Quiz - $1 Million Tax Deferred or Not?

[sgeeeee]

Okay, here's another way to look at it with numbers:

Tax deferred account assumptions:
Accumulation phase - $2000 per year contributed for 30 years
7% earnings each year
untaxed
Distribution phase - $2000 per year withdrawn for 30 years
7% earnings each year
withdrawals taxed at 28%
Result - total account balance after 60 years = $1,222,774

Taxable account assumptions:
Accumulation phase - $2000 per year contributed for 30 years
7% earnings each year
earnings taxed at X%
Distribution phase - $2000 per year withdrawn for 30 years
7% earnings each year
earnings taxed at X%
Result - The value of X that results in a total account balance after 60 years of $1,222,774 = 9.75%

 

[MasterBlaster]

Sgeeee:

Your model is flawed.

The taxable earnings are not taxed (each year) until withdrawal as capital gains in the distribution phase.

The only way for your assumptions to work is for an account with 100 percent/per year turnover. For buy and hold stocks (or low turnover index funds/tax-managed funds) without (or without large) dividends the gains will not be taxed until distributed.

 

[sgeeeee]

Sgeeee:

Your model is flawed.

. . .

I love you guys.

I have not proposed a model. I simply ran numbers on a spreadsheet. As people requested different numbers, I ran them. I think I've presented results from 3 different cases. I've even offered to send people the spreadsheet for those who can't set one up themselves. They are just numbers that result from the various assumptions people have suggested.

But rather than suggest other data or run your own scenarios, why not simply criticize the numbers that have resulted and make statements like, "bad assumptions", or "your model is flawed".

 

[unclemick]

Hmmm

I feel at this point to interject a strong denial - "I am not now nor have I ever been an 'official' resident of Missoula."

As to $1 mil or spreadsheets - I plead the fifth.

heh heh heh heh - do have a whiskfull fondness for no. 2 pencils and K&E graph paper.

 

[sgeeeee]

Hmmm

I feel at this point to interject a strong denial - "I am not now nor have I ever been an 'official' resident of Missoula."

As to $1 mil or spreadsheets - I plead the fifth.

heh heh heh heh - do have a whiskfull fondness for no. 2 pencils and K&E graph paper.

Has anyone ever accused your graph paper of making bad assumptions?

 

[unclemick]

Unfortunately yes

I gave up public exposure of my graph paper years ago - let alone even discussing my assumptions.

heh heh heh heh heh heh heh heh heh

 

[azanon]

2.) You have $1 Million in a non-tax deferred account and have to pay taxes each year on the gains realized.

I would take this option, except elect to not pay any tax, any year (except when i want the money) by investing exclusively in a portfolio of common stocks that exhibit growth entirely by capital gains (small companies and/or aggressive companies) and not dividends.   Buy and hold those puppies myself and pay no tax!

That way i have all the benefits of no taxes year after year (option 1), yet have the power to liquidate all of it if need be penalty free, and only have to pay taxes on the portion that I liquidate should i decide to do so at any given point in time.

Guess i tend to want my cake and eat it too.   

---  the fact that one can do this emphasises that the real beauty of IRAs really isnt the tax deferred growth;  there are enough good investments that can give you that anyway (such as common stocks held personally (not in a mutual fund) that dont pay dividends).   The unique beauty in them is the tax exemption of earned income in the year that you earned it for money deposited (traditional), or the ability to delay paying taxes on the orignally earned income till you withdraw it while using that same money for compounded growth (Roth).

 

[Texas Proud]

I have not proposed a model. I simply ran numbers on a spreadsheet. As people requested different numbers, I ran them.

OK.. why not run mine... saves me time and effort in doing it as I still do that nasty thing that starts with a W....

I would say that the portfolio will earn 8%... 1.5% of that will be dividends... 1.0% interest and the rest capital gain.. the capital gain will only have 25% taxable each year with the rest deferred until you start to withdrawl..

Marginable tax rate is 28%.. but your income after retirement will be 100% from this account..

I see you getting the benefit of the low tax rates today on your earnings, but will get the benefit of the low rates on the withdrawl on the first X amount until you reach the marginal rate..

