Monthly Budget and Tax

[Gumby]

Not sure about lumping income taxes with living expenses. Perhaps not a realistic scenario, but if someone is returning say 15%/yr on their stash and paying a third of that in income taxes, then income taxes alone would be a 5% WR, which sounds "above SWR" even though their stash is growing rapidly. Would it be more appropriate to charge income taxes against projected investment returns instead of adding them to living expenses?

You can do it however you like, but if you want FIRECalc to give you useful information, you should gross up your spending for taxes.

 

[dunkelblau]

Totally silly.

First, even if someone was getting 15% it doesn't mean that the entire 15% would be taxable. Might be in tax-deferred or tax-free accounts like a Roth IRA. Could be entirely tax-free depensing on tax placement of assets.

Second, 33% tax rate is unlikely.

Overall, hogwash.

How about a single laid-off 50 YO NYC resident who inherited 1M shares of AGNC in a taxable account and has no other significant assets or liabilities and whose estimated living expenses (excluding taxes) are $200k/yr? FI or not? Obviously the lack of diversification is a huge red flag, but I would consider such a person to be FI even if his annual living expenses including income taxes is (likely) >4%.

You can do it however you like, but if you want FIRECalc to give you useful information, you should gross up your spending for taxes.

Fair enough, but a few surprise 10-bagger cash-mergers this year won't get me to tighten my belt -- as far as I'm concerned the more the merrier

 

[pb4uski]

How about a single laid-off 50 YO NYC resident who inherited 1M shares of AGNC in a taxable account and has no other significant assets or liabilities and whose estimated living expenses (excluding taxes) are $200k/yr? FI or not? Obviously the lack of diversification is a huge red flag, but I would consider such a person to be FI even if his annual living expenses including income taxes is (likely) >4%. ...

Check your numbers. $200k withdrawals on 1M shares of AGNC currently at $9.56/share is $9.56m and only a 2.1% withdrawal rate.

Secondly, if someone inherited the shares they would get a stepped up basis so any shares sold would have negligible taxable gains only for the appreciation since the date of death. Also, any qualified dividends and LTCG would be subject to preferential rates, generally 0% and 15%... not 33% (unless it really is $9.56m, in which case you can afford it).

Your credibility is decaying with every post you make.

 

[dunkelblau]

Check your numbers. $200k withdrawals on 1M shares of AGNC currently at $9.56/share is $9.56m and only a 2.1% withdrawal rate.

Secondly, if someone inherited the shares they would get a stepped up basis so any shares sold would have negligible taxable gains only for the appreciation since the date of death. Also, any qualified dividends and LTCG would be subject to preferential rates, generally 0% and 15%... not 33% (unless it really is $9.56m, in which case you can afford it).

Your credibility is decaying with every post you make.

I think you're making exactly the point I intended-- your 2.1% withdrawal rate calculation excludes the income taxes on the AGNC dividends which I presume are taxable. I happen to hold a little bit of AGNC and my 1099 has them marked "Non-Qualified", they're now $0.12/sh per month, so I was assuming that the combined federal, state, and city income taxes on the 12*1M*$0.12 = $1.44M/yr of effective "ordinary income" would total >200k/yr (assuming no unusual deductions or exemptions).

I certainly agree with you that my advice to such a person would be to immediately trade all but a few % of his AGNC for diversified equity and bond funds because this should incur no taxes due to the step up and will save on taxes going forward. But I think this move would not be required to consider this person as "FI".

Now if you inform me that AGNC dividends are actually tax-free, well then never mind my credibility, I need to learn more about this (and would appreciate a source link)!

 

[pb4uski]

I think you're making exactly the point I intended-- your 2.1% withdrawal rate calculation excludes the income taxes on the AGNC dividends which I presume are taxable. I happen to hold a little bit of AGNC and my 1099 has them marked "Non-Qualified", they're now $0.12/sh per month, so I was assuming that the combined federal, state, and city income taxes on the 12*1M*$0.12 = $1.44M/yr of effective "ordinary income" would total >200k/yr (assuming no unusual deductions or exemptions).

