Net Worth - Adjusting for Taxes?

[GMueller]

Calculating net worth should be very simple.  However, it appears that there are multiple ways to perform the calulation (i.e., what is included, what is not).  I'm curious how many members make an adjustment for taxes that will become due when an account is liquidated.  For example, if I calculate my net worth without accounting for taxes, I come up with something in neighborhood of $1.15M  However, in reality, if I were to liquidate all my accounts, Uncle Sam would have his share, leaving me with a net  balance of about $1.04M.  How do you calculate Net Worth:  with, or without, adjusting for taxes?

 

[73ss454]

It would be hard to figure taxes because one has no way of knowing what the future taxes will be. How could one know what tax bracket you'll be in 10 or 20 years from now.

 

[wabmester]

I handle estimated taxes as part of my estimated expenses, not as a reduction in net worth, although the net effect is probably the same.

 

[donheff]

I handle estimated taxes as part of my estimated expenses, not as a reduction in net worth, although the net effect is probably the same.

I agree. Figure out your expenses. Then figure out how much more you need to pull to cover taxes, then see if it is within a reasonable SWR. Alternatively, compute your SWR, estimate the taxes on that amount and decide if what is left gives you more than enough for expenses.

It gets pretty uncertain when you forecast out more than a few years. Changes from taxed to untaxed accounts, social security coming in, the impact of increasing withdrawls to meet inflation on the marginal tax rate, etc., call for a very conservative estimate. I leave plenty of wiggle room so I can scale back my expenses if the reality is different than my guesstimates.

 

[WilliamG]

Agree with the aboves, handle estimated taxes as a projected expense. Tax law is not constant and this enables you to repeatedly evaluate tax handling as part of your expense planning including when to take from what accounts (eg., Roth, normal taxable, reg IRA, etc).

 

[Scrooge]

How do you calculate Net Worth:  with, or without, adjusting for taxes?

When I was using FIRECalc, I was adding taxes to my yearly expenses. In my own ER calculator, I make allowances for changing tax brackets over the next 50 years as my projected taxable income changes: 401K to Roth conversion, RMDs, social security taxes, etc. I also allow for changes in tax laws, although long term changes are naturally hard to predict.

 

[renferme]

To calculate net worth, I just add up my investments and savings, plus the value of my pension, plus what I have in the house (value that I can sell it, minus selling expenses, minus the mortgage). Mortgage is the only debt.

 

[Rich_by_the_Bay]

Not sure how (or why) you'd factor taxes into net worth. For most holdings their value increases over time and even if taxable upon withdrawal or liquidation, the growth occurs tax-deferred. Also, different assets are taxed differently depending on whether it's gains, dividends, deferred dollars taxed as income, etc.

For me it works best to ignore taxes re: net worth, but just to factor them into my expenses for planning.

 

[MJ]

When I was using FIRECalc, I was adding taxes to my yearly expenses. In my own ER calculator, I make allowances for changing tax brackets over the next 50 years as my projected taxable income changes: 401K to Roth conversion, RMDs, social security taxes, etc. I also allow for changes in tax laws, although long term changes are naturally hard to predict.

Same here. Did you swipe my excel spreadsheet?

 

[Robert the Red]

It depends on what you think "net worth" is for, and when. If it is to be spent all at once and soon, then allowing for current tax rates is necessary. If it is to be spent gradually many years from now, then your current tax rates are probably kind of meaningless. If it is to be spent not at all (just live off interest and dividends?) and passed on to heirs, then estate tax may come in (if you are lucky enough to have that much, anyhoo). If you're going to give it all to a charity for homeless elephants, then taxes probably don't come in much at all.

 

[retire@40]

You are technically correct in saying taxes should be deducted in arriving at your net worth, but because of the tremendous difficulties, if not impossibilities, in calculating the deferred tax, it is usually always ignored.

For example, if you liquidate all your investments today, you would have one tax amount, but if you liquidate over time and select which investments to liquidate to minimize your yearly taxes, you would have a totally different amount.

Since it is much easier to know what the tax is upon liquidation, it is usually taken as an expense at that point.

 

[SteveR]

It depends on what you think "net worth" is for, and when.  If it is to be spent all at once and soon, then allowing for current tax rates is necessary.  If it is to be spent gradually many years from now, then your current tax rates are probably kind of meaningless.  If it is to be spent not at all (just live off interest and dividends?) and passed on to heirs, then estate tax may come in (if you are lucky enough to have that much, anyhoo).  If you're going to give it all to a charity for homeless elephants, then taxes probably don't come in much at all.

Exactly what I was thinking.

Taxes are all relative to the source at the time you liquidate and other sources of income in that tax year. Also, many of us will never spend all or our net worth in our lifetime and the tax considerations then become a whole different animal for our beneficiaries.

I would never calculate taxes as part of my net worth. However, if I were doing a calculation for other purposes like income streams, inheritance potential, etc, then I would include taxes because at that point they would be important otherwise, they are not useful.

 

[justin]

All of my dollars are equal, but some dollars (the after tax dollars) are more equal than others.

 

[Scrooge]

Same here. Did you swipe my excel spreadsheet? 

