Basic SWR Question

[Trooper]

We've just complete our 1st full year of retirement, and I'm in the process of calculating our withdrawal rate for 2017.

What do you include in the numerator? Obviously Amazon purchases LOL...but wondering about things like income taxes, RMDs (we have an inherited IRA for which these are required), etc. Also, do you offset your withdrawals with investment income such as dividends and capital gains?

 

[USGrant1962]

Generally WR is total expenses (including taxes) over total portfolio. RMDs are not necessarily a withdrawal - they transfer from your IRA to a bank account or money market account. Only if you spend them they are in the numerator. If you put them back in your portfolio they are not. The taxes you pay on them are always an expense.

Same with dividends and investments. If you spent them they are in the numerator, otherwise the just moved around within your portfolio.

A better way to look at it is your 2017 spending (including taxes) over your start-of-year portfolio value. The ins and outs of RMDs, dividends, etc. are not really part of the equation.

 

[Meadbh]

Expenses = money you spend.

Expenses include taxes. You have to find that money somewhere and it’s not coming back. Expenses include all the goods and services you bought throughout the year, whether it was a sofa bought with your credit card or a cup of coffee you paid for in cash.

How I calculate total annual expenses is to download the data from my credit cards and my chequing accounts (I have two of each) and to delete any credit card payments and deposits to the chequing accounts. Then add the remainder. (I used to do a much more detailed monthly calculation, but the principle still holds.)

RMDs have nothing to do with expenses. Let’s say you spent $50,000, including taxes, in the year before you had to start taking RMDs. Expenses were $50,000. Next year, you are obliged to take $20,000 in RMDs. You spent $51,000, including taxes. What were your expenses? $51,000 of course. Not $71,000. Not $29,000.

Another scenario: you have a pension that exceeds your expenses. You reach the age of RMDs. You take out the RMD and deposit it in your taxable investment account. You haven’t spent any of that money.

Taking RMDs simply means you were forced to move money out of a tax sheltered account. The RMD will contribute to your taxable income. But as we all know, income and expenses are not closely correlated. You could save it somewhere else, or spend it (in which case it will show up in expenses). But the RMD is not included in the calculation of your expenses.

 

[audreyh1]

We've just complete our 1st full year of retirement, and I'm in the process of calculating our withdrawal rate for 2017.

What do you include in the numerator? Obviously Amazon purchases LOL...but wondering about things like income taxes, RMDs (we have an inherited IRA for which these are required), etc. Also, do you offset your withdrawals with investment income such as dividends and capital gains?

LOL - that’s not how you are actually supposed to do it, although many people here do.

The SWR models however assume you choose your withdrawal rate based on your analysis of your needs, risk tolerance, longevity, etc., then use that number to take an amount out of your retirement assets each year. That is to cover all your annual spending, including taxes, that not already covered by additional sources of income such as SS or pension. If you had already set some funds aside (outside the retirement assets) to cover certain irregular expenses (say a child’s college fund, or to save for a new car, or an HSA account) then obviously those also don’t need to be covered by the withdrawal.

The models assume total return including investment income - so no there is no offset.

 

[rodi]

For me the numerator is my total spending minus the income from non portfolio sources.
(In our case rental income and DH's SS.)

Our portfolio includes an inherited IRA - so the RMD is part of the withdrawal. If the RMD were bigger than the withdrawal needed the remainder would be put back into the portfolio. TAXES on the RMD are definitely part of the numerator (total spend).

Most WR calculations assume TOTAL returns... so Cap Gains and Divs are part of the returns... and are assumed to be used as PART of your withdrawal OR reinvested.... NSTAAFL.

(TotalSpending-OtherIncomeSources)
WR = ------------------------------------------------------
(Total Investment Portfolio )

And it's only a SWR (safe withdrawal rate) if the withdrawal is small enough to be sustainable...

 

[Huston55]

LOL - that’s not how you are actually supposed to do it, although many people here do.

The SWR models however assume you choose your withdrawal rate based on your analysis of your needs, risk tolerance, longevity, etc., then use that number to take an amount out of your retirement assets each year. That is to cover all your annual spending, including taxes, that not already covered by additional sources of income such as SS or pension. If you had already set some funds aside (outside the retirement assets) to cover certain irregular expenses (say a child’s college fund, or to save for a new car, or an HSA account) then obviously those also don’t need to be covered by the withdrawal.

The models assume total return including investment income - so no there is no offset.

What She Said^^^

WDR = WD from your Investment Accounts/NW of Investment Accounts*

-or-

WDR = [Total Expenses (incl taxes) - Non-Investment Income (SS, Pension, etc)]/NW of Investment Accounts#

* Some folks include real estate; I don’t, especially primary residence (as think it should be treated differently).

