Taxes?

[cyclone6]

I am 45, and about to pull the plug on full-time work.  A couple days a week?  Perfect - keeps the mind sharp and the extra bucks don't hurt either...

My question is taxes.  Lets say Firecalc tells me I can safely withdraw $45,000 per year.  So I set up a diversified portfolio.  Come December, the mutual funds all pay capital gains distributions and common interest.  Taxable to me.  Lets say the taxes due on the portfolio and any re-balancing are $10,000.  Am I supposed to take that $10,000 off the $45,000 withdrawal, or I am supposed to use additional proceeds from the portfolio to pay it?

Is the Firecalc number a true spending number, or a number that has to be reduced to pay taxes?

Thanks! 

 

[audreyh1]

You are must pay the taxes out of your withdrawal - otherwise you are just taking a larger withdrawal!

My experience with my mostly taxable portfolio is that taxes on capital gains and dividend distributions have averaged about 0.5% per year over many years. Therefore I count on no more than 3.5% after taxes.

Audrey

 

[jdw_fire]

Welcome cyclone6 and congrats on your impending retirement.  In answer to your question, FIRECalc produces pre-tax numbers.  In other words you pay taxes out of your W/D amount.

 

[jdw_fire]

My experience with my mostly taxable portfolio is that taxes on capital gains and dividend distributions have averaged about 0.5% per year over many years.  Therefore I count on no more than 3.5% after taxes.

Audrey

So are you suggesting cyclone6 plan on paying 12.5% in taxes?  This would seem a little high based on a $45k/yr W/D if a significant portion of it is dividends and cap gain distributions.  Look at this just using regular income, a married couple gets the first $16,400 of income free from tax, the next $14,600 at 10% and the last $14,000 at 15% which makes an overall % tax paid of 7.9%

When it comes to what your W/D percentage is check out the discussion on the  "Help me design a portfolio that generates $50,000 a year" thread.

 

[retire@40]

So are you suggesting cyclone6 plan on paying 12.5% in taxes?  This would seem a little high based on a $45k/yr W/D if a significant portion of it is dividends and cap gain distributions.  Look at this just using regular income, a married couple gets the first $16,400 of income free from tax, the next $14,600 at 10% and the last $14,000 at 15% which makes an overall % tax paid of 7.9%

When it comes to what your W/D percentage is check out the discussion on the  "Help me design a portfolio that generates $50,000 a year" thread.

You also need to figure in any state tax.

 

[audreyh1]

So are you suggesting cyclone6 plan on paying 12.5% in taxes?  This would seem a little high based on a $45k/yr W/D if a significant portion of it is dividends and cap gain distributions.  Look at this just using regular income, a married couple gets the first $16,400 of income free from tax, the next $14,600 at 10% and the last $14,000 at 15% which makes an overall % tax paid of 7.9%

No, I said the taxes on my portfolio average around 0.5%.  This has nothing to do with withdrawals.

The OP was talking about having to pay the taxes due on the distributions and capital gains paid out by his mutual funds.  He is talking about a taxable account.

Unlike withdrawing from an IRA, he doesn't necessarily owe taxes on the $45K he withdraws.  He owes taxes on the mutual fund distributions and any capital gains he realizes that year.

It's a TOTALLY different ball game.  Taxes are totally different.

Audrey

 

[jdw_fire]

Unlike withdrawing from an IRA, he doesn't necessarily owe taxes on the $45K he withdraws.  He owes taxes on the mutual fund distributions and any capital gains he realizes that year.

It's a TOTALLY different ball game.  Taxes are totally different.

Audrey

I agree, however I must have misunderstood your statement

My experience with my mostly taxable portfolio is that taxes on capital gains and dividend distributions have averaged about 0.5% per year over many years. Therefore I count on no more than 3.5% after taxes.

Audrey

which seems to be referring to a W/D rate and interestingly enough when the 3.5% is added to the 0.5% in the previous sentance it comes to the often used 4%.  If the 3.5 is not a W/D rate then what is it?  If it is then why so low?

 

[audreyh1]

I take a 4% withdrawal rate from my portfolio. But I also have to pay any taxes incurred by my portfolio out of that amount. Since I pay out about 0.5% of my portfolio in taxes on the investments, only about 3.5% on average is available to me (after taxes) to spend as I wish.

It varies every year.

Basically - when you withdraw from a taxable portfolio, you have to pay investment taxes out of that withdrawn amount.

When you withdraw from an IRA, you have to pay income taxes out of the amount you withdraw.

In either case, the SWR is a PRE-tax amount. Money you actually get to live on, of course, is POST-tax.

Audrey

 

[cyclone6]

Thanks for the responses...

Let me see if I have this right.  I understand that investments go up and down, sometimes painfully, sometimes joyfully.  Lets take this hypothetical situation:

I retire in Aug with 1.2 M in a diversified portfolio.  On Jan 1 I sell some investments, re-balance, and place $45K in a high-yielding MM for the next year.

Come April 15 taxes are due.  I have made no money during the year outside the capital gains and interest payments on my portfolio.  Its been a decent year - a 7% return on the portfolio.  A $84k return.  Minus personal exemption and standard deduction, the taxable amount is $75k.  So lets assume that I owe $10,000 on that income.

On April 15 I send a check to the IRS for $10,000.  And for this year, at least, I am living on $35k instead of $45k.  Correct?

After I pay my taxes, I live out the year.  And then come the next  Jan 1, I take the $45k figure and multiply it by 1.03 (or whatever the inflation rate was that year) and that becomes my withdrawal rate for year #2.

And what do you do when you have a down year on investments?  Does the carryover of the losses greatly reduce the taxes owed so I won't see a $10,000 tax bill?

I guess more generally, how do all of you deal with withdrawals and the tax situation?  I am lining up the retirement portfolio now, and I am sticking with mostly Vanguard funds and a few ETFs with very low expense ratios and low turnovers.

As an aside, if our markets pull a 1990 Japan market I've got many cans of beans and rice (and a gun!) stored in a cave here in Colorado.

Thanks again!  I'd sure like to know enough that I can write something down on a piece of paper and refer to it as my "plan".  I guess we'll all see what the future has to hold...


Thanks again! 

 

[jdw_fire]

I take a 4% withdrawal rate from my portfolio.  But I also have to pay any taxes incurred by my portfolio out of that amount.  Since I pay out about 0.5% of my portfolio in taxes on the investments, only about 3.5% on average is available to me (after taxes) to spend as I wish.

Audrey,

Based on your explanation above I did understand you in the first place, so my original analysis stands as stated.  It appears your income each year exceeds your W/D for you to be paying that high of a percentage of your W/D in taxes (or you live in a state that has a high tax rate).

Thanks for the responses...

Let me see if I have this right.  I understand that investments go up and down, sometimes painfully, sometimes joyfully.  Lets take this hypothetical situation:

I retire in Aug with 1.2 M in a diversified portfolio.  On Jan 1 I sell some investments, re-balance, and place $45K in a high-yielding MM for the next year.

Come April 15 taxes are due.  I have made no money during the year outside the capital gains and interest payments on my portfolio.  Its been a decent year - a 7% return on the portfolio.  A $84k return.  Minus personal exemption and standard deduction, the taxable amount is $75k.  So lets assume that I owe $10,000 on that income.

cyclone6,

Unless you sold all of your portfolio or your entire portfolio was producing income at the 7% rate you won't have $75k taxable income.  If your portfolio is 75% stocks/stock mutual funds then most of your "7% return on portfolio" will be rising stock prices and therefore unrealized gain that is not taxable until sold.

On April 15 I send a check to the IRS for $10,000.  And for this year, at least, I am living on $35k instead of $45k.  Correct?

After I pay my taxes, I live out the year.  And then come the next  Jan 1, I take the $45k figure and multiply it by 1.03 (or whatever the inflation rate was that year) and that becomes my withdrawal rate for year #2.

And what do you do when you have a down year on investments?  Does the carryover of the losses greatly reduce the taxes owed so I won't see a $10,000 tax bill?