I certainly agree with you that my advice to such a person would be to immediately trade all but a few % of his AGNC for diversified equity and bond funds because this should incur no taxes due to the step up and will save on taxes going forward. But I think this move would not be required to consider this person as "FI".

Now if you inform me that AGNC dividends are actually tax-free, well then never mind my credibility, I need to learn more about this (and would appreciate a source link)!

I don't know anything about AGNC but from a quick look it appears to be a bit of an odd duck... any stock with a 15% dividend raises red flags with me to begin with so when you say that its dividends are non-qualified then it isn't surprising.

While I never suggested that the recipent should immediately trade all but a few % of their AGNC shares, I agree that would be a wise move.

To be honest, your example with $9 million and a 15% yield is so extreme and outrageous as to be ridiculous. If you did indeed inherit 1 million shares of AGNC, then contraulations to you.

No matter how you cut it though, spending input into FIRECalc needs to include taxes.

 

[SecondCor521]

I think you're making exactly the point I intended-- your 2.1% withdrawal rate calculation excludes the income taxes on the AGNC dividends which I presume are taxable. I happen to hold a little bit of AGNC and my 1099 has them marked "Non-Qualified", they're now $0.12/sh per month, so I was assuming that the combined federal, state, and city income taxes on the 12*1M*$0.12 = $1.44M/yr of effective "ordinary income" would total >200k/yr (assuming no unusual deductions or exemptions).

I certainly agree with you that my advice to such a person would be to immediately trade all but a few % of his AGNC for diversified equity and bond funds because this should incur no taxes due to the step up and will save on taxes going forward. But I think this move would not be required to consider this person as "FI".

Now if you inform me that AGNC dividends are actually tax-free, well then never mind my credibility, I need to learn more about this (and would appreciate a source link)!

The 4% rule as typically formulated addresses both dividends (they're included as part of investment returns), and taxes (they're included as part of expenses). @pb4uski probably figured you knew that and it went without saying.

It also typically assumes a US portfolio of some reasonable AA that is rebalanced to, usually annually.

If someone holding AGNC wanted to, it would be possible for a person to calculate a historical safe WR% based on its annual returns and dividend history. But the relevance of that calculation to the 4% rule would probably be tenuous because a quick look at AGNC's chart shows that it doesn't bear much resemblance to, say, the S&P500.

And of course, there is the age old comment that 4% and the analogous AGNC analysis would both be historical in nature; the future may be different from the past.

I have no idea if AGNC dividends are tax free or not. Consult your tax advisor on that one.

 

[dunkelblau]

No matter how you cut it though, spending input into FIRECalc needs to include taxes.

If we look at this through the lens of managing spending, I can imagine how a hardline budgeteer could hit an unexpected windfall from a cash merger (meaning he can't decide to not sell) at a huge premium on one of his share holdings. Should this person cancel his trip to Cancun to pay down the extra estimated tax caused by this sale? IMO it's more appropriate to upgrade his trip to first-class, budget be damned, so long as his stash nets out positive YoY.

On a more serious note, I wonder if holding taxable positions with large unrealized gains means you should delay Roth conversions until year end? If you get a surprise forced cash-out shortly after you do a conversion, is there any take-back provision in Roth conversion rules? If there's no way to reverse this, it may be safer to wait until the coast is clear. This is my first year sans W2 and I got an unexpected large cash-out a couple of weeks ago and another surprise cash-merger announcement last week, so I'm glad I didn't rush into the Roth conversion I was thinking about. Maybe I'll have "better luck" next year?

The 4% rule as typically formulated addresses both dividends (they're included as part of investment returns), and taxes (they're included as part of expenses). @pb4uski probably figured you knew that and it went without saying.

It also typically assumes a US portfolio of some reasonable AA that is rebalanced to, usually annually.

Good point, I imagine it's unlikely that any X% rule could apply to such a concentrated portfolio. So perhaps he's really not FI until he swaps into a mix of, say, SPY and BND.

 

[RunningBum]

How about a single laid-off 50 YO NYC resident who inherited 1M shares of AGNC in a taxable account and has no other significant assets or liabilities and whose estimated living expenses (excluding taxes) are $200k/yr? FI or not? Obviously the lack of diversification is a huge red flag, but I would consider such a person to be FI even if his annual living expenses including income taxes is (likely) >4%.