# Simplified with assumption you withdraw only what’s needed for annual expenses.

 

[pb4uski]

I segregate our "retirement portfolio" from our local savings and checking accounts that we use to pay our bills since those localaccounts are only $10-20k at any given point in time. With this arrangement it is easy for me to determine my "withdrawals"... it is transfers from the retirement assets to our local checking account, including dividends from our taxable accounts (that are part of our retirement assets) that go directly into our checking account.

The withdrawals for the year divided by our numerator is our withdrawal rate for the year. The numerator would be either the value of our retirement assets at the beginning of the year or at the time we retired, depending on what measure is needed.

 

[Moemg]

It isn't rocket science. I just look at the total value of my investment accounts on Dec.31 and take a percentage of that . I use 4% .That amount plus my SS and pension is my spending amount for the year which includes taxes and everything else. If at the end of the year there is money left over it goes into a slush fund for future expenses ( cars , Vacations , home improvements ,etc.)

 

[Trooper]

Expenses = money you spend.

Expenses include taxes. You have to find that money somewhere and it’s not coming back. Expenses include all the goods and services you bought throughout the year, whether it was a sofa bought with your credit card or a cup of coffee you paid for in cash.

How I calculate total annual expenses is to download the data from my credit cards and my chequing accounts (I have two of each) and to delete any credit card payments and deposits to the chequing accounts. Then add the remainder. (I used to do a much more detailed monthly calculation, but the principle still holds.)

RMDs have nothing to do with expenses. Let’s say you spent $50,000, including taxes, in the year before you had to start taking RMDs. Expenses were $50,000. Next year, you are obliged to take $20,000 in RMDs. You spent $51,000, including taxes. What were your expenses? $51,000 of course. Not $71,000. Not $29,000.

Another scenario: you have a pension that exceeds your expenses. You reach the age of RMDs. You take out the RMD and deposit it in your taxable investment account. You haven’t spent any of that money.

Taking RMDs simply means you were forced to move money out of a tax sheltered account. The RMD will contribute to your taxable income. But as we all know, income and expenses are not closely correlated. You could save it somewhere else, or spend it (in which case it will show up in expenses). But the RMD is not included in the calculation of your expenses.

Thanks Meadbh and everyone else. Your method is pretty close to what I did, except I don't download credit card statements since they are paid out of checking anyway. I came up with 3.4% which is maybe a little high, because the estimated tax payments included in our spending were overestimated and I will be getting a refund.

 

[43210]

You most definitely do NOT need to include taxes in spending. (Whether it makes sense or not depends on your overall situation.)

For example, consider someone who is retired with no income, and is spending from their taxable account, while doing Roth conversions. Suppose almost all their tax is from their Roth conversions. Well the spending and taxes are almost totally disconnected. It may be more suitable to measure assets in Traditional accounts in post-tax dollars, so that when you Roth convert you are converting unrealized tax to realized tax. But it would be totally nuts to classify that tax as "spending".

The tax decisions can be complex (especially when various income/asset/(M)AGIs affect all kinds of stuff). You have to figure it one way or another. But simplistically calling tax "spending" is really a very bad case of putting a square peg in a round hole.

 

[Huston55]

You most definitely do NOT need to include taxes in spending. (Whether it makes sense or not depends on your overall situation.)

For example, consider someone who is retired with no income, and is spending from their taxable account, while doing Roth conversions. Suppose almost all their tax is from their Roth conversions. Well the spending and taxes are almost totally disconnected. It may be more suitable to measure assets in Traditional accounts in post-tax dollars, so that when you Roth convert you are converting unrealized tax to realized tax. But it would be totally nuts to classify that tax as "spending".

The tax decisions can be complex (especially when various income/asset/(M)AGIs affect all kinds of stuff). You have to figure it one way or another. But simplistically calling tax "spending" is really a very bad case of putting a square peg in a round hole.

I think most of the posters above inferred that one needs to make a current estimate of taxes for one’s current situation, even though taxes in retirement will almost certainly be very different; I know I certainly did.

So, I’d venture to say that you’re in violent agreement with the posters before you.

 

[pb4uski]

You most definitely do NOT need to include taxes in spending. (Whether it makes sense or not depends on your overall situation.)

For example, consider someone who is retired with no income, and is spending from their taxable account, while doing Roth conversions. Suppose almost all their tax is from their Roth conversions. Well the spending and taxes are almost totally disconnected. It may be more suitable to measure assets in Traditional accounts in post-tax dollars, so that when you Roth convert you are converting unrealized tax to realized tax. But it would be totally nuts to classify that tax as "spending".

