Firecalc and taxes

[Bali]

Hello,

I am new to this group and truly appreciate all the great conversations in various thread. I have learned a lot since I joined.

I haveva firecalc question and apologize if it was answered before. I am playing with firecalc. For the expenses, I am putting after taxex yearly expense. Do you know if firecalc takes taxex under consideration with the calculations? I.e 401k withdrawels will be subject to income tax.

Than You.

 

[Brett_Cameron]

I do not believe it does.

 

[Bali]

Do you suggest a way around this, i.e how can I include taxex in calculations? For example if my after tax expenses are 30k yearly, should I be increasing it by 25% and make it before tax while entering this number?

Thans again.

 

[rbmrtn]

I also believe it does not consider taxes. You can include taxes as part of spending but it could change significantly over a retirement span. The following is from the firecalc intro...

Why don't you have a space for taxable portfolio and another space for nontaxable portfolio?
FIRECalc ignores taxable versus nontaxable portfolios right now. Since it only uses historical data to determine how a portfolio would behave, with no guesses by anyone about what will happen to inflation, market performance, and so forth, and we don't have historical tax rates for the period for which I have market data, I can't add tax planning without changing the philosophy of the program. Just planning on x% tax rates would make all the historical examples meaningless, when changing tax rates would have at least some effect on the market returns.
If I can figure out how to do this in a way that would not corrupt the results, I'll do it. For now, I prefer to leave the tax planning portion to programs like www.i-orp.com -- an outstanding tool!

Try the i-orp calculator for tax input.

 

[Bali]

Thank you ver much for the responses, much appreciated.

 

[urn2bfree]

You have to include taxes as part of your expenses. I cannot figure out how to link to other threads on here using the iPad App, but I recently started a thread about what tax rate people use in their calculations. The best suggestion was to use an online tax estimator like TurboTax to see. It turns out that it really is an amazing range of rates depending on how much of your money you are taking from where. My effective tax rate is likely to be about 12% or less in retirement (Federal AND State). With each state being different of course.you have to know how your state treats the different income sources.

30% tax rate is possible but would mean you are taking a HUGE amount of money out of your tax deferred accounts. Remember money you take out of your currently taxed savings is only potentially subject to being taxed (Federally) on the part of the withdrawal which is dividend or capital gains (return of principle does not get taxed or even counted to determine you tax bracket) and currently only subject if you end up above the 15% marginal tax bracket which is something like $70,000 right now.

Example-(ignoring Social Security and pensions as sources of income and ignoring exemptions and carry over capital losses from prior tax years which allow you to deduct from these crude numbers):
You need $100,000 a year. You made $30,000 in dividends from a taxable account. From your taxable account you sell some stock to generate $35,000 but the capital gain is $10,000 of it, the rest return of your principle. You take $41,176 from your IRA or 401k. Total to spend = $100,000. Federal taxes owed = 15% of that last $41.176 only. Federal tax rate on the total is 6.18%. Take all $100,000 of it from your IRA or 401k and you would owe 15% Federally, so you would have to take out $117,647 to be left with $100,000 to spend. (assuming you owe ZERO State taxes-which is not likely in most states)

 

[urn2bfree]

You have to include taxes as part of your expenses. I cannot figure out how to link to other threads on here using the iPad App, but I recently started a thread about what tax rate people use in their calculations. The best suggestion was to use an online tax estimator like TurboTax to see. It turns out that it really is an amazing range of rates depending on how much of your money you are taking from where. My effective tax rate is likely to be about 12% or less in retirement (Federal AND State). With each state being different of course.you have to know how your state treats the different income sources.

30% tax rate is possible but would mean you are taking a HUGE amount of money out of your tax deferred accounts. Remember money you take out of your currently taxed savings is only potentially subject to being taxed (Federally) on the part of the withdrawal which is dividend or capital gains (return of principle does not get taxed or even counted to determine you tax bracket) and currently only subject if you end up above the 15% marginal tax bracket which is something like $70,000 right now.

Example-(ignoring Social Security and pensions as sources of income and ignoring exemptions and carry over capital losses from prior tax years which allow you to deduct from these crude numbers):
You need $100,000 a year. You made $30,000 in dividends from a taxable account. From your taxable account you sell some stock to generate $35,000 but the capital gain is $10,000 of it, the rest return of your principle. You take $41,176 from your IRA or 401k. Total to spend = $100,000. Federal taxes owed = 15% of that last $41.176 only. Federal tax rate on the total is 6.18%. Take all $100,000 of it from your IRA or 401k and you would owe 15% Federally, so you would have to take out $117,647 to be left with $100,000 to spend. (assuming you owe ZERO State taxes-which is not likely in most states)

I forgot to add that I assume any interest income you make you make it in tax deferred accounts.

 

[allanlevy]

I am frankly quite disturbed by FIRECALC's ignoring taxes. Other than this it would be a great tool. But to ignore taxes and leave it to a user to estimate taxes as part of expenses is pretty bad. The reason it is bad is you can't estimate taxes for each of the approx 100 scenarios FIRECALC runs, and the tax will be a function of the scenario. That is each 30 year period has substantially different income streams. Each therefore would have different tax expenses. You can just estimate a single tax expense, and apply it, but then that doesn't differentiate all the scenarios FIRECALC calculates. But I guess there is no real alternative. Any thoughts?

 

[allanlevy]

I found ORP did not run (file not found 404 error)

 

[REWahoo]

...you can't estimate taxes for each of the approx 100 scenarios FIRECALC runs, and the tax will be a function of the scenario. That is each 30 year period has substantially different income streams. Each therefore would have different tax expenses. You can just estimate a single tax expense, and apply it, but then that doesn't differentiate all the scenarios FIRECALC calculates. But I guess there is no real alternative. Any thoughts?

None other than the obvious fact you've just answered your own question...

 

[Fishingmn]

I totally understand why they don't. Too many variables. It's not just taxable vs non-taxable accounts. You've got a whole variety of tax consequences to consider (on top of 40+ state taxes). Heck, my 9 rental properties make for a huge guessing game with the passive income and myriad of depreciation rules.

 

[Katsmeow]

Personally I like it that Firecalc doesn't estimate taxes. I prefer to estimate my own taxes which are based upon my spending and my particular deductions. I use Fidelity RIP but actually don't like that it estimates taxes since I think I can do better estimating my own taxes.

 

[omni550]

I found ORP did not run (file not found 404 error)

Try i-orp....http://www.i-orp.com/

omni

 

[allanlevy]

Personally I like it that Firecalc doesn't estimate taxes. I prefer to estimate my own taxes which are based upon my spending and my particular deductions. I use Fidelity RIP but actually don't like that it estimates taxes since I think I can do better estimating my own taxes.

Wait! the statement seems wrong (to me) ---Remember money you take out of your currently taxed savings is only potentially subject to being taxed (Federally) on the part of the withdrawal which is dividend or capital gains (return of principle does not get taxed or even counted to determine you tax bracket) and currently only subject if you end up above the 15% marginal tax bracket which is something like $70,000 right now.

You are not "taking out" $ from your non-deferred account. It is generating income itself, whether you spend it or not. And that income is subject to tax (whether you spend it, or not). You don't get to choose a withdraw amount from it really. That is why estimating your taxes and applying that to the expense portion of FIRECALC to determine failure scenarios is such a problem. It is because each scenario, has its own historical performance, and consequently its own historical tax implications. By using your own estimate you are applying that estimates underlying tax bases, against all scenarios regardless of the return characteristics of the each scenario, each different. Then you use the aggregate failure rate from the MC simulation. That scares me. Its like combining apples and oranges. It generates an error margin, of size frankly I do not know. Should I worry about the size of this error margin?

I do of course acknowledge what you say that you like that you can apply your own tax rate and feel its more accurate. I see this, especially if your holdings are tax complex (eg rentals, RE, etc). But what is the error margin effect of estimating your taxes, and then applying that estimate to the expected spending, and having that then be used to generated 100+ failure rate scenarios, based on the non apples - apples tax rate of the given scenario vs the apples tax rate of the given scenario (not included in FC) and the non-apples tax rate of your single estimate not aligned with the scenario's tax characteristic based on its particular return characteristic.

 

[foxfirev5]

I don't see how Firecalc could accurately estimate taxes. Nor would I want that feature. While tax planning is certainly important it's not what I seek with this tool. It's comprehensive approach to planning includes everything I need for a good overall plan.

 

[MuirWannabe]

Just add buffer for your feared error margin on taxes. It seems pretty straghtforward to me. Kind of the beauty of Firecalc.

 

[marko]

To me, this is pretty simple.

In the working world, when you think about your income, you don't think about your spending amount, you think about your total income which also accounts for taxes.

Same with FIRECALC. You need to know how much money you need to 'make' (withdraw) in order to cover your spending and taxes.

Will it be exact? No. But even in the paycheck world, there's always some difference between your plan and reality.

 

[Willers]

Same with FIRECALC. You need to know how much money you need to 'make' (withdraw) in order to cover your spending and taxes.

Will it be exact? No. But even in the paycheck world, there's always some difference between your plan and reality.

+1 That's how I did it. I added my expected taxes into my income requirement number. It won't be exact, but if you are like my impression of most on this forum, you'll err on the high side and be happy when it is less.

 

[youbet]

Taxes are just another expense.

 

[MichaelB]

Taxes are just another expense.

Yup. (That's twice now. are we going for a record in agreements? )
FIRECalc tells us how much we can afford to spend. What we spend it on - taxes, mortgage, or beer - is unique to each of us.

 

[Meadbh]

Unfortunately death and taxes are always with us, and tax regimes change. I think it is important not to place complete reliance on a single calculator that doesn't account for tax liabilities. I have recently worked with my financial institution on a detailed financial plan for retirement and it has been quite an eye opener with respect to taxes. For example, if I died today, my estate would be liable for over 600K in taxes. If I live to be 90, I will have paid a total $2m in taxes between now and then. When I reach the age of RMDs, I am going to jump to the highest marginal tax bracket. There are strategies I can use to reduce my tax liability, but to assume that taxes must be included in a predetermined "SWR" number does not do justice to the complexity of the situation. For example, I am paying more taxes this year than I anticipated, because my investments have done better than expected. That throws my "SWR" off. When I reach the age of RMDs, my "withdrawal" will increase dramatically without my consent, to pay taxes (although I could reinvest what I don't spend). What I have learnt from this analysis is that when taxes (and debt servicing) are accounted for, lifestyle expenses are best planned and projected as an independent variable. They can then be sensitivity tested and optimized using the software. I was pleased to find that the initial amount I had expected to spend on lifestyle expenses was conservative and that I can safely loosen the pursestrings a little.

 

[allanlevy]

Taxes are just another expense.

FIRECALC asks for an entry of SS income "precisely as the SS admin" tells you you are likely to get from the SSA. But this amount is pretax.

So if you follow FIRECAL's instructions you enter a pretax SS income. But if you want the tool to be accuaret shouldn't you tax taxes out of that SS income to enter into FIRECAL the post tax SS income.

For example SS stated by SSA * .85 (the amount subject to ordinary income tax * ordinary income tax rates (eg like 45% considering fed and state for the upper tax margins).

You enter the post not pre tax SS income correct? Despite FIRECAL's statement just enter what the SSA estimates for you (ie pretax)?

-Allan

 

[REWahoo]

You enter the post not pre tax SS income correct?

No, that is incorrect.

As has been previously stated (multiple times), FIRECalc does NOT consider taxes, so ALL your inputs should be pre-tax.

 

[allanlevy]

you wrote ..."There are strategies I can use to reduce my tax liability" [when you are pulling money out for RMD etc]...I find (forecast) myself to be in the same position, that is paying the highest level of taxes on my taxable earnings...frighteningly sensing I need to pay 39% fed and 7% state and 2% local tax continuously and for the rest of my days and nights. Its enough to make me want to "pass" early. But that seems a poor approach to reducing taxes indeed. So I wonder, what strategies are you / others thinking about to reduce taxes in a situation like this.

The subject is probably worth a thread of its own, its so important. One strategy I know, of course, is to gift to the max to kids (but that reduces estate tax, not ordinary income tax on taxable earnings).

I would be very interested (as I am certain so would be others) on approaches to minimize tax and taxable earnings during retirement please.

-Allan

 

[allanlevy]

we may be saying the same thing...putting in a pretax ss amount and then taking say 45% of it and placing that as an incremental expense is the same thing as just inputting post tax SS amount. Correct?