Throw in if SS is taxable way out when...

NOW, this has a LOT of assumptions that to me is more real life..

 

[dmpi]

I would take this option, except elect to not pay any tax, any year (except when i want the money) by investing exclusively in a portfolio of common stocks that exhibit growth entirely by capital gains (small companies and/or aggressive companies) and not dividends.   Buy and hold those puppies myself and pay no tax!

I wish I knew how to pick small aggressive companies that only go up, so you never have to sell it!

 

[azanon]

I wish I knew how to pick small aggressive companies that only go up, so you never have to sell it!

Me too!  That way I could just buy the one winner instead of having to build a whole portfolio of them so that the winners offset the losers! 

Anyone else?

BTW, small and aggressive dont necessarily have to go together.   There are plenty of sizable (read:  stable) companies out there that dont pay dividends.  Heck, even Microsoft didnt until just a few (couple?) years ago.

Another tip: With long term capital gains caped at 15% now, that makes these types of stocks very attractve. No tax when you dont sell, .... and not a lot of tax when you do.

 

[sgeeeee]

OK.. why not run mine... saves me time and effort in doing it as I still do that nasty thing that starts with a W....

I would say that the portfolio will earn 8%...  1.5% of that will be dividends... 1.0% interest and the rest capital gain..  the capital gain will only have 25% taxable each year with the rest deferred until you start to withdrawl..

Marginable tax rate is 28%.. but your income after retirement will be 100% from this account..

. . .

42. . .

Obviously, you haven't provided enough information to run the simulation.

 

[Texas Proud]

42. . .

Obviously, you haven't provided enough information to run the simulation.

What else do you want

 

[Nords]

I love you guys.     
But rather than suggest other data or run your own scenarios, why not simply criticize the numbers that have resulted and make statements like, "bad assumptions", or "your model is flawed".   

Hey, SG, can we presume that you're on board to develop the next version of FIRECalc?

If it helps get you to say "Yes!", we'll ask TH to write the user's guide!

 

[sgeeeee]

Hey, SG, can we presume that you're on board to develop the next version of FIRECalc?

If it helps get you to say "Yes!", we'll ask TH to write the user's guide!

Yeah. Put my name down. We'll do lunch and talk about a schedule sometime. Of course if TH writes the user's guide it will probably say simply: "You blockhead. You don't need a stupid simulation."

 

[HFWR]

And split out that hairball...

 

[sgeeeee]

What else do you want

Tex,

I'm afraid that no general simulation can get to the answers you are seeking.  

In the accumulation phase, the tax deferred account will clearly build faster (all else being equal).  So at the beginning of the withdrawal stage, you are starting with different nest egg amounts.  How much different?  It depends on what you assume about investment amount, return performance, period of accumulation, and tax rate on the taxable account.  You can't give a general answer short of providing a fairly complex formula.

In order to compare the two cases fairly during the distribution phase, you first have to normalize the initial withdrawal rates to account not only for the difference in starting nest egg value, but also the difference in taxes.  This gets very messy since the taxes on the tax deferred account are based on withdrawal amount while the taxes on the taxable account are based on earnings.  

If I use the same scenario as before with $2000 a year deposited for 30 years, then apply two constraints during withdrawal:
1) assume a 4% total withdrawal from the nest egg accumulated in each case, and
2) hold the amount of initial spendable withdrawal (after taxes) to be equal for both cases,
I can come up with additional comparisons.

I force the two constraints above to occur by allowing the effective tax rate on the taxable account to vary and assume the same effective tax rate on that account both during accumulation and withdrawal.

Here's what I find:  If you assume the tax deferred account tax rate is 28%, then you need a taxable account tax rate of less than 10.3% to achieve the same results.  If you assume a tax deferred account tax rate of 18%, then you need a taxable account tax rate of less than 6.4% to achieve the same results.

Even after I've done all of the above, the comparisons are still not quite the same.  Since I am assuming a withdrawal of 4% of the portfolio each year in the simulation and since the taxes for the two cases are based on different quantities, the actual spendable portion of the withdrawal figures diverge slightly over the 30 year period.  This can be significant leading to a much lower spending rate for the taxable account  after 30 years.