do you include taxes from investments in your budget for SWR?

[packrat44]

I don't think this could really happen. If your SWR is, say, $100K (4% of $2.5M), that would be your income for the year. I don't see any realistic way that $2.5M could be manipulated to create a taxable output that would eat up more than the ~15-20% of taxes that $100K income would ordinarily create. Remember, some of that is probably going to be cap gains at a lower rate than ordinary income. Also, with any forethought you should be able to manipulate your drawdown to minimize taxes. It's fun, gives you something to do in retirement.

Maybe if you described a scenario that would realistically create the dilemma you are worried about we could address it better.

It can happen, at least in the short run. Federal income taxes alone exceed 100% of my SWR for tax years 2010; 2011; and 2012. This is due to large conversions from TIRA to RIRA.

 

[harley]

It can happen, at least in the short run. Federal income taxes alone exceed 100% of my SWR for tax years 2010; 2011; and 2012. This is due to large conversions from TIRA to RIRA.

I still don't see the issue. If you convert IRAs, then you're doing it with the full kknowledge of the tax implications. If you can't pay the taxes, don't do the conversion. This is really searching for a problem to apply a solution to. If you are this worried about being taxed at a higher rate than your income, keep working. Or don't buy that lottery ticket. Or move to a country with less than a100% tax rate, which seems to be what we're talking about here.

 

[packrat44]

I still don't see the issue. If you convert IRAs, then you're doing it with the full kknowledge of the tax implications. If you can't pay the taxes, don't do the conversion. This is really searching for a problem to apply a solution to. If you are this worried about being taxed at a higher rate than your income, keep working. Or don't buy that lottery ticket. Or move to a country with less than a100% tax rate, which seems to be what we're talking about here.

My comment that you can exceed 100% of ones SWR (in the short run) still stands. It is NOT an issue with me and it does not worry me in the slightest. If I did not have the ability to pay the taxes or if it did not appear to make financial sense for my circumstances, I would not have chosen that move. Some people appear to get wrapped around the axle regarding SWR; I do not. It is simply one tool to help you get to your desired results. (PS - I have never bought so much as one lottery ticket in my life.)

 

[RunningBum]

One way or another, taxes have to be considered. A working plan that doesn't include the expense of taxes is not a working plan.

If I got a windfall, I'd pay the taxes out of that windfall and keep it out of my budget. You probably didn't expect the windfall, so it wasn't used in the SWR calculation anyway. If you did expect it (like an inheritance), I'd treat it like I do capital gains, which I'll cover next.

If the uneven income is due to taking capital gains in some years from a taxable account, I simply reduce the value of the investment by the capital gains tax I expect to pay. So if I have a $1M in investments that have $100K in unrealized cap gains, and I expect to pay 15% fed and 5% state tax, I reduce the value by $20K and consider the value to be $980K. If I use a 4% SWR, I multiply .04 * $980K, not $1M. I still have to take into account the expense of taxes on dividends that investment gives me every year, which I do include as an expense, but if I happen to take a large cap gains one year from selling a profitable stock, I don't consider that an expense because I've already accounted for it. A lot of people don't like this because they consider any tax as an expense, but I find this method takes into account the cap gains tax just as well, while not causing huge blips in my budget.

If you really have a 20% return on a loan or some other investment, I'm not sure what I'd do. Seems to me that this high rate of return would also have a high degree of risk, one I'm not willing to take in retirement. It may be a real life situation for someone, but it would be an academic exercise for me, and my salmon is done baking, so I'm going to eat rather than try to figure this out.

 

[gadgetdog]

thank you all for the thoughtful replies

Just wanted to thank everyone for their thoughtful replies and examples.

I'll put the investment related tax payments as part of my expense budget now.

 

[arebelspy]

If you really have a 20% return on a loan or some other investment, I'm not sure what I'd do. Seems to me that this high rate of return would also have a high degree of risk, one I'm not willing to take in retirement.

I think that's a good point. I'm in higher return, riskier stuff now, but as I approach retirement my plan is to make my portfolio more conservative. Just as most people shift their AA to less equities and more bonds as they approach retirement. If someone is in something with returns that high where SWR of 3-4% doesn't make sense, they probably will want to move to less risky, unless they have no problem sleeping at night despite their risk level.

Just wanted to thank everyone for their thoughtful replies and examples.

I'll put the investment related tax payments as part of my expense budget now.

Hah! What a great, calm, simple way to end the debate. Well done, OP.

 

[jdw_fire]

I said all taxes on investment income (which is what the OP is talking about) should be paid out of your SWR. I never said said taxes on inheritance, lottery or W2 income should be paid out of your SWR.

But whatever.

actually, what you said was

Yes, income taxes will have to be paid out of your SWR.

 

[FIREd]

actually, what you said was

Yes, I was responding to the OP who was talking about investment income. You had not even entered the conversation at that point, so I couldn't possibly have responded to you, or your examples.

 

[Packman]

I"m using the 9-9-9 plan. Taxes are zero on investment gains

 

[jdw_fire]

Some people can argue about anything. SWR are assumed to be pretax income. Taxes are part of the expense. If the portfolio is tax deferred the tax liability is predictable. If the portfolio is taxable, the investor needs to invest in a tax efficient manner, and taxes will vary in any given year.

