Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
Confused on tax burdens on 4% withdrawals
Old 09-27-2007, 08:36 AM   #1
Full time employment: Posting here.
 
Join Date: Oct 2006
Posts: 524
Confused on tax burdens on 4% withdrawals

I am in the early stages of planning for FIRE. I understand the basic concept of the 4% withdrawal rate and am currently tracking our spending since May 1 this year. Of course spending is after tax $ while money withdrawn from investments is subject to taxes.

I am sure this is more complex than I think, but how do I estimate what my tax burden will be on that gross 4% withdrawal number? I have 401K, IRA, CD, I-Bonds that will be drawn from in the gap between RE and SS. To offset taxes during the gap period the only tax deductions I will likely have are property taxes. I will also have to pay for 100% of my medical insurance which has always been 100% paid by my employer, but that will disappear when I leave. Is medical insurance tax deductible, or are only actual medical expenses in excess of a certain level?

Sorry for such naÔve questions, but I donít know where to start.
__________________

__________________
Tom52 is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Old 09-27-2007, 08:42 AM   #2
Thinks s/he gets paid by the post
retire@40's Avatar
 
Join Date: Feb 2004
Posts: 2,670
You have two choices:

1. Try to do a pro forma tax return based on the amounts you have.

2. Hire a CPA to do this for you.
__________________

__________________
No man is free who is not master of himself. --- Epictetus
Enjoy Yourself (It's Later Than You Think). --- Guy Lombardo
retire@40 is offline   Reply With Quote
Old 09-27-2007, 08:47 AM   #3
Thinks s/he gets paid by the post
FIRE'd@51's Avatar
 
Join Date: Aug 2006
Posts: 2,315
Unreimbursed medical expenses (including medical insurance) are deductible on Schedule A to the extent that they exceed 7.5% of your Adjusted Gross Income.
__________________
FIRE'd@51 is offline   Reply With Quote
Old 09-27-2007, 08:52 AM   #4
Moderator Emeritus
Rich_by_the_Bay's Avatar
 
Join Date: Feb 2006
Location: San Francisco
Posts: 8,827
Tom, your withdrawals from a 401K are just like ordinary income; you have to "gross them up" to allow for taxes and meet your expenses after taxes. Better be sure you incorporated that into your projections. If you need $50k to live on you may need to withdraw $62.5 to cover 20% taxes.

Medical insurance premiums (and certain other business costs) might be fully deductible if you are self-employed, so keep that in mind. That's a big deal for many (as is obtaining that insurance in the first place).
__________________
Rich
San Francisco Area
ESR'd March 2010. FIRE'd January 2011.

As if you didn't know..If the above message contains medical content, it's NOT intended as advice, and may not be accurate, applicable or sufficient. Don't rely on it for any purpose. Consult your own doctor for all medical advice.
Rich_by_the_Bay is offline   Reply With Quote
Old 09-27-2007, 09:01 AM   #5
Thinks s/he gets paid by the post
Rustic23's Avatar
 
Join Date: Dec 2005
Location: Lake Livingston, Tx
Posts: 3,624
Pick up a copy of Turbo Tax. Go to the second had software shop and buy an old copy cheap. Then play like you are retired. It should give you a pretty good idea what you are in for.
__________________
Rustic23 is offline   Reply With Quote
Old 09-27-2007, 09:22 AM   #6
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jun 2005
Posts: 8,615
Quote:
Originally Posted by Rustic23 View Post
Pick up a copy of Turbo Tax. Go to the second had software shop and buy an old copy cheap. Then play like you are retired. It should give you a pretty good idea what you are in for.
That's a GREAT answer for almost ALL your tax questions. Just run the scenario in TurboTax. I would just get the latest version every year. You are gonna need it to do your taxes anyways. One can have multiple scenarios by doing multiple tax returns. Simply use "File / Save As ... " to save a new scenario to a different file.
__________________
LOL! is offline   Reply With Quote
Old 09-27-2007, 09:41 AM   #7
Administrator
W2R's Avatar
 
Join Date: Jan 2007
Location: New Orleans
Posts: 38,823
So, suppose you figure that your entire tax burden and any other deductions will probably amount to about 25%, and you want to follow an SWR of 4%, then really you will be living on 3% after taxes.

Is that correct? This is something I have been assuming but wasn't sure about either.
__________________
Already we are boldly launched upon the deep; but soon we shall be lost in its unshored, harbourless immensities.