That person could do what I do. Discount the AGNC investment by the taxes you'd expect to pay when liquidating by your plan. In other words, not dumping it all today (unless that's your plan), which might trigger as high as a 23.8% fed tax + state. Instead you'd be selling it over the years at 15% fed + 10% (?) NY state and city income tax.

So if your AGNC investment was worth $10M, and it had doubled since inheriting such that $5M is cap gains, you discount the investment by 25% of $5M, or $1.25M. So your $10M holding is really worth $8.75M after tax.

Supposing this is your only taxable income, you could figure the withdrawal % rate as your withdrawals/$8.75M and ignore the income tax as an expense, because you've already discounted the asset by the taxes you owe.

This isn't a very popular method here because taxes really are an expense, but as long as it works out, nobody else should care what you do.

The good part of this is that you don't skew your budget because of financial moves you make that really have nothing to do with your other living expenses or spending. Roth conversions are the golden case for this. I owe income tax on the amount I convert. But I'm not spending that money. I'm just moving it from one pocket to the other, while ridding myself of a deferred tax liability. I'm not going to cut back on my spending because the tax of doing conversions used up some of my budget. So I don't treat the tax due to a conversion as an expense, nor do I treat cap gains from the sale of an asset as an expense. They are deferred tax liabilities. Liabilities are subtracted from assets.

I'll probably get flak again for stating this, but I don't care. I've been managing my money this way for nearly 30 years when my employee stock options took off, and it has never caused me any problems or confusions about my financial state. Trying to do a budget or track my expenses to my planned WR with uneven taxes depending on when I exercised options, did Roth conversions and sold appreciated stock would have been a nightmare. So it's an easy decision for me to do it my way, which makes perfect sense to me, rather than adhere to someone else's standard which would be a mess for me.

For calculations on the amount of my estate, I remove the tax on appreciated assets (but not my tIRA) because of the stepped up basis heirs will get. So I have two sets of "books", but it all fits on one spreadsheet.

 

[TheWizard]

I also haven't used Firecalc anytime recently.
But here's the point: there are two different financial numbers for each calendar year: your Adjusted Gross Income and your Total Spending.

Total Spending includes taxes of all sorts but does not include excess income which went into a savings account or taxable investment account...

 

[RunningBum]

Actually what I'm doing isn't that far off from what corporations do. I'm discounting my assets by a deferred tax liability, and the tax paid when I liquidate the asset is a one-time expense that I don't count in my yearly WR calculation. I see that in corporate financial statements a lot (when I used to pay attention to them). One time expenses that are excluded when looking at year-to-year comparisons.

 

[TheWizard]

Actually what I'm doing isn't that far off from what corporations do. I'm discounting my assets by a deferred tax liability, and the tax paid when I liquidate the asset is a one-time expense that I don't count in my yearly WR calculation. I see that in corporate financial statements a lot (when I used to pay attention to them). One time expenses that are excluded when looking at year-to-year comparisons.

That makes sense when dealing with a tax-deferred account, perhaps, but not for a taxable account.
When I sold shares in my taxable account last year to raise $$$ for my new car, I sold a bunch of lots with small losses, hence a tax benefit...

 

[dunkelblau]

Actually what I'm doing isn't that far off from what corporations do. I'm discounting my assets by a deferred tax liability, and the tax paid when I liquidate the asset is a one-time expense that I don't count in my yearly WR calculation. I see that in corporate financial statements a lot (when I used to pay attention to them). One time expenses that are excluded when looking at year-to-year comparisons.

A couple of years ago I would have disagreed with this approach as being overly complicated, but I think I see the benefit now. My issue is when calculating expense rate as annual expenses divided by net portfolio value, unusual gains that incur commensurate income taxes hurt the numerator but the net gains don't proportionately reflect in the denominator. Perhaps a simpler approach could be to add "typical" taxes to expenses, and ignore taxes that come from one-offs where there is an after-tax gain on the one-off that exceeds what a typical after-tax return would have been?

That makes sense when dealing with a tax-deferred account, perhaps, but not for a taxable account.
When I sold shares in my taxable account last year to raise $$$ for my new car, I sold a bunch of lots with small losses, hence a tax benefit...

