value would be $925k.

My taxable has had a great run but unrealized gains are still only 30% of the value, so the after-tax value would be 95% of fair value assuming a 15% LTCG rate.

 

[RunningBum]

Technically, net worth is supposed to be reported on an after-tax basis. But as a practical matter, very few people actually do that. My guess is that even fewer people do it when calculating withdrawal rates. It seems more straightforward and intuitive to include taxes as part of one's expenses and leave the portfolio gross. I suppose you could exclude taxes from both the numerator and denominator, but that won't change the rate vs doing it gross... 40/1000=4%... 30/750=4%... 34/850=4%. It would not be correct to exclude taxes from the portfolio but still include them in expenses when calculating WR.

I wouldn't say very few of us do it, but we probably are in the minority. As far as expenses, I only budget taxes for dividends and cap gains distributions, which are fairly regular and predictable. For cap gains taxes on sales from my taxable account, conversions to Roth, and any distributions from my tIRA if I haven't fully converted it, I have already reduced my net worth to account for this so I don't feel like I have blown my budget or have to cut out other items just to pay taxes on a conversion or sale of an appreciated holding.

 

[LoneAspen]

That's right. Once total income reaches $250,000, you are looking at the 3.8% NIIT (net investment income tax) on capital gains and qualified dividends which essentially bumps the capital gains tax rate up to 18.8%. Once income crosses approx $450K, capital gains above that level will be taxed at 20% (plus the NIIT on top of that for a total of 23.8%).

And really high cap gains/qualified dividend income also tends to trigger some AMT especially if your ordinary income is very low.

So to avoid those, total annual income (not including IRA withdrawals) needs to stay below $250,000 for married filing jointly.

I hadn't considered the AMT effect as well. Thanks for posting that.

I've been trying to run various "what if" scenarios in my head for in a few years, if I decided to sell part of my shares from a company IPO, and buy a house outright. Based on the areas I'm looking, it would probably fall above $400k.

Normally, I'd get a mortgage but I probably won't be working at that time, and any asset-based loan probably wouldn't be for enough for me to buy the home I'd want, plus I really don't want to jump through mortgage hoops the next time I buy. I'd rather buy outright on my terms and be done with it.

But...at the $400k+ level, I'd be looking at 23.8% plus AMT (maybe?)

I guess one other thing I could do is buy a cheaper fixer-upper, renovate while I live in it, and then sell it a few years down the road and get to exclude part of the sale (up to $250k I think?) from capital gains.

Definitely something to think about.

 

[robnplunder]

No, because I pay all taxes out of the amount I withdraw. So it's a non-issue in determining a safe withdrawal rate.

Same here (when I RE). My budget includes "would be tax" line. It is significantly less than what I have been paying while working for megacorp.

 

[2017ish]

Same here (when I RE). My budget includes "would be tax" line. It is significantly less than what I have been paying while working for megacorp.

This is our case as well. Unless income tax rates double across the board, we will be paying far less than now. Given the uncertainty as to what actual rates will be (and at which income levels they will phase in and out), as well as the fact that we will be withdrawing across different types of accounts (and maybe doing Roth Conversions) so as to minimize lifetime taxation, it is much easier to have it as a planned budget line than to attempt accounting for it in net worth.

Basically, in very simplified categories, our budget will be "Amount to withdraw," less taxes, less "what we would like to spend."

 

[grasshopper]

Oww my head hurts....

 

[jerome len]

I have to consider taxes in making all my retirement income decisions......that's why I switched to a ROTH IRA years ago and include muni bonds in my taxable accounts. Not only Federal taxes but State taxes as well. I'd never live in New York or California......their taxes are just too high for me.

 

[FUEGO]

I figure I won't owe much at all to the feds, and only $600-1200 to the state each year. So even though 3/4 of my investments are in traditional IRA/401ks, I don't expect the tax bite to be very big.