- - H. Melville, 1851
W2R is offline   Reply With Quote
Old 09-27-2007, 09:52 AM   #8
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
audreyh1's Avatar
 
Join Date: Jan 2006
Location: Rio Grande Valley
Posts: 16,452
My experience over the last 7 years has been that taxes on my portfolio (all taxable investments, not IRA or 401K) have averaged about 0.5%. This means I can count on an after tax withdrawal of about 3.5%.

If you are withdrawing from an IRA or 401K, then you should just look up the taxes on the amount taking into account deductions, etc., to figure out what the tax hit will be.

Audrey
__________________
audreyh1 is online now   Reply With Quote
Old 09-27-2007, 10:00 AM   #9
Thinks s/he gets paid by the post
lazygood4nothinbum's Avatar
 
Join Date: Feb 2006
Posts: 3,895
check me on this but i think if you need to withdraw early from 401k or tira that monies paid from there for medical expenses (including insurance premiums) would be subject to normal income tax but not to early withdrawal penalties.
__________________
"off with their heads"~~dr. joseph-ignace guillotin

"life should begin with age and its privileges and accumulations, and end with youth and its capacity to splendidly enjoy such advantages."~~mark twain - letter to edward kimmitt 1901
lazygood4nothinbum is offline   Reply With Quote
Old 09-27-2007, 10:40 AM   #10
Thinks s/he gets paid by the post
jIMOh's Avatar
 
Join Date: Apr 2007
Location: Milford, OH
Posts: 2,085
Use a Roth IRA and money is tax free.

If using a traditional IRA, 401k, or other tax defferred vehicle, I use fairmark web site to check tax rates.

Here is a link
Reference Room

basics (married, filing jointly)

first 10,900 is tax free (standard deduction).

tax owed:

first $16,050 is taxed at 10% (max owed of $1605)
money between $16051 and $65150 is taxed at 15% (max owed is $65150-$16051=49099*15%=$7365, plus $1605 from previous bracket is $8970 total).
money between 65151 and 131450 is taxed at 25%. (max owed is $131450-$65151=$66299*25%=$16575, plus $8970 from previous brackets is $25,545).

The brackets are "graduated", with a 28%, 33% and 35% if you withdraw more.

Use the tables, or post income needed here, and I can post the math I would use.

Your state taxes are not included in this.
__________________
Light travels faster than sound. That is why some people appear bright until you hear them speak. One person's stupidity is another person's job security.
jIMOh is offline   Reply With Quote
Old 09-27-2007, 10:54 AM   #11
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
youbet's Avatar
 
Join Date: Mar 2005
Location: Chicago
Posts: 9,965
Tom52

Since you have multiple possibilities for your withdrawal scenarios, the advise given above to use TurboTax, or another tax software package, to run some estimates is best.

You'll probably have dividends which are taxed at 15%, interest taxed as ordinary income, stock sales taxed as short or long term capital gains, etc. Of course, when you cash that CD, only the interest, not the withdrawn principal, is taxed.

Sit down with TurboTax and run some scenarios. Making the withdrawal decisions will be tougher than actually calculating the tax. But, until you decide how and where your withdrawals will take place, you won't be able to estimate the taxes.
__________________
"I wasn't born blue blood. I was born blue-collar." John Wort Hannam
youbet is offline   Reply With Quote
Old 09-27-2007, 11:50 AM   #12
Thinks s/he gets paid by the post
Rustic23's Avatar
 
Join Date: Dec 2005
Location: Lake Livingston, Tx
Posts: 3,624
Jimoh,
So in reality:

0-10900 - 0
10900 - 26950 - 1605
26950 - 75050 - 7365
75050 - 142,350 - 16,575

as the $10,900 is added to each bracket. The only reason I put this up is the $75,050 becomes of interest to me as I figure out how much to convert from regular IRA to Roth.
__________________
Rustic23 is offline   Reply With Quote
Old 09-27-2007, 12:08 PM   #13
Thinks s/he gets paid by the post
FIRE'd@51's Avatar
 
Join Date: Aug 2006
Posts: 2,315
Quote:
Originally Posted by jIMOh View Post

Here is a link
Reference Room

basics (married, filing jointly)

first 10,900 is tax free (standard deduction).
Actually, for 2008, at least the first 17,900 is tax-free for married, filing jointly, since there would be at least two 3500 exemptions
__________________
FIRE'd@51 is offline   Reply With Quote
Old 09-27-2007, 12:22 PM   #14
Thinks s/he gets paid by the post
SecondCor521's Avatar
 
Join Date: Jun 2006
Location: Boise
Posts: 2,398
Quote:
Originally Posted by Want2retire View Post
So, suppose you figure that your entire tax burden and any other deductions will probably amount to about 25%, and you want to follow an SWR of 4%, then really you will be living on 3% after taxes.

