How do you figure taxes on your yearly required expenses?

[tomc5179]

OK - this might be a stupid question, but I need to ask and see if I'm figuring this right.

Say I have a base, yearly requirement of $40K without tax that I need to live off of. Am I correct in multiplying that by 1.15 (cap gains tax) to arrive at $46K that my portfolio needs to generate?

 

[braumeister]

I'm sure you will get good and detailed answers, but here's a quick reply.
Your portfolio will generate income for you, but it will most likely be in the form of interest, dividends, capital returns, capital gains, etc. There are different tax rates for each. You should really figure your actual taxes (from the foregoing), including things like property taxes. You also should consider things like inflation and tax increases.

Have you used the FIRECalc to look at your situation?
FIRECalc: A different kind of retirement calculator

 

[tomc5179]

I'm sure you will get good and detailed answers, but here's a quick reply.
Your portfolio will generate income for you, but it will most likely be in the form of interest, dividends, capital returns, capital gains, etc. There are different tax rates for each. You should really figure your actual taxes (from the foregoing), including things like property taxes. You also should consider things like inflation and tax increases.

Have you used the FIRECalc to look at your situation?
FIRECalc: A different kind of retirement calculator

Yes - I've run firecalc countless numbers of times and have played with inflation and miscellanious costs. I'm just wondering if there's a common, ballpark multiplyer that people are using to figure the taxes on the yearly amount.

 

[REWahoo]

Yes - I'm just wondering if there's a common, ballpark multiplyer that people are using to figure the taxes on the yearly amount.

I think there are too many variables to have a "rule of thumb" tax rate. But IF you thought you'd be paying an average of 15% in taxes and wanted to net $40K afterward, you'd find the grossed up amount by dividing $40K by .85 rather than multiplying by 1.15.

 

[LOL!]

You need to get out your copy of TurboTax and complete a "what-if" tax return. Remember that the first several thousand dollars of income is tax-free. You didn't say if your money comes from an IRA withdrawal or cashing in a CD or selling a mutual fund in a taxable account. You didn't say if you have diligently tax-loss harvested in the past. Your taxes on $40K could very easily be ZERO.

Check it out with your tax software.

 

[JDARNELL]

Use the turbo tax tax estimator on their website.

Tomcat98

 

[W2R]

Well, when doing my planning I multiplied everything by an arbitrary 0.7 to get an after-tax amount (after both federal and state taxes). Of course, in retirement I have found that my taxes on pension, dividends, and TSP withdrawal income sources lumped together really have been much lower (11% federal, 3% state) and I could have multiplied by around 0.86 or so. Still, it's always nice to have a little "slop" in the calculations for safety.

You could always try something like that until you are pretty sure that you are getting close, and then haul out Turbotax and do a realistic estimate.

 

[rescueme]

IF you thought you'd be paying an average of 15% in taxes and wanted to net $40K afterward, you'd find the grossed up amount by dividing $40K by .85 rather than multiplying by 1.15.

Yes; that is the correct manner to calculate the gross needed for an assumed 15% tax rate

I use the calcuation every month when I withdraw my required monthly income, along with taxes (don't have to file quarterly taxes in this manner; they are taken out and submitted to the IRS by FIDO without any bother to me).

 

[tomc5179]

Thank you everybody for your replies. I've been a lurker reading the forum and studying for I think the past 5 years as I get closer to my target. As best as I can tell, I think I'm really close. If I figure my yearly expenses (everything - living, vacation, health insurance, taxes, 10K contingency) that puts me at a 2.9% withdrawl rate. The only thing is, I just turned 45 and the state of the economy and health insurance has me worried about quitting now.

On the one hand it is SO exciting to be close to my goal, but then it is SO frustrating to not know what the economy and health insurance is going to do!

 

[easysurfer]

Thank you everybody for your replies. I've been a lurker reading the forum and studying for I think the past 5 years as I get closer to my target. As best as I can tell, I think I'm really close. If I figure my yearly expenses (everything - living, vacation, health insurance, taxes, 10K contingency) that puts me at a 2.9% withdrawl rate. The only thing is, I just turned 45 and the state of the economy and health insurance has me worried about quitting now.

On the one hand it is SO exciting to be close to my goal, but then it is SO frustrating to not know what the economy and health insurance is going to do!

Tom,

Congrats on being so close to you goal. When I FIRE'd back in Jan 2008, health insurance was one of the last things I had to make sure I had. I was 47 at the time. Looking back, if it was in Oct 2008 rather than Jan, I probably would not have FIRE'd because the market was doing so bad. That said, I'm still happy that I chose to FIRE when I did.

Unless you are extremely wealthy and have money to burn, I think some parts of ER is a leap of faith as no one really knows for sure how things (the market, the nature of health care) will be in the futue.