If my portfolio does amazingly well, then I'll be withdrawing more money and have a higher AGI and pay more tax. A problem I hope to severely suffer from as I get older.

 

[audreyh1]

I hadn't considered the AMT effect as well. Thanks for posting that.

I've been trying to run various "what if" scenarios in my head for in a few years, if I decided to sell part of my shares from a company IPO, and buy a house outright. Based on the areas I'm looking, it would probably fall above $400k.

Normally, I'd get a mortgage but I probably won't be working at that time, and any asset-based loan probably wouldn't be for enough for me to buy the home I'd want, plus I really don't want to jump through mortgage hoops the next time I buy. I'd rather buy outright on my terms and be done with it.

But...at the $400k+ level, I'd be looking at 23.8% plus AMT (maybe?)

I guess one other thing I could do is buy a cheaper fixer-upper, renovate while I live in it, and then sell it a few years down the road and get to exclude part of the sale (up to $250k I think?) from capital gains.

Definitely something to think about.

If your realized GAIN on the sale of the IPO shares (not the total proceeds) plus other income stays below $464,851 for married filing jointly, you won't incur that 20% cap gain rate. And it applies only to the income above that limit. That total income limit corresponds to the 39.6% tax bracket, by the way.

AMT is only incurred on ordinary income, not any of the long-term realized gains or qualified dividends or muni income (except for "private activity interest). It's 26% for the first $185,400, 28% above that. This shows the calculations more clearly. These calculations apply to ANY realized gains or other long-term income, not just exercised stock options. myStockOptions.com | In general, how does the alternative minimum tax (AMT) calculation work?

 

[LoneAspen]

If your realized GAIN on the sale of the IPO shares (not the total proceeds) plus other income stays below $464,851 for married filing jointly, you won't incur that 20% cap gain rate. And it applies only to the income above that limit. That total income limit corresponds to the 39.6% tax bracket, by the way.

AMT is only incurred on ordinary income, not any of the long-term realized gains or qualified dividends or muni income (except for "private activity interest). It's 26% for the first $185,400, 28% above that. This shows the calculations more clearly. These calculations apply to ANY realized gains or other long-term income, not just exercised stock options. myStockOptions.com | In general, how does the alternative minimum tax (AMT) calculation work?

The gain on my IPO shares will be almost the total proceeds, as my cost to purchase them was very low (below $1, and they're trading at almost $30 and I expect it to go up over the next couple years).

Also, none of the "married" brackets apply to me, as I'm not married, so I have to go by the "single" numbers, which I presume are much lower (although I haven't researched enough to know for sure).

I'm also predicting that if/when I decide to sell, I will have no other source of income except selling shares, as I won't be working or drawing a salary anymore, I'll be strictly living off investment income, so am assuming that everything I sell will be subject to cap gains.

The whole AMT thing is confusing to me. I incurred it when I exercised my ISOs, but had hoped I wouldn't have to pay it when I sold. I need to read more about it, thanks for the link.

 

[audreyh1]

The gain on my IPO shares will be almost the total proceeds, as my cost to purchase them was very low (below $1, and they're trading at almost $30 and I expect it to go up over the next couple years).

Also, none of the "married" brackets apply to me, as I'm not married, so I have to go by the "single" numbers, which I presume are much lower (although I haven't researched enough to know for sure).

I'm also predicting that if/when I decide to sell, I will have no other source of income except selling shares, as I won't be working or drawing a salary anymore, I'll be strictly living off investment income, so am assuming that everything I sell will be subject to cap gains.

The whole AMT thing is confusing to me. I incurred it when I exercised my ISOs, but had hoped I wouldn't have to pay it when I sold. I need to read more about it, thanks for the link.

First of all, the link I gave you covered the single tax bracket numbers as well.

SECOND - in all caps because this is really important: you will be able to take a sort of an AMT credit against the sale of your ISO shares, because you already paid AMT on part of the gain. Your AMT basis for those shares includes the value on which you paid AMT when you exercised them. So that may reduce your AMT considerably in the year that you sell them. You may be well ahead here.