Is that correct? This is something I have been assuming but wasn't sure about either.

Depends on what you mean by that 25%. If you mean that you have an effective tax rate of 25% and you live on $X per year, and you have a portfolio value of $Y of which you want to withdraw 4%, we have:

$X + 0.25 * $X = 4% * $Y
1.25 * $X = 4% * $Y
$X = (4% * $Y) / 1.25
$X = 3.2% * $Y

So you'd really be living on a 3.2% withdrawal rate.

Sorry if I sound pedantic, but since $Y is probably a relatively big number to most people, the 0.2% increase may be significant to someone.

Also, be sure to realize that, due to exemptions, deductions, credits, and other tax things, an effective tax rate of 25% is far different from a marginal tax rate of 25%. Someone with a marginal tax rate of 25% might easily have an effective tax rate of 14%. Learn and understand the difference.

2Cor521
__________________
"At times the world can seem an unfriendly and sinister place, but believe us when we say there is much more good in it than bad. All you have to do is look hard enough, and what might seem to be a series of unfortunate events, may in fact be the first steps of a journey." Violet Baudelaire.
SecondCor521 is offline   Reply With Quote
Old 09-27-2007, 12:26 PM   #15
Moderator Emeritus
Nords's Avatar
 
Join Date: Dec 2002
Location: Oahu
Posts: 26,616
Quote:
Originally Posted by Tom52 View Post
I am sure this is more complex than I think, but how do I estimate what my tax burden will be on that gross 4% withdrawal number? I have 401K, IRA, CD, I-Bonds that will be drawn from in the gap between RE and SS. To offset taxes during the gap period the only tax deductions I will likely have are property taxes. I will also have to pay for 100% of my medical insurance which has always been 100% paid by my employer, but that will disappear when I leave. Is medical insurance tax deductible, or are only actual medical expenses in excess of a certain level?
You'd be deducting medical insurance/expenses if they were greater than 7.5% of your adjusted gross income, as already mentioned, AND only if they were greater than the standard deduction. If your AGI is $63,000 then your deductible medical insurance/expenses would start at $4725, but the standard deduction is $10,700 this year so you'd have to have substantial expenses to beat the standard deduction. Of course if COBRA premiums run $1000/month then it's no problem...

If your AGI is around $63K then most of your dividend income will be taxed at the 15% bracket and most of your long-term cap gains will be taxed at 5% or less. (This is fraught with exceptions but within $500 or so of the tax you'll owe.) You'll probably find yourself paying about 10-15% above your income as taxes. In our five years of ER we've paid from 2%-13% of taxable income, with the 2% coming after a lot of home energy improvements (and a pile of tax credits). This year we'll probably be closer to 11-12%.

If the success of your entire ER planning rests on the "single point of failure" of calculating your taxes down to the nearest percent, then it might be better to build more portfolio or trim back the expenses.
__________________
*
*

The book written on E-R.org, "The Military Guide to Financial Independence and Retirement", on sale now! For more info see "About Me" in my profile.
I don't spend much time here anymore, so please send me a PM. Thanks.
Nords is offline   Reply With Quote
Old 09-27-2007, 12:46 PM   #16
Thinks s/he gets paid by the post
FIRE'd@51's Avatar
 
Join Date: Aug 2006
Posts: 2,315
Quote:
Originally Posted by Nords View Post
If your AGI is around $63K then most of your dividend income will be taxed at the 15% bracket and most of your long-term cap gains will be taxed at 5% or less.
Actually your dividend income would be taxed at 5% as well in this scenario. Next year, dividends and LT capital gains which fall into the 10% and 15% brackets will be taxed at zero. So in 2008, a couple filing a joint return and taking the standard deduction whose entire income comes from dividends and LT capital gains would actually pay no federal tax on the first 83K of income.
__________________
FIRE'd@51 is offline   Reply With Quote
Old 09-27-2007, 12:53 PM   #17
Moderator Emeritus
Nords's Avatar
 
