Avoiding a Tax Spiral?

[mountainsoft]

I've thought about this before, but this morning it's not making sense to me.

Let's say you have annual expenses of 40K per year (just an example). So you withdraw 40K from your portfolio. Then you have to pay taxes, I'll say 10% just for ease of calculation. So you withdraw another 4K to pay taxes. That brings your total withdrawal to 44K. So now your taxable income is 44K, so you have to withdraw another .4K to cover the extra taxes. But now your total withdrawal is 44.4K, and so on.

I'm sure I'm being especially dense this morning, but how do you avoid this spiraling situation?

 

[W2R]

I've thought about this before, but this morning it's not making sense to me.

Let's say you have annual expenses of 40K per year (just an example). So you withdraw 40K from your portfolio. Then you have to pay taxes, I'll say 10% just for ease of calculation. So you withdraw another 4K to pay taxes. That brings your total withdrawal to 44K. So now your taxable income is 44K, so you have to withdraw another .4K to cover the extra taxes. But now your total withdrawal is 44.4K, and so on.

I'm sure I'm being especially dense this morning, but how do you avoid this spiraling situation?

I include taxes in my annual expenses. This completely eliminates your problem.

If my annual expenses (including my taxes) were too high to be covered by my WR , then I'd cut back on discretionary expenses. You know, sort of like what we all did when working to get to where we are.

 

[karen1972]

You just need to take out enough to begin with ie if you need 40k in the end, you don't add 10% you divide by .9, so if you need 40K you would be taking out $44,444 in your example.

 

[SumDay]

I guess I come at it from a little different angle.

I know how much we need to live on and I know/guesstimate how much we'll pay in taxes, so that's what I withdraw.

It's a little more complicated than that because there's withholding from SS checks and pension, but it all works out. So far anyway.

 

[njhowie]

Don't think of it as separate money coming out for expenses and then taxes. Just think of it all as expenses where the tax is included in the expenses. You're also generally not taking it out as two individual transactions of $40k and then $4k for taxes, you're taking out some amount periodically during the year. Just mentally think of it as one chunk of $44k which includes both the withdrawal of expenses and taxes.

 

[LRDave]

You just need to take out enough to begin with ie if you need 40k in the end, you don't add 10% you divide by .9, so if you need 40K you would be taking out $44,444 in your example.

This is the answer....

 

[JoeWras]

Yes. This is a great advanced algebra word problem, too! (Sum of series)

 

[GenXguy]

I use a personally created spreadsheet that I enter in the amounts I'll withdraw from the different buckets, and it automatically calculates federal and state taxes based on the actual tax tables and applicable deductions as well as how much disposable money I'll have and how much discretionary money is left over. Thank goodness I won't have to pay anywhere near 10% of my expenses in taxes!

 

[ShokWaveRider]

We do not do this, we take what we need, when we need it, then worry about taxes at tax time, and again take what we need to pay them (at that time).

 

[joeea]

Let's say you have annual expenses of 40K per year (just an example). So you withdraw 40K from your portfolio. Then you have to pay taxes, I'll say 10% just for ease of calculation. So you withdraw another 4K to pay taxes. That brings your total withdrawal to 44K. So now your taxable income is 44K, so you have to withdraw another .4K to cover the extra taxes. But now your total withdrawal is 44.4K, and so on.

Thus you can never withdraw enough! It's a paradox!

-Zeno

 

[LRDave]

Thus you can never withdraw enough! It's a paradox!

-Zeno

IRS rounding will resolve the paradox in this case.

 

[Chuckanut]

Yes. This is a great advanced algebra word problem, too! (Sum of series)

Wouldn't The Calculus be a help here? The study of continuous change, IIRC.

Note: My college math professor always referred to it as "The Calculus", spoken in a very respectful tone. Otherwise, "calculus" was a collection of minerals that formed a solid mass on our teeth, in our kidneys and other places.

I am reminded of the story about Hercules and how he could never catch up with the slow moving turtle because he was condemned to always cutting the distance between them in half. If only he had know about The Calculus.

 

[gauss]

^^I was think of convergent vs divergent infinite series /summations - even before the explicit reference to The Calculus.

 

[sengsational]

While I like the "word problem" I don't think it's necessary to solve it. You buy the tax software in November, do your taxes for the year using estimates where needed and setting tIRA/401k pulls to manage to your long term tax minimization strategy, then set the withholding level on the pull to pay the level of taxes on your pro forma tax calculation. A once a year deal in December and the formal submittal later, but no quarterly estimated taxes, and really small tax refunds/payments.

 

[mickeyd]

Let's say you have annual expenses of 40K per year

You don't have $40K expenses; you have $44K expenses. Take $44K from your IRA (I assume) and send $4K to Uncle Sam via EFTPS. Settle up any balance/difference when you do your FIT.

 

[mountainsoft]

I include taxes in my annual expenses. This completely eliminates your problem.

Yeah, I figured I was overlooking the obvious.

My post made it sound like I would make multiple withdrawals, but I meant it as calculating the total amount to withdraw in one operation.

As we get closer to retirement I can't help but feel I'm overlooking a small detail somewhere. So it's little things like this that can cause me to worry about nothing.

 

[Rianne]

The chart in this article seems to say you pay the least amt. of taxes married filing joint returns. Do I understand this correctly?
https://www.forbes.com/sites/kellyp...dard-deduction-amounts-and-more/#43c2c9ee7930

 

[JoeWras]

Wouldn't The Calculus be a help here? The study of continuous change, IIRC.

^^I was think of convergent vs divergent infinite series /summations - even before the explicit reference to The Calculus.

Using The Calculus absolutely is the easiest solution!

Sum of series is the pre-calculus way.

I need to warm my old math skills when I have a rainy day. This would be a fun problem to express through formulae.

 

[misanman]

As indicated in other replies:

WithdrawalAmount = Expense/(1-TaxRate) = $4,444.44

 

[cathy63]

As indicated in other replies:

WithdrawalAmount = Expense/(1-TaxRate) = $4,444.44

I don't see that indicated in any other replies, and I was about to post it myself until I got to your post.

This is called "grossing up" and employers do it all the time when they pay out taxable benefits such as some types of relocation expenses.

 

[jazz4cash]

I don't see that indicated in any other replies, and I was about to post it myself until I got to your post.



This is called "grossing up" and employers do it all the time when they pay out taxable benefits such as some types of relocation expenses.

See post #3. I wish my employer had used this method to calculate the grossed up benefit.

 

[cathy63]

See post #3. I wish my employer had used this method to calculate the grossed up benefit.

Thanks! I was looking for the formula and missed that Karen did the math.

 

[JoeWras]

Not mentioned because the solution was obvious.

 

[bada bing]

I withdraw the money to pay the previous year's taxes in early April. The tax on
that withdrawal isn't due until April, the following year. That is how the math
challenged and lazy do it.

The question reminds me of the story of designing a writing implement for
astronauts. NASA spent millions of dollars designing a pen that would work in
zero G. The USSR sent pencils with their cosmonauts.

 

[ocean view]

Just to clarify a point in your example: you say withdraw 40K from your portfolio and then calculate tax on the entire amount. In your example your portfolio must be a tIRA or some other tax deferred account. Right?

If not from a tIRA, then the taxable portion is likely much smaller and could be zero if coming from a Roth.