 

[scrabbler1]

Tom, when I retired in late 2008 at age 45, one of the many things I did was to create a spreadsheet which included simulated state and federal income tax returns transformed to include all income as dividends and cap gains instead of a mixture of that with wage income. This way, I could play out what-if scenarios for income taxes due and make sure I paid enough in estimated taxes by the end of the year (or early January of the following year) and update it as the year went on. This was particularly important in December when some of my mutual funds began paying cap gain distributions, sometimes unexpected, and I had to quickly get my estimated taxes up to levels to avoid penalties the following April.

This worked out very well for 2009, my first full year of retirement and is working just fine so far in 2010.

 

[ksr]

I've discovered that, now that I no longer work full-time, I not only pay much less in taxes that I'd anticipated, but that I have a lot more control over the issue as well. For example, if you choose an HSA-eligible health insurance plan, you can deduct your allowable HSA contribution each year. So each year now I calculate if the HSA-eligible plan is still the best choice for me, factoring in the potential tax savings of HSA contributions.

I've also been able to better time the sale of some stocks (for tax purposes). When I was working I had some company stock (from options) that I held off selling while still working because I was in a much higher tax bracket. Now that I'm in a very low tax bracket, I've gradually been selling them off. Of course the market has also given me more tax-loss harvesting options in the past couple of years, too.

I do a little pt work (teach a couple of classes), but even here I look at the tax ramifications and try to ensure that my total income won't push me into a higher tax bracket. Heaven knows, there's no sense working more and keeping less of my income!

Essentially it seems like I'm better able to "architect" my income and resulting income taxes now.

 

[Animorph]

Don't forget your tax basis! You should be paying CG taxes only on gains, not your original investment. Also, CG tax rates may be going up for you in the future.

I do a fully detailed projection, no short cuts.

 

[MasterBlaster]

here's a handy little calculator to estimate what you could owe:

1040 Tax Calculator - Financial Calculators from Dinkytown.net

When I use that calculator and have only $40k in long-term capital gains, married and stanard deduction (don't itemize) then it indicates there will be no income tax due.

Put in your own numbers to verify

 

[W2R]

Here is the IRS form and instructions for estimating federal income tax in retirement. I suppose you could fill out the worksheet on page 7 for estimating your federal income tax.

http://www.irs.gov/pub/irs-pdf/f1040es.pdf

 

[walkinwood]

On the one hand it is SO exciting to be close to my goal, but then it is SO frustrating to not know what the economy and health insurance is going to do!

How close to your goal are you?

Nothing to add to your original question that hasn't already been mentioned. Tax law is complicated, so use a program or last year's 1040 form to figure out what you may pay. Use last year's mutual fund distributions as a guide. Bob Clyatt, in his book, "Work Less, Live more" estimates it at less than 5% of annual withdrawal. (ie. for ERs who are not withdrawing from tax deferred accounts)

 

[RunningBum]

As a couple others mentioned, but in case you didn't catch it, don't forget about state taxes as well as fed, unless your state doesn't have an income tax.

 

[tomc5179]

How close to your goal are you?

I'd like to be at 2.5% SWR or under and I'm at 2.9% right now. My main concerns right now are what is going to be happening with health insurance, what the economy is going to wind up doing and I also have some commercial rental buildings that are giving me some income. I want to keep them at the minute as they are occupied, but the tenants that are operating businesses in them have told me that they are having a difficult time. I'd hate to lose them and the income. OTOH, I'd hate to have to try and sell the buildings right now in this market.

On the one hand I think I should say heck with it, I'm very close to my goal and at 2.9% I'll more than likely be OK, but on the flip side, I'm 45 and I could trudge through another 5 yrs of work to build my cushion higher. I'm leaning toward another 5 years. I can always re-evaluate in another year or two.

The main thing is that when I quit working, I plan to quit for good and not want to have to go back to work.

 

[RedHawk]

Couple thoughts. You taxes due are heavily dependent on how your assets are split between taxable and tax-deferred accounts. If your assets are in tax deferred accounts, withdrawals will be at ordinary income rates not capital gain rates. Also if your assets are in taxable accounts, you will be taxed on the total income produced by your investments not just those funds withdrawn.

 

[skyvue]

If your over 59.5 and your only source of income is withdrawals from your 401k, is that withdrawal amount taxed the same as if it were earned from working?

For instance, assuming your 60 and single and you withdrawal $50K for the year from the account, what amount or percentage will you pay in federal income taxes? (Assuming no other income or non-standard deductions)

 

[ziggy29]

If your over 59.5 and your only source of income is withdrawals from your 401k, is that withdrawal amount taxed the same as if it were earned from working?

Yes, at least at the federal level -- IF the 401K distribution came from an account funded exclusively with pre-tax contributions.

Some states have special exclusions for certain types of retirement income, but in other states it is considered like any other ordinary income.