Sadly, the software that I used to code my ER calculator predates not only Excel, but also VisiCalc 

Hey, we mastodons want to retire early too!  8)

 

[audreyh1]

Most of my investments are in taxable accounts. I pay taxes on the accounts whether or not I withdraw funds. Usually distributions can cover any withdrawal.

When I look at SWR, I account for the 0.5% on average that taxes take out of my investments. In other words, for me 3.5% after taxes is really the most money I can expect to spend in any given year.

I never liquidate the entire set of investments, so that point is kind of mute.

Since I retired, long term capital gains taxes when from 20% to 18% to 15%. And qualified dividends when from short-term rates to 15%. Things are always changing.

Audrey

 

[scrinch]

Your home equity isn't your house's market value alone, it's the market value less the outstanding mortgage balance (which is possibly zero). And it isn't complicated because your adjustable mortgage interest rate might go up or down in the future....or even if you have a negative amortization mortgage. It is the value of your house today minus what you owe on it today. So why isn't your net worth today equal to the value of your assets today minus what you owe on those assets (taxes) today? The asset value and the taxes owed might change tomorrow, but that doesn't change the value calculated today, does it?

Okay, maybe it is semantics, but let's not kid ourselves that what we calculate is really our net worth. It's the next-to bottom line, not the very bottom line.

 

[dmpi]

I agree with srinch. Your net worth is your current assets minus your liabilities. And one of your liabilities is of course the taxes that you owe. Since you do not know what future tax rates you'll be in, you can simply use today's rate for your calculation.
If you look at this from a planning standpoint, you are trying to maximize your future net worth, you would rather have your heavy hitter investments (stocks) in a lower tax rate (like a Roth IRA), while lower yielding investments (i.e. CDs) can be in a taxable account.

 

[sgeeeee]

. . . Your net worth is your current assets minus your liabilities. And one of your liabilities is of course the taxes that you owe. . .

Maybe I'm missing something, but this makes no sense to me. In addition to paying taxes for the rest of my life, I'm going to have to eat meals for the rest of my life. I'm going to have to wear clothes for the rest of my life. I'm going to have to pay for healthcare for the rest of my life. Why would I subtract taxes from net worth and not these other items? But if I subtract everything I will ever have to pay for in the future from my current net worth, then I will have no expenses.

 

[GMueller]

I subtract taxes because they are a claim against my net worth. I believe I can estimate how much is owed with reasonable certainty -- either now, or in the future. I don't feel free to spend what effectively belongs to the Government. There is a significant difference between $1,000,000 an account where taxes have already been paid and $1,000,000 in an account where no taxes have been paid. I prefer to acknowledge that difference by adjusting for taxes. IMHO, it's a shame there is no standardized methodology for calculating networth (with respect to taxes) because the lack of methodology often results in the comparison of apples and oranges.

 

[d]

I subtract taxes because they are a claim against my net worth

what about sales taxes? to be consistent you should also subtract these ... which seems, of course, to make no sense.

 

[retire@40]

Maybe I'm missing something, but this makes no sense to me.  In addition to paying taxes for the rest of my life, I'm going to have to eat meals for the rest of my life.  I'm going to have to wear clothes for the rest of my life.  I'm going to have to pay for healthcare for the rest of my life.  Why would I subtract taxes from net worth and not these other items?  But if I subtract everything I will ever have to pay for in the future from my current net worth, then I will have no expenses.   

The reason you deduct income taxes and not meals and clothes is because in the case of taxes, you are deducting "deferred" taxes as I believe I stating in my previous post. 

This means when your investments grow in value, you immediately incur a tax liability.  Our tax system allows you to defer these taxes until they are sold, but the liability attaches as soon as the investment increases in value.

 

[dmpi]

I IMHO, it's a shame there is no standardized methodology for calculating networth (with respect to taxes) because the lack of methodology often results in the comparison of apples and oranges.

I agree too. We should have standard methods for computing pretax and posttax networth and not mix the two. For me the delta is about 250K between the two.

 

[audreyh1]

Since I don't compare my net worth to anyone else's, that pretty much makes is a mute point for me.

All I care about is how much I can afford to withdraw/spend each year. That already takes taxes into account. For me that's all that really matters.

Audrey

 

[rs0460a]

Sorry if this point was already made, but I do include the value of my home in my "gross net worth". In reality, I don't know what it's actual "worth" will be untill it is sold. It's a bit like taxes on your investments; they may go up/down in the future. As a home, you don't know the "value" until you get somebody willing to "pay the price". Along with settlement costs (realtor, taxes, etc.) that could be considered as "tax", you really can't say what you are "worth", even if you are including taxable funds. How do you know what the future holds (as far as taxes)?

I always state my "Gross Net Worth". That indicates that there will be "adjustments" made in the future. For the folks that attempt to show their gross net worth, minus taxes, I guess you can call it their "net-net worth"?

- Ron

 

[unclemick]

Audrey - I'm with you.

Also - I viewed my net worth differently during the accumulation phrase - transition to ER - and in ER (distribution).

13th year into ER - I'm more with the Norwegian widow and less De Gaul.

How much can I spend - and er ah how much longer do I think I have to spend it. No heirs to speak of here.

heh heh heh