Do you calculate taxes due in your net worth?

[donheff]

Net worth is net worth. The method to calculate it is in many texts and it seems a waste of time to dream up reasons to tweak it. It is what it is and isn't much use other than to compare yourself with others. Adjusting net worth by potential taxes doesn't really help much with determining whether you can afford ER. Better to use the tried and true method - calculate your anticipated income needs; evaluate your income generating assets and appropriate SWR; estimate likely taxes based on anticipated sources and amounts withdrawn; determine whether the remainder will be enough to meet your initially calculated income needs.

To make the calculation OP want to use to adjust the gross tax rate you would need to run through that entire set of steps anyway. You can't reasonably just choose numbers like 50% and 20% and assume they are in the ballpark. It depends on what your brackets are and what various local taxes add up to.

 

[Danmar]

One reason you may wish to include taxes is to understand the size of any legacy you may leave. Probably not too important for most people but nevertheless.....

 

[mpeirce]

> Adjusting net worth by potential taxes doesn't really help much with determining whether you can afford ER.

Sure it does (in many cases). Especially when you are planning ER.

In my case, during the run up to ER I held a fair number of stock options. The gain when I exercised them was treated as regular income (NQSOs) and the tax man's cut of this was rather substantial. If I had overlooked this - or just miscalculated it by a lot - I would have been way off on the ultimate assets available to fund ER.

Given that experience, I like to keep tabs on potential future taxes. This also informs my decision to maximize ROTH conversions while I can. I don't label it "net worth", but it's an important number when I'm analyzing my financial situation.

 

[RunningBum]

Net worth is net worth. The method to calculate it is in many texts and it seems a waste of time to dream up reasons to tweak it. It is what it is and isn't much use other than to compare yourself with others. Adjusting net worth by potential taxes doesn't really help much with determining whether you can afford ER. Better to use the tried and true method - calculate your anticipated income needs; evaluate your income generating assets and appropriate SWR; estimate likely taxes based on anticipated sources and amounts withdrawn; determine whether the remainder will be enough to meet your initially calculated income needs.

To make the calculation OP want to use to adjust the gross tax rate you would need to run through that entire set of steps anyway. You can't reasonably just choose numbers like 50% and 20% and assume they are in the ballpark. It depends on what your brackets are and what various local taxes add up to.

LOL, a common argument given here about subtracting out taxes is that it's difficult to know the tax rate, yet you have to know this very same thing to estimate taxes as an expense in your budget. You'll get to the same place using either method, so to say that subtracting out taxes won't help much and the other way is better is flat out wrong. Both methods are subject to estimating future tax situations.

I will try to stop calling my number "net worth" to avoid the issue people have about definitions. So, I have assets that I add up and future liabilities I subtract from that to come up with a number I use for VPW. Whether I do things like annuitize pensions and SS to include as assets, and subtract estimated taxes from deferred income and unrealized cap gains, is my business but if someone asks the question like the OP did I will chime in. I've yet to be shown where this method breaks down and treating those taxes as an expense does not.

 

[scrabbler1]

Since I ERed, my income taxes have been a small part of my annual expenses, so I don't make any special adjustments for them. That being said, mpeirce makes a good point about determining a tax bill if there will be a lot of taxes due from handling a lump sum such as company stock. That was a big issue for me in the months leading up to my ER and in the months afterward. I had to make sure I would (a) not face any penalties for underpayment, and (b) be able to pay those income taxes at the optimal time (i.e. as late as possible).

Even when I did those two things, I was treated to a most pleasant surprise when I was preparing my federal income tax return. I thought NUA (Net Unrealized Appreciation) was subject to the 10% penalty for early withdrawal from a retirement plan. It was not, and that saved me nearly $30k in taxes. The literature I received from my employer before I ERed never really mentioned that exception.

 

[2017ish]

Not included in the "net worth" that is at the bottom of my quicken account list. But, definitely included in our projected retirement spending--albeit as a mushy "xx% m/l."

 

[gerntz]

I use quarterly NW as our budgeting tool. If it's going up, spending fine. If going down, need to think about adjusting spending.

Also, to me NW today is cash out value of assets. I would owe some taxes if I did that & count those payments as a liability.

 

[frankbrenowitz]

There have been lots of different definitions of net worth bandied about. Net worth (for individuals) is exactly the same as owner's equity (for businesses) and consists of ALL assets minus ALL liabilities. It's what you own minus what you owe. For those with large amounts of tax deferred assets, the future tax obligations cannot be ignored, although very difficult to calculate accurately. Businesses have a line on their balance sheet called "deferred taxes" to disclose their future tax obligations and it is often the largest item after long-term debt. I calculate deferred taxes on my personal balance sheet at my anticipated future tax rate just like every public business. That being said, for planning purposes i calculate the sustainable withdrawals only from invested asset balances (from which amount taxes will be paid) that will provide the cash flow I need in retirement.