If expenses + taxes make the withdrawal rate too high you need a bigger portfolio to retire.

your accusing me of just arguing about anything is presumptuous, insulting, and plainly not true. i created an example based closely on my own situation and basically your position is that i should/must invest in something with lower returns so that i can pay the income taxes produced out of the SWR. you should take a moment and just think about that. "i need to give up higher returns so that i can fit you'alls written in stone rule that i MUST pay my income taxes out of the SWR i have chosen." that is ludicrous!

 

[jdw_fire]

Yes, I was responding to the OP who was talking about investment income. You had not even entered the conversation at that point, so I couldn't possibly have responded to you, or your examples.

and you werent the only 1 i was addressing but the post of yours that i quoted above was 1 that i was responding to. and even if you want to limit this to "investment" income, my example of hard money lending as well as the examples of CGs are investment income. dont be so closed minded, my thought on how to deal with the income taxes is actually a very reasonable way to deal with those situations, in fact it appears others do something similar.

 

[jdw_fire]

Realistic example:

there was nothing unrealistic about my example, like i said above, it was closely based on what i have done. it is sad that just because none of you people who are insulting me have done any hard money lending nor consistantly made the size of returns i mentioned you immediately attack what i said. if we were to get another inflation like we had in the late 70s/early 80s treasuries will probably have interest rates approaching the 1s i mentioned.

Realistic example: $1M taxable portfolio. You have held some stock for a long time, it has done well, and now represents 15% of your portfolio. You don't think it looks so good going forward, and you want to divest yourself of the stock and diversify. So you sell it for $150K, your cost basis is (for this example) $50K; that gives a $100K net LT CAP GN, so $15K taxes due that year.

I would not want to cut my $40,000 expenditures down to $25,000 that year to pay my taxes. That would hurt. But there is no way you are going to sell 15% of your portfolio each year, and it is very unlikely that your cost basis on average is so low. So you need to look at those factors and estimate an average amount for taxes.

-ERD50

o and btw, if you did any substantial trading in gold/silver this year and were successful you could have easily made enough money to have the taxes consume a large part, if not all of your SWR.

 

[ERD50]

there was nothing unrealistic about my example, like i said above, it was closely based on what i have done.

I was just trying to present a scenario that maybe more people could relate to. Putting most of a portfolio in 'hard money', 20% loans is not something I've seen anyone on this forum admit to. Lottery winners are pretty rare.

The points the same though, we agree there.

I re-read your post, and missed this the first time - when did I 'insult' you?

-ERD50

 

[obgyn65]

Yes. Every expense, tax, etc. is included in my annual spending using the SWR approach.

So, do you include include the tax payment for investment returns in your SWR budget?

 

[MichaelB]

your accusing me of just arguing about anything is presumptuous, insulting, and plainly not true. i created an example based closely on my own situation and basically your position is that i should/must invest in something with lower returns so that i can pay the income taxes produced out of the SWR. you should take a moment and just think about that. "i need to give up higher returns so that i can fit you'alls written in stone rule that i MUST pay my income taxes out of the SWR i have chosen." that is ludicrous!

No one has accused you or anyone else of anything. Sorry you are insulted but there is no presumption. The only "position" of mine is that taxes are part of the SWR. All that other stuff about investing and giving up returns has nothing to do with me, and I really don't see it in the other responses either. Relax.

 

[harley]

ok, to all the people who said "yes, income taxes must be paid out of the ER's SWR", what if your taxes due are larger than your SWR? are you going to stiff the IRS and not eat for a year? i dont think so, i think the correct answer is situation dependant. if you are making a large enough taxable return on your money i think it is total appropriate to make the taxes on that large return an investment expense that is not taken out of your SWR. be careful of hard and fast rules.

After re-reading this and in an effort not to offend anyone, here is my response to the OP. By the way, arguments are in room 12A, next door. This is abuse.

In most cases of living off your SWR, you will be paying all of your taxes out of the income thrown off from your cash flow. In the case of a lottery win or a huge year of dividends or other unexpected income, you would pay the taxes owed due to the windfall out of the windfall, and then pay your normal taxes out of your normal cashflow (SWR). How's that?

 

[Alan]

In most cases of living off your SWR, you will be paying all of your taxes out of the income thrown off from your cash flow. In the case of a lottery win or a huge year of dividends or other unexpected income, you would pay the taxes owed due to the windfall out of the windfall, and then pay your normal taxes out of your normal cashflow (SWR). How's that?

No good - too logical, try again, not enough to argue about.

 

[MichaelB]

No good - too logical, try again, not enough to argue about.

Double, double, toil and trouble

 

[Bestwifeever]

After re-reading this and in an effort not to offend anyone, here is my response to the OP. By the way, arguments are in room 12A, next door. This is abuse.

In most cases of living off your SWR, you will be paying all of your taxes out of the income thrown off from your cash flow. In the case of a lottery win or a huge year of dividends or other unexpected income, you would pay the taxes owed due to the windfall out of the windfall, and then pay your normal taxes out of your normal cashflow (SWR). How's that?

Still so many questions remain--what if I want to pay my SWR taxes out of my lottery winnings? Why doesn't FIREcalc address that idea? And can you tell me where I can buy this winning lottery ticket?

 

[Alan]

This thread has now run its course.

Thanks folks.

Porky Pig Cartoon Ending "That's All Folks!" - YouTube