The tax decisions can be complex (especially when various income/asset/(M)AGIs affect all kinds of stuff). You have to figure it one way or another. But simplistically calling tax "spending" is really a very bad case of putting a square peg in a round hole.

I disagree. SWR is safe withdrawal rate... if money leaves the portfolio then it doesn't matter if it was spent on food, travel, mortgage payments, taxes, a new roof, a new car, a vacation home or hookers.... it left the portfolio.

I include all withdrawals when calculating a WR. When we bought a winter condo a couple years ago I calculated two WRs... one with the winter condo and one without. The one without would apply IF I considered the winter condo to be part of my retirement portfolio (but I don't even though a fair argument could be made that I should).

 

[REWahoo]

I disagree. SWR is safe withdrawal rate... if money leaves the portfolio then it doesn't matter if it was spent on food, travel, mortgage payments, taxes or hookers.... it left the portfolio.

Yep.

 

[USGrant1962]

I disagree. SWR is safe withdrawal rate... if money leaves the portfolio then it doesn't matter if it was spent on food, travel, mortgage payments, taxes, a new roof, a new car, a vacation home or hookers.... it left the portfolio.

Yes, I understand 43210s comment about the complexity of taxes, but if you have to write a check to the IRS or your state it is spending from your portfolio and requires a withdrawal of some sort.

 

[RunningBum]

As long as you've accounted for taxes one way or another (either using an estimated after-tax value of your portfolio, or including tax as an expense), it all works out. I took large capital gains and made a large Roth conversion this year, but I'm not counting the tax on that as part of my withdrawal for the year, because I had already devalued the asset. Otherwise, I'd have blown past my WR target, only because I did some asset shuffling to better position myself for future years.

 

[43210]

A perfectly legitimate way of looking at Trad 401k/IRA/etc is that Uncle Sam already (and always) owns a portion of the balance (even if the exact percentage is not known). (You can do the same with unrealized cap gains.) If you don't take that into account you are arguably miscalculating your assets. You can treat the taxes as if they were already gone, right from the outset, and that certain tax events merely convert unrealized tax to realized tax.

I'm not saying you have to account for it this way. (I'm still thinking about how best to do it.) But you can. So treating taxes as "spending" is not necessary.

 

[43210]

As long as you've accounted for taxes one way or another (either using an estimated after-tax value of your portfolio, or including tax as an expense), it all works out. I took large capital gains and made a large Roth conversion this year, but I'm not counting the tax on that as part of my withdrawal for the year, because I had already devalued the asset. Otherwise, I'd have blown past my WR target, only because I did some asset shuffling to better position myself for future years.

I'd expect everyone can agree with this. You have to account for taxes, but there are different ways of looking at it.

 

[Trooper]

I disagree. SWR is safe withdrawal rate... if money leaves the portfolio then it doesn't matter if it was spent on food, travel, mortgage payments, taxes, a new roof, a new car, a vacation home or hookers.... it left the portfolio.

Dang - I forgot about hookers!

 

[audreyh1]

You most definitely do NOT need to include taxes in spending. (Whether it makes sense or not depends on your overall situation.)

For example, consider someone who is retired with no income, and is spending from their taxable account, while doing Roth conversions. Suppose almost all their tax is from their Roth conversions. Well the spending and taxes are almost totally disconnected. It may be more suitable to measure assets in Traditional accounts in post-tax dollars, so that when you Roth convert you are converting unrealized tax to realized tax. But it would be totally nuts to classify that tax as "spending".

The tax decisions can be complex (especially when various income/asset/(M)AGIs affect all kinds of stuff). You have to figure it one way or another. But simplistically calling tax "spending" is really a very bad case of putting a square peg in a round hole.

Taxes are expenses whether or not you consider them “spending”. They have to be covered one way or another. In the case of Roth conversions you either take the taxes owed from the conversion putting less with the Roth or you have to cover them from your annual withdrawal/income. It seems like most people do the latter to maximize their amount in the Roth account. It is part of their annual costs in that case.

We live off our taxable investments. I cannot budget our taxes, they are quite unpredictable as distributions vary wildly as do rebalancing needs. But I do have to cover them with our annual withdrawal. When I withdraw the annual funds I set aside what I estimate will go to owed taxes and estimated taxes during the year in savings. The remainder is then available for after-tax spending. A small reconciliation is made when we file the taxes in April.

 

[Trooper]

I have a spreadsheet that forecasts the next 30+ years of my portfolio. It's not as sophisticated as retirement calculator, but here's how it treats taxes:

I come up with an amount that's needed from the portfolio each year, based on budgeted spends, less income from SS and pension. Then I gross that up by the combined state and local tax rates. For example if we'll spend $80K in a given year, and SS/pensions take care of $30K of that, then I need $50K from the portfolio. But because a portion of our investments are qualified, I divide the $50K by (1-tax rate) to come up with what the portfolio needs to provide.