I think you used what accountants call a DTA (deferred tax asset). This is one of the attractive features of companies that have a long history of losses. An acquirer may be able to buy that company for peanuts and cancel out its profits against acquired DTAs that haven't expired. A DTL (deferred tax liability) would apply to assets that have appreciated.

 

[RunningBum]

That makes sense when dealing with a tax-deferred account, perhaps, but not for a taxable account.
When I sold shares in my taxable account last year to raise $$$ for my new car, I sold a bunch of lots with small losses, hence a tax benefit...

Why wouldn't it work? It shouldn't take a wizard to see that if you don't have gains, you don't discount the asset. I use my total net cap gains on my VG taxable account so when I've had any unrealized losses they just cancel out unrealized gains, which I have a lot of. I count the tax benefit of my cap loss carryover as an asset, so I guess I'd count any unrealized loss as an asset as well, even if I didn't have unrealized gains to cancel out.

 

[TheWizard]

Why wouldn't it work? It shouldn't take a wizard to see that if you don't have gains, you don't discount the asset. I use my total net cap gains on my VG taxable account so when I've had any unrealized losses they just cancel out unrealized gains, which I have a lot of. I count the tax benefit of my cap loss carryover as an asset, so I guess I'd count any unrealized loss as an asset as well, even if I didn't have unrealized gains to cancel out.

Point is, I had/have significant gains in older lots that I didn't sell and will probably never sell.
Hence, stepped up basis at some future date...

 

[RunningBum]

Point is, I had/have significant gains in older lots that I didn't sell and will probably never sell.
Hence, stepped up basis at some future date...

I have the same. So it doesn't make sense to try to factor in income taxes in a budget. But, if unexpected things happen, I won't hesitate to sell those big gainers. Might as well know what I'd really net from the sale and use that.

 

[KarenF]

Really appreciate all the responses. For summary:
$700k In Stocks and Bonds
$1.6m in IRA tax deffered
$730k in 401k tax deferred
$1.3m in tax deferred.

So.....I am assuming I will get nailed with taxes, as most my $$ is sitting in tax deferred accounts?

Whether you will get nailed is relative, but you will have to pay taxes on your withdrawals. Putting your gross amount of withdrawals in Firecalc is the way to go. We have both state and federal taxes withdrawn when we take money out, so we don't have to mess with estimated taxes.

 

[Koolau]

Whether you will get nailed is relative, but you will have to pay taxes on your withdrawals. Putting your gross amount of withdrawals in Firecalc is the way to go. We have both state and federal taxes withdrawn when we take money out, so we don't have to mess with estimated taxes.

Yeah, estimated taxes are a real pain. I'd rather over pay (and get some back) than deal with quarterlies. Just my thing so YMMV.

 

[TickTock]

Really appreciate all the responses. For summary:
$700k In Stocks and Bonds
$1.6m in IRA tax deffered
$730k in 401k tax deferred
$1.3m in tax deferred.

So.....I am assuming I will get nailed with taxes, as most my $$ is sitting in tax deferred accounts?

Yes, all withdrawals from tax-deferred accounts are taxed as ordinary income.

Preliminary numbers indicate as low as $37k per year.

That seems a bit high to me, but there's a bunch of information lacking: are there other sources of income (pension/rental/SS/other) and are you looking only at federal taxes, or federal/state/local/property or some combination of those?

Back-of-the-envelope, 4% WR on $.3MM is $172k. $37k is a 21.5% tax rate.

I don't know (because I'm retiring this March and it hasn't happened yet), but I'm betting our largest expense will be healthcare/ACA. Especially this year, as with bonus and carry-over PTO it's roughly 5 months pay. Add to that taxable bond interest at ~5.2% average and dividends from stock funds in the taxable account.

I have traditionally used 3 total categories: spend, save, and taxes (with taxes being a special case of spending). While w*rking there wasn't a whole lot we could do to manage taxes, but (especially starting in 2025) we should have a lot more flexibility. I don't have a paid financial advisor, but we're leaning heavily on our CPA to guide us and help with tax management. It's complex enough that I don't have confidence in *not* making some mistake that would cost us far more in taxes that we pay the CPA...