 

[pb4uski]

Probably numerous ways to figure out how much money you have but do you think calculating future taxes due is most realistic to get today's NW number. If 50% of 1 mill is in 401k/IRA and 20% is unrealistic cap gains in a regular account Do you really have $1 mill. Do you guys figure this way?

You're referring to what is commonly called "deferred income taxes". And no, I don't bother with it, principally because what rate will apply is unclear. For taxable account unrealized capital gains, our tax rate is 0% because we plan to stay within the 15% tax bracket at which 0% applied to qualified dividends and long-term capital gains. For tax-deferred accounts, we will pay tax, but some will be sheltered by itemized deductions and exemptions, some will be at the 10% tax bracket, some at 15% and once our SS starts, some will be at 25%.

In the rare instance that you were preparing a personal financial statement for a bank that was to be opined on by a CPA then it would need to include deferred income taxes.

 

[RunningBum]

To make the calculation OP want to use to adjust the gross tax rate you would need to run through that entire set of steps anyway. You can't reasonably just choose numbers like 50% and 20% and assume they are in the ballpark. It depends on what your brackets are and what various local taxes add up to.

Also, the 50% and 20% the OP mentioned weren't estimated tax rates at all. It was % of assets that were still subject to be taxed in the OPs scenario. In the $1M portfolio, $500,000 in a tIRA/401K is the 50% mentioned.

 

[LOL!]

Our income taxes are so low right now that it doesn't matter whether we include them or not. What we do, however, is invest extremely tax efficiently, so that we can be unconcerned about income taxes.

There have been many threads showing how to avoid income taxes on one's retirement income, so there is no need to bring those techniques into this thread.

 

[Niuatoputapu]

There have been lots of different definitions of net worth bandied about. Net worth (for individuals) is exactly the same as owner's equity (for businesses) and consists of ALL assets minus ALL liabilities. It's what you own minus what you owe. For those with large amounts of tax deferred assets, the future tax obligations cannot be ignored, although very difficult to calculate accurately. Businesses have a line on their balance sheet called "deferred taxes" to disclose their future tax obligations and it is often the largest item after long-term debt. I calculate deferred taxes on my personal balance sheet at my anticipated future tax rate just like every public business. That being said, for planning purposes i calculate the sustainable withdrawals only from invested asset balances (from which amount taxes will be paid) that will provide the cash flow I need in retirement.

+1, I agree with Frank. It is incorrect to state that three people, one with $1 million in a 401(k), one with $1 million in stock with a $400K basis, and one with $1 million in a money market have the same Net Worth (all else being equal). Income taxes are a factor. That said, most discussion on this site does talk about "investment assets" or "total assets less outstanding mortgages" rather than net worth.

 

[Cobra9777]

You're referring to what is commonly called "deferred income taxes". And no, I don't bother with it, principally because what rate will apply is unclear. For taxable account unrealized capital gains, our tax rate is 0% because we plan to stay within the 15% tax bracket at which 0% applied to qualified dividends and long-term capital gains. For tax-deferred accounts, we will pay tax, but some will be sheltered by itemized deductions and exemptions, some will be at the 10% tax bracket, some at 15% and once our SS starts, some will be at 25%.

In the rare instance that you were preparing a personal financial statement for a bank that was to be opined on by a CPA then it would need to include deferred income taxes.

I don't do this either. But if I did, it would be the average rate implied by the withdrawal plan in its entirety, during my lifetime. I would exclude the tax liability incurred by my heirs. In my case, this is already estimated as part of the overall withdrawal plan.

Also, if I'm reading it right, SOP 82-1 requires that: "The provision should be computed as if the estimated current values of all assets had been realized ... on the statement date, using applicable income tax laws and regulations..." In note 12 of the example, it includes this tidbit:

Estimated income taxes have been provided on the excess of the estimated current values of assets over their tax bases as if the estimated current values of the assets had been realized on the statement date, using applicable tax laws and regulations. The provision will probably differ from the amounts of income taxes that eventually might be paid because those amounts are determined by the timing and the method of disposal or realization and the tax laws and regulations in effect at the time of disposal or realization.

So if one was actually following the accounting guidance, the rate for many of us with large tax-deferred balances would probably be 39.6%, which is beyond goofy IMHO.

 

[Refresher]

You're referring to what is commonly called "deferred income taxes". And no, I don't bother with it, principally because what rate will apply is unclear. For taxable account unrealized capital gains, our tax rate is 0% because we plan to stay within the 15% tax bracket at which 0% applied to qualified dividends and long-term capital gains. For tax-deferred accounts, we will pay tax, but some will be sheltered by itemized deductions and exemptions, some will be at the 10% tax bracket, some at 15% and once our SS starts, some will be at 25%.

In the rare instance that you were preparing a personal financial statement for a bank that was to be opined on by a CPA then it would need to include deferred income taxes.