Of course, coming up with the tax rate is quite the crap shoot.

 

[pb4uski]

A perfectly legitimate way of looking at Trad 401k/IRA/etc is that Uncle Sam already (and always) owns a portion of the balance (even if the exact percentage is not known). (You can do the same with unrealized cap gains.) If you don't take that into account you are arguably miscalculating your assets. You can treat the taxes as if they were already gone, right from the outset, and that certain tax events merely convert unrealized tax to realized tax.

I'm not saying you have to account for it this way. (I'm still thinking about how best to do it.) But you can. So treating taxes as "spending" is not necessary.

As a former CPA, I totally understand deferred income taxes, but there are significant measurement issues when calculating deferred income taxes for individuals.... should one use the 0% or 15% capital gains rate (there is no separate capital gains rate for corporate income taxes so it is not an issue for them)... for ordinary rate timing differences what rate should be used? Depending on what tax strategies one uses it might be 12% or 22% or a combination of both some other rate (again not an issue for corporate taxes since it is a flat 21% (formerly 35%)).

As a result, I think it is easier to not bother with deferred taxes and that seems to be the majority view on this forum.... but I can understand why some might chose to do differently and there is a small minority that do.

 

[audreyh1]

I have a spreadsheet that forecasts the next 30+ years of my portfolio. It's not as sophisticated as retirement calculator, but here's how it treats taxes:

I come up with an amount that's needed from the portfolio each year, based on budgeted spends, less income from SS and pension. Then I gross that up by the combined state and local tax rates. For example if we'll spend $80K in a given year, and SS/pensions take care of $30K of that, then I need $50K from the portfolio. But because a portion of our investments are qualified, I divide the $50K by (1-tax rate) to come up with what the portfolio needs to provide.

Of course, coming up with the tax rate is quite the crap shoot.

And federal income taxes, right?

Yes - you have to calculate the additional amount you have to withdraw. I assume the SS and pension amounts you are using are also after income tax? It not, you also need to account for taxes that have to be paid on those.

As long as that net budget (less SS and pension) plus taxes does not exceed what you calculated as your personal safe withdrawal rate, you are good.

A great deal of work can go into choosing a withdrawal method and rate. People need to take into account what asset allocation they prefer, how many years to account for, what % success rate they want to target, whether they want to preserve some of their portfolio for heirs, etc. Then run models like FIRECALC, and chose a withdrawal rate you decide is safe enough for you.

Once the withdrawal method and rate is selected the mechanics are pretty simple.

 

[pb4uski]

I have a spreadsheet that forecasts the next 30+ years of my portfolio. It's not as sophisticated as retirement calculator, but here's how it treats taxes:

I come up with an amount that's needed from the portfolio each year, based on budgeted spends, less income from SS and pension. Then I gross that up by the combined state and local tax rates. For example if we'll spend $80K in a given year, and SS/pensions take care of $30K of that, then I need $50K from the portfolio. But because a portion of our investments are qualified, I divide the $50K by (1-tax rate) to come up with what the portfolio needs to provide.

Of course, coming up with the tax rate is quite the crap shoot.

True, but another approach is to imbed a simple taxable income and tax calculation in your spreadsheet.... in our case TI = interest, dividends, capital gains (based on taxable portfolio withdrawals and unrealized gains percentage), pension, 85% of SS, Roth conversions and RMDs less $24k standard deduction... then calculate federal and state income taxes and those become part of the annual withdrawal... but it adds A LOT of complexity to the model. Not sure if it is worth it but it does address the tax rate dilemma.

 

[RunningBum]

As a former CPA, I totally understand deferred income taxes, but there are significant measurement issues when calculating deferred income taxes for individuals.... should one use the 0% or 15% capital gains rate (there is no separate capital gains rate for corporate income taxes so it is not an issue for them)... for ordinary rate timing differences what rate should be used? Depending on what tax strategies one uses it might be 12% or 22% or a combination of both some other rate (again not an issue for corporate taxes since it is a flat 21% (formerly 35%)).

As a result, I think it is easier to not bother with deferred taxes and that seems to be the majority view on this forum.... but I can understand why some might chose to do differently and there is a small minority that do.

One has the identical problem with those taxes when you budget your expenses. Part of the SWR calculation is not just how much you have in assets, but also how much you'll need yearly. If you don't reduce your assets by deferred taxes, then you'd better know about how much to budget for that expense. So I don't think not being certain about the tax rate is an argument for one way or another.

 

[Huston55]

Dang - I forgot about hookers!

Does that mean you have to go back to W*rk?