Carrying on with your example yes you would be living on the $35k this year if your taxes owed for last year are $10k.

Yes, your second year W/D is = previous year W/D *(1+inflation rate).

The taxes you owe are dependent on the gain you realized during the year and any unused capital losses from previous years and ...   
Your W/D is calculated the same as the equation above unless you are uncomfortable with that amount and then you alter your W/D.

 

[HFWR]

A few thoughts...

• Index funds generally have relatively low turnover, and therefore have low cap distributions.
• Managing your gains against losses can help optimize (limit) your tax bite.
• A good mix of taxable, ROTH, and 401k/traditional IRA "buckets, as well as a year or two expenses in cash, allows flexibility in managing withdrawals in down years and/or  in optimizing taxes.

 

[audreyh1]

Based on your explanation above I did understand you in the first place, so my original analysis stands as stated.  It appears your income each year exceeds your W/D for you to be paying that high of a percentage of your W/D in taxes (or you live in a state that has a high tax rate).

Yes, in some years my portfolio throws off more than my withdrawal needs in terms of distributions and realized cap gains.  It's also perhaps a function of the size of the portfolio and half the income produced being subject to AMT some years.  I pay no state income tax - only federal taxes.

Taxes, in a taxable portfolio, CAN eat significantly into a person's withdrawal percentage.   Again, it depends on the size of the portfolio and how tax efficient the investments are.

If your investments produced long-term cap gains type income (such as qualified dividends) equal to your withdrawal needs, you are looking at paying 15% in taxes.  So 12.5% of the withdrawal rate on average doesn't seem so far off.

Audrey

 

[modlair]

I would like to pose a question for the distinguished gathering . . .

Okay, a down year means two things for taxes. 1) You don't pay any that year and 2) You have tax loss carryforwards to attenuate taxes in a future year.

Or do you? What do we think of the relative merits of using the tax loss carry forward to reduce tax liability in the next up year vs. using them to shield from taxes the choice of doing a Roth conversion from a traditional IRA. I think you're maxed at $3000 for this effect, but should one always take advantage of that 3K when it's available for this Roth conversion purpose, or just chop another 3K off the immediate tax liability.

Is there an advantage, disadvantage or is it no diff?

 

[dory36]

There's a great tax otimization tool at http://i-orp.com/TaxCutForm.html -- it tells you where to take your withdrawals from to maximize use of available deductions.

 

[modlair]

A good mix of taxable, ROTH, and 401k/traditional IRA "buckets, as well as a year or two expenses in cash, allows flexibility in managing withdrawals in down years and/or in optimizing taxes.

Speaking strictly of taxable accounts, consider a non tax efficient mutual fund that generates distributions during a year approximately equal to the overall fund return. This fund will not have a lot of unrealized capital gains in it at any point in time and in good years, you're going to be taxed -- but hopefully at a rate near 15% (for LT CGs within).

When a bad year comes along, this fund needs to be sold.

This looks at first glance like you're selling at the bottom, but what I'm suggesting is the money should be immediately wrapped into a roughly equivalent vehicle. For example a fund reflecting one index vs a fund(s) which, when weighted correctly, reflect the first index at a high correlation coefficient. This undoes selling at the bottom. The new fund(s) will go up when the old one does.

(I don't know if all index funds are as efficient as S&P. I suspect some sector indexes have lots of dividend paying stocks.)

Anyway, for the IRS's purposes, this is a capital loss. If it's a bad year, you should have no income. Grab this loss and put it in your back pocket as a tax loss carry forward. A bad year can erase taxes for many years to come.

How does this compare with having as your original fund . . . a fund that is very tax efficient and does not generate any distributions to speak of and therefore has embedded in it a lot of long term capital gain?

During a down year, you can't get any TLCF for selling this because of the accumulated gains. Your future years of gains therefore will have no TLCF shield to hide behind.

I suspect it's a wash, but I dunno. Has anyone given this thought?

Hmm, I guess inflation's cheapening of the value of the TLCF may render it the inferior strategy. But . . . I dunno.