Join Date: Dec 2002
Location: Oahu
Posts: 26,616
Quote:
Originally Posted by FIRE'd@51 View Post
Actually your dividend income would be taxed at 5% as well in this scenario. Next year, dividends and LT capital gains which fall into the 10% and 15% brackets will be taxed at zero. So in 2008, a couple filing a joint return and taking the standard deduction whose entire income comes from dividends and LT capital gains would actually pay no federal tax on the first 83K of income.
Good point, lemme restate:
"... your dividend income will be taxed at the 15% income tax bracket"...

Then there's that whole issue with qualified dividends, non-qualified dividends, dividends subject to foreign tax...
__________________
*
*

The book written on E-R.org, "The Military Guide to Financial Independence and Retirement", on sale now! For more info see "About Me" in my profile.
I don't spend much time here anymore, so please send me a PM. Thanks.
Nords is offline   Reply With Quote
Old 09-27-2007, 10:55 PM   #18
Recycles dryer sheets
whitestick's Avatar
 
Join Date: Apr 2005
Posts: 415
Quote:
Originally Posted by FIRE'd@51 View Post
Next year, dividends and LT capital gains which fall into the 10% and 15% brackets will be taxed at zero. So in 2008, a couple filing a joint return and taking the standard deduction whose entire income comes from dividends and LT capital gains would actually pay no federal tax on the first 83K of income.
Let me ask an expanded question around that statement. IF a couple had 20k of pension income, 57k of Short Term CG, and 125k of Long Term CG for 2008, what would that work out to be for taxes, for each part. I'm having trouble understanding the interrelationships with the various income types, and the total AGI that number causes for taxes for each. Oh and the LTCG is to pay off the house and high interest debts, so it would be a one time thing, but holding it off till 2008 seemed to be a better way to go for tax purposes, I think:confused:
Oh and Thanks for the help, I'm not trying to be lazy, I just don't understand this.
__________________
Mens ability to see the future is limited by their horizons of today!
Unknown!
whitestick is offline   Reply With Quote
Old 09-28-2007, 08:19 AM   #19
Thinks s/he gets paid by the post
FIRE'd@51's Avatar
 
Join Date: Aug 2006
Posts: 2,315
Quote:
Originally Posted by whitestick View Post
Let me ask an expanded question around that statement. IF a couple had 20k of pension income, 57k of Short Term CG, and 125k of Long Term CG for 2008, what would that work out to be for taxes, for each part. I'm having trouble understanding the interrelationships with the various income types, and the total AGI that number causes for taxes for each. Oh and the LTCG is to pay off the house and high interest debts, so it would be a one time thing, but holding it off till 2008 seemed to be a better way to go for tax purposes, I think:confused:
Oh and Thanks for the help, I'm not trying to be lazy, I just don't understand this.
Using your numbers and assuming you take the standard deduction, you have 77k (20k pension plus 57k STCG) which will be taxed at ordinary income rates. So 6k (83k - 77k) of your 125k LTCG will be taxed at 0% and the other 119k at 15%. This is for 2008. For 2007, the 83K number is 81k (the 83k comes from indexing the brackets, standard deduction, and exemptions for inflation). So applying your numbers to 2007, you would have 4k (81k - 77k) of the 125k LTCG taxed at 5% and 121k taxed at 15%. The net savings on the LTCG for delaying until 2008 would thus be 5% on 4k plus 15% on 2k = $500. My numbers are approximate since I have rounded the 81k and the 83k to the nearest thousand.

Of course, this would have to be weighed against the after-tax cost to carry the 125k debt for the months involved.
__________________

__________________
FIRE'd@51 is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
are FireCalc withdrawals after tax dollars? spncity FIRECalc support 3 05-31-2007 06:28 PM
Confused xprinter Young Dreamers 6 05-02-2007 09:08 PM
I'm so confused..... txdakini FIRECalc support 4 03-04-2007 09:40 PM
Tax Rate - confused planning101 Young Dreamers 2 02-22-2007 11:16 AM
U.S. has one of world's lowest tax burdens?!? Nords FIRE and Money 37 04-17-2006 11:11 AM

 

 
All times are GMT -6. The time now is 09:39 AM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.