It won't affect your potential higher cap gain rates, but it will help with AMT.

If you don't have any ordinary income that same year, you don't end up paying AMT anyway, but maybe it reduces your other taxes? Or there is a carry forward? This is something you really need to research.
http://www.nceo.org/articles/stock-options-alternative-minimum-tax-amt

 

[Gumby]

There is an AMT carry-forward credit. See AMT Credit for a start on the research.

 

[audreyh1]

There is an AMT carry-forward credit. See AMT Credit for a start on the research.

Thanks for providing the link. When I finally sold ISO shares I was able to take all the AMT credit that year, so I didn't need to carry forward.

LoneAspen - Fairmark is a really good source for understanding the AMT. I see several other links on that article that are worth you reading.

 

[Sunset]

I hadn't considered the AMT effect as well. Thanks for posting that.

I've been trying to run various "what if" scenarios in my head for in a few years, if I decided to sell part of my shares from a company IPO, and buy a house outright. Based on the areas I'm looking, it would probably fall above $400k.

Normally, I'd get a mortgage but I probably won't be working at that time, and any asset-based loan probably wouldn't be for enough for me to buy the home I'd want, plus I really don't want to jump through mortgage hoops the next time I buy. I'd rather buy outright on my terms and be done with it.

But...at the $400k+ level, I'd be looking at 23.8% plus AMT (maybe?)

I guess one other thing I could do is buy a cheaper fixer-upper, renovate while I live in it, and then sell it a few years down the road and get to exclude part of the sale (up to $250k I think?) from capital gains.

Definitely something to think about.

Could you not sell a few IPO shares at a time, over a few years, to stay under the $400K level ?
hmmmm..... now that I read page 3, that seems a little less likely as its your only income.

 

[audreyh1]

He may need a lump sum to buy a house.

Of course he could split that over two years, building up his "house" fund.

 

[phil1ben]

That's right. Once total income reaches $250,000, you are looking at the 3.8% NIIT (net investment income tax) on capital gains and qualified dividends which essentially bumps the capital gains tax rate up to 18.8%. Once income crosses approx $450K, capital gains above that level will be taxed at 20% (plus the NIIT on top of that for a total of 23.8%).

And really high cap gains/qualified dividend income also tends to trigger some AMT especially if your ordinary income is very low.

So to avoid those, total annual income (not including IRA withdrawals) needs to stay below $250,000 for married filing jointly.

Audrey, I don't mean to high-jack the thread but one question. I know muni-bond interest goes into the calculation of modified gross income (MGI). However, for purposes of calculating the percentage you owe on capital gains, (i.e. above 250K or 450K) is muni bond interest included. By way of example if one had 250K in muni bond interest in a year together with 150K of other taxable interest would the capital gain tax percentage be 15% or 18.8%. Thank you.

 

[audreyh1]

Audrey, I don't mean to high-jack the thread but one question. I know muni-bond interest goes into the calculation of modified gross income (MGI). However, for purposes of calculating the percentage you owe on capital gains, (i.e. above 250K or 450K) is muni bond interest included. By way of example if one had 250K in muni bond interest in a year together with 150K of other taxable interest would the capital gain tax percentage be 15% or 18.8%. Thank you.

No. Muni bond dividends do not show up on your AGI and so don't affect either the AMT (exception "private interest activity") or capital gains taxes, or the NIIT.

 

[sengsational]

I'd answer "yes", at a rough-cut level.

I have a spend history that does not include income tax. When I do my savings multiple calculation, I discount the tax deferred funds by 30% to cover state and federal taxes. I think this is better than having income tax as an expense item because my income tax expense will be all over the place as time goes by. For instance now, its low because I'm spending after tax funds. Later it will rise when I spend from the 401k. It will go down again when I spend from Roths.

One of these days I'm going to make a detailed year-by year sheet, like anamorph, based on i-orp as a starting point.