Withdrawal rate irony

[David1961]

As a retiree who has investments that generate taxable income or distributions, I find that if I have a very good year for my investments, my tax bill increases and thus my withdrawal rate increases. And of course, the opposite is true if my investments have a bad year. Of course, if the portfolio value goes up significantly in one year, then I can theoretically take more out that year while keeping the same withdrawal rate.

One reason why I keep track of portfolio value as well as withdrawal rate.

Not really a question, just the way my mind loves to analyse things.

 

[scrabbler1]

I have had spikes in my annual WR when I unexpectedly large distributions, usually the more erratic cap gains, especially if they happen to be short-term cap gain distributions which are always taxed at the higher ordinary income rate.


I don't fret when this happens, though, because it was additional, unanticipated income which triggered the added expense. But because I automatically reinvest my cap gain distributions, I do feel a cash squeeze because I have to come up with the cash to pay the taxes, sometimes as estimated taxes midyear.


I do watch the portfolio value, as you do, so my WR has dropped some thanks to the denominator increasing nicely every year despite all the money I don't add in dividends I take as cash.

 

[audreyh1]

As a retiree who has investments that generate taxable income or distributions, I find that if I have a very good year for my investments, my tax bill increases and thus my withdrawal rate increases. And of course, the opposite is true if my investments have a bad year. Of course, if the portfolio value goes up significantly in one year, then I can theoretically take more out that year while keeping the same withdrawal rate.

One reason why I keep track of portfolio value as well as withdrawal rate.

Not really a question, just the way my mind loves to analyse things.

I use a % of remaining portfolio withdrawal method, so my annual income grows and shrinks with my portfolio.

I track the % of my portfolio that I pay in income taxes each year. After good market years, distributions from my mutual funds go up, sometimes quite a bit, so even though the $ amount withdrawn goes up with portfolio gains, the taxes that come out also have gone up, and my after-tax income won't grow as much.

Similarly, after a bad year, distributions tend to drop substantially, and suddenly taxes are down. Gosh in 2009 I think they pretty much went to 0! So even if my pre-tax income drops big, with smaller taxes, my after-tax income may not go down much.

This has an interesting after-tax income smoothing effect.

 

[RunningBum]

Does it really go up very much? Unless you are selling appreciated assets, your taxable income shouldn't go up that much. If your portfolio grows $100K, and you get a 2% yield of dividends/distributions, that's $2000 more income. If your fed+state tax rate on that is 20%, that's $400. Does that really make a big difference? On a $1M portfolio, that's .04%.

 

[audreyh1]

It's the capital gains distributions. They can double from one year to the next, or disappear entirely.

Yes, good reason to avoid them. But sometimes you already own the assets and there are more severe tax consequences in selling.

 

[ejman]

It's the capital gains distributions. They can double from one year to the next, or disappear entirely.

Yes, good reason to avoid them. But sometimes you already own the assets and there are more severe tax consequences in selling.

Indeed. CG distributions from actively managed funds I own practically disappeared 2008-2010. Dividend distributions were much more uniform dropping some in 2009 but getting back to average afterwards.

 

[David1961]

Yes, mostly capital gains.

 

[audreyh1]

Indeed. CG distributions from actively managed funds I own practically disappeared 2008-2010. Dividend distributions were much more uniform dropping some in 2009 but getting back to average afterwards.

There was a huge leap in 2014, like 45%. Also saw a 47% from 2011 to 2012, after a 33% rise in 2011 to 2012 - but that was mostly recovery from 2009/2010 very low distributions paid out.

Fortunately last year saw a 30% drop in capital gains distributions, partly because I got rid of a couple of naughty (excessive payouts) funds when I had the chance to do so without tax consequences, but also other funds dropped too.

 

[DrRoy]

If you were in largely index funds/ETF's rather than actively managed, the cap gains distributions would be much more steady.

 

[FUEGO]

When I think about the long term (as in 30+ years), I always assumed that I'll probably have a higher income later than now, since most of those FIREcalc runs leave me with a growing portfolio. Of course that means higher taxes! But since I'll have so much more money, it's no big deal to pay higher taxes.