Actually we do know the rate. If you had to raise all the money you can today you would sell everything to get a cash figure. Your tax is determined by this years bracket on all taxable money. That tax due needs to sent to the IRS and whats left from the proceeds of all sales is what you have.

Its not a number that is really important in planning but it is what you have right now.

 

[audreyh1]

I add a monthly accrual for my estimated annual tax bill to my liabilities each month. It's not so much about the impact on net worth but the impact on my cash/near cash when the time comes to make the payment.

I do the same thing for other a few other non-monthly expenses, such as home maintenance and travel.

When I take my withdrawal in January, I estimate the taxes still to be paid for the prior year, and the quarterly estimated taxes to be paid during the current year, and set those funds aside. This is refined when we file our taxes in March/April. The rest, then, is available for spending!

But I still count all funds in my net worth until they actually get withdrawn by the IRS.

 

[pb4uski]

....So if one was actually following the accounting guidance, the rate for many of us with large tax-deferred balances would probably be 39.6%, which is beyond goofy IMHO.

Actually we do know the rate. If you had to raise all the money you can today you would sell everything to get a cash figure. Your tax is determined by this years bracket on all taxable money. That tax due needs to sent to the IRS and whats left from the proceeds of all sales is what you have. .....

While it is convenient to think of the DTL as taxes that would be due if you sold all your taxable account investments or withdrew all your tax-deferred money... and it is a fair way to think of it for US corporate DTLs because of the corporate rate structure.... it doesn't really work that way. The guidance says:

ASC 740-10-30-9:
Under tax law with a graduated tax rate structure, if taxable income
exceeds a specified amount, all taxable income is taxed, in substance,
at a single flat tax rate. That tax rate shall be used for measurement of
a deferred tax liability or asset by entities for which graduated tax rates
are not a significant factor. Entities for which graduated tax rates are
a significant factor shall measure a deferred tax liability or asset using
the average graduated tax rate applicable to the amount of estimated
annual taxable income in the periods in which the deferred tax liability or
asset is estimated to be settled or realized. See Example 16 (paragraph
740-10-55-136) for an illustration of the determination of the average
graduated tax rate. Other provisions of enacted tax laws shall be
considered when determining the tax rate to apply to certain types of
temporary differences and carryforwards (for example, the tax law may
provide for different tax rates on ordinary income and capital gains). If
there is a phased-in change in tax rates, determination of the applicable
tax rate requires knowledge about when deferred tax liabilities and
assets will be settled and realized.

This rarely comes into play in the US in practice because there is little progressiveness in US corporate tax rates and they quickly become 35%... so generally 35% is used and any differences caused by the graduated tax structure of US corporate income taxes are immaterial.

So you would have to schedule out the realization of your taxable account unrealized gains and apply 15% and schedule out the realization of your tax-deferred accounts and apply ordinary rates... so there is little wonder that so few people do it.

Now what is interesting is an apparent conflict in the guidance in SOP 82-1 and the ASC... I suspect that the ASC would trump a 35-year old SOP, but I don't really know for sure... when I was working I might have thought that to be an interesting question.. but I am now retired.

 

[Surewhitey]

OP, nope

 

[Sunset]

No i do not, if i drop dead and my son inherits everything that is about what he would receive as the step up value. ......

Your wife is not in your will ? Seems like she would contest it, if you die.

 

[Refresher]

While it is convenient to think of the DTL as taxes that would be due if you sold all your taxable account investments or withdrew all your tax-deferred money... and it is a fair way to think of it for US corporate DTLs because of the corporate rate structure.... it doesn't really work that way. The guidance says:



This rarely comes into play in the US in practice because there is little progressiveness in US corporate tax rates and they quickly become 35%... so generally 35% is used and any differences caused by the graduated tax structure of US corporate income taxes are immaterial.

So you would have to schedule out the realization of your taxable account unrealized gains and apply 15% and schedule out the realization of your tax-deferred accounts and apply ordinary rates... so there is little wonder that so few people do it.

Now what is interesting is an apparent conflict in the guidance in SOP 82-1 and the ASC... I suspect that the ASC would trump a 35-year old SOP, but I don't really know for sure... when I was working I might have thought that to be an interesting question.. but I am now retired.

WOW

The deal is if a person has that hypothetical $1m portfolio and looses a lawsuit (post #8) he really doesn't have $1m to deliver. His case should be I can liquidate pay the IRS and that's what I have left. Not sure how the courts would see it but that's all he has without incurring a big tax bill.

 

[Cobra9777]

...So you would have to schedule out the realization of your taxable account unrealized gains and apply 15% and schedule out the realization of your tax-deferred accounts and apply ordinary rates... so there is little wonder that so few people do it.

Now what is interesting is an apparent conflict in the guidance in SOP 82-1 and the ASC... I suspect that the ASC would trump a 35-year old SOP, but I don't really know for sure...

I agree, although SOP 82-1 is pretty clear and it's the only standard I'm aware of that deals directly with personal NW. What you described is exactly the blