Does FIRECalc figure taxes?

[HBH]

When I'm entering the figures into FIRECalc, for the 1st question (Withdrawals), should I enter the amount I expect to spend, EXCLUSIVE of income tax from the withdrawls?

If so, where do income taxes figure into the FIRECalc calculations?

Thanks for any assistance.....

 

[dory36]

From the FAQ:

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.

 

[HBH]

Thanks for your reply.

In that case, should I add my estimated income taxes to my estimated expenses to arrive at a more correct estimate?

HBH

 

[dory36]

Yep.

 

[ESRBob]

HBH-
If you are doing a withdrawal from savings (SWR) in ER, your taxes are likely to be pretty minimal -- maybe 5% or so of what you spend each year, due to low tax brackets, plenty of deductions/exemptions and the progressive nature of the tax code.

But if you are planning to live off withdrawals from a traditional IRA or a pension, then your taxes will be higher, as both of those get taxed 100% as income (as opposed to a more tax-friendly blend of interest, capgains, dividends and return of principal for those withdrawing from after-tax funds to support spending) When running FIRECalc, you may want to make your own assessment based on your likely tax situation, and then use that gross number as the one you'll be needing to withdraw in ER.

 

[HBH]

Thanks for all of the replies. I'm doing this for my sister who's retiring in 4 weeks.

When I run the figures (WITH income tax) through FireCalc, I get a success rate of 100%.

When she retires, the ESOP from her privately held company will be rolled over as cash into her self-directed IRA, so most of her yearly income will be taxable.

Her main issue now is how to move the cash from the ESOP into her selected investments.

I'm suggesting to her that she keep the cash in a money market account (within the IRA) and dollar cost average the cash into the various funds over 1 year.

HBH

 

[MJ]

HBH-
If you are doing a withdrawal from savings (SWR) in ER, your taxes are likely to be pretty minimal -- maybe 5% or so of what you spend each year, due to low tax brackets, plenty of deductions/exemptions and the progressive nature of the tax code.

Maybe I need some tax advice cause my annual taxable income, the majority from laddered CDs. will be taxed at about 25% (Fed+State).

 

[ESRBob]

Vagabond,
Perhaps you are just a very well-off early retiree, in the higher brackets (100k+ of income?) or single, with very few deductions/exemptions?

But getting the bulk of your income from laddered CDs is also setting you up for the highest tax bite per dollar of income. Some people find it a worthwhile tradeoff, though, for the security. I feel comfortable getting income from dividends, capgains as well as interest. I also am cofortable letting some of my annual interest income be in the IRA, then selling some appreciated assets to raise cash to live on. This return of principal is untaxed, and the interest in the Roth IRA is also untaxed.

I also have a little self-employment company that generates some deductions -- something I think early retirees could generally do if they need or want to earn a bit of extra cash to help make ends meet or pay for luxuries.

Anyway, these are a few of the ideas that are allowing me to keep taxes quite low -- a 5th year of under 5% of spending, (although sometimes the Roth conversions would push it a bit higher). Plenty of others here living off a SWR have reported being roughly in the same ballpark, (although some capgains tax loss carryforwards have probably helped a lot of people lower their tax bills in the aftermath of the dotcom era)

 

[youbet]

HBH:

As already stated, Firecalc does not consider taxes.

Individual tax scenarios in retirement will vary widely from individual to individual. Thanks to programs like TurboTax, it's a snap to do what-if scenarios and estimate what your tax situation might look like, especially if you are within a few years of ER.

Once I estimated what taxes will likely be the first few years of ER, I consider them an expense and included them in my budget.

 

[gindie]

HBH -
Please do some research before automatically rolling over her ESOP into an IRA.  She might be able to take advantage of a special tax treatment for company stock called Net Unrealized Appreciation (NUA).  It is a method where, if you transfer all the ESOP stock to a taxable account (not first converting them to cash) then:

1) At the time of the ESOP distribution, she'll owe ordinary income tax ONLY on the original cost of the shares.

2) Then, when the shares are sold,
    a) she'll owe long-term capital gains taxes on the difference between the original cost of the shares and the price at the time of the distribution (this is the NUA).
    b) she'll owe either long-term or short term capital gains on the amount of appreciation since the distribution, depending on how long she held the shares after the distribution.

The above strategy is subject to rules (age, etc.).  But it is something to look into before automatically rolling into an IRA where everything is subject to ordinary income tax.

==================

Example:  Assume

1) Original cost of ESOP shares is $10,000. 
2) Value of ESOP account at retirement is $20,000. 
3) Value of account when spending the money at least 1 year after retirement is $30,000. 
4) Ordinary income tax rate is 25%. 
5) Long-term cap gains is 15%.

If rollover into IRA, taxes will be $7500 ($30,000 * .25)

If using NUA, taxes are $5500 made up of $2500 at time of distribution (original $10,000 * .25) plus $1500 ((20,000-10,000) * .15) plus $1500 ((30,000-20,000) * .15) when shares are sold.

 

[2B]

HBH -
Please do some research before automatically rolling over her ESOP into an IRA.  She might be able to take advantage of a special tax treatment for company stock called Net Unrealized Appreciation (NUA).  It is a method where, if you transfer all the ESOP stock to a taxable account (not first converting them to cash) then:

1) At the time of the ESOP distribution, she'll owe ordinary income tax ONLY on the original cost of the shares.

2) Then, when the shares are sold,
    a) she'll owe long-term capital gains taxes on the difference between the original cost of the shares and the price at the time of the distribution (this is the NUA).
    b) she'll owe either long-term or short term capital gains on the amount of appreciation since the distribution, depending on how long she held the shares after the distribution.

The above strategy is subject to rules (age, etc.).  But it is something to look into before automatically rolling into an IRA where everything is subject to ordinary income tax.

gindie knows the straight poop. Listen to him/her.

 

[HBH]

HBH -
Please do some research before automatically rolling over her ESOP into an IRA.

I understand very little of what you've said, but enough to make SURE my sister consults a good accountant before she actually aquires those shares from her company.

Thank you VERY much for that advice......

HBH