In fact, I'll probably pay way more at 70.5 due to RMDs versus what I'm paying now ($0 federal income tax, though there's a small slug of self employment tax due to a side hustle). No biggie - growth in assets will more than offset growth in tax liability. And in the worst case - the portfolio value declines over time - I'll owe a lot less in taxes (or none) which is fortunate since the money will mostly be gone!

As a result, I'm hoping to write very large checks to Uncle Sam when I'm "old"

 

[MrLoco]

If you were in largely index funds/ETF's rather than actively managed, the cap gains distributions would be much more steady.

This. If you own index funds and/or tax managed funds in your taxable account....very little in the way of capital gains in December. No "churning" of the fund by a fund manager. Plus a healthy dose of muni bonds and your tax bill will significantly decrease.

 

[audreyh1]

If you were in largely index funds/ETF's rather than actively managed, the cap gains distributions would be much more steady.

Well - yeah. If you have a lot in taxable accounts it can take a while to reposition things to reduce taxes. I'll probably be working on that for the rest of my life!

 

[Bir48die]

Some of us have investment people and we're not in control of when our assets are sold. So, we are at their whim on timing. However, results have been good so paying taxes on gains has become not only commonplace but expected.

 

[travelover]

Some of us have investment people and we're not in control of when our assets are sold. So, we are at their whim on timing. .............

This would make me uncomfortable. Aren't they working for you?

 

[Johanson]

Some of us have investment people and we're not in control of when our assets are sold. So, we are at their whim on timing. However, results have been good so paying taxes on gains has become not only commonplace but expected.

This would make me uncomfortable. Aren't they working for you?

This would make me very uncomfortable. I may turn those decisions over to someone else someday but I will have suffered some significant mental decline at that point.

 

[Souschef]

My WR is literally driven by my RMD, which, at my age, is 5% of my IRA's. My IRA's are about 55% of my total assets.

 

[mickeyd]

Not a big fan of following a strict WR for me. I can see where it would be beneficial for many, but it doesn't seem to be necessary to our stash. Since the loin's share of our accounts are TIRA/Roth, I use the RMD to guide me annually on the WR. Of course, it is not necessary to spend all of the RMD just because IRS says you must WD it from your IRA.


The RMD is a requirement to tax, not a requirement to spend.

 

[David1961]

Well - yeah. If you have a lot in taxable accounts it can take a while to reposition things to reduce taxes. I'll probably be working on that for the rest of my life!

I feel like that also.

 

[David1961]

I feel like that also. Is it worth selling funds and paying capital gains taxes on the gains just to lower taxes at some later date? Although to be fair, the cost basis on those funds is probably pretty high and the tax liability would probably be fairly small.

 

[audreyh1]

I feel like that also. Is it worth selling funds and paying capital gains taxes on the gains just to lower taxes at some later date? Although to be fair, the cost basis on those funds is probably pretty high and the tax liability would probably be fairly small.

Not really IMO unless the the gain is small. If you can fit it within a 0% cap gain taxable income, it's probably worth it.

You have to be opportunistic.

If a fund predicts a large capital gain distribution, I always check how it compares against the my gain in the fund. If it is higher or close, I go ahead and sell the fund and reinvest in something more tax efficient.

If we have another event like 2008, where you can realize some (temporary) losses in funds, you can use that to offset gains and mover a bunch to more tax efficient funds with low or even negative tax liability.

But I have funds where my unrealized gain is 100% to 200%. I'm not likely to sell those - at least not the lowest cost shares.

 

[RunningBum]

I feel like that also. Is it worth selling funds and paying capital gains taxes on the gains just to lower taxes at some later date? Although to be fair, the cost basis on those funds is probably pretty high and the tax liability would probably be fairly small.

Same here. I have one non-index fund (VG PRIMECAP) that is about 33% LTCGs, meaning that for every $3 of value, $1 is LTCGs. And it's a fairly big holding for me. I didn't worry about it to much in the past, but now that I'm trying to manage to the ACA subsidy, it's a risky holding since it could throw some large distributions and push me off the cliff that I'm already close to. But if I sell it off I'm clearly going to lose all subsidies. Plus it's beaten the total stock market index fund by a significant amount for every period reported (YTD, 1, 3, 5, and 10 years). So, it's very doubtful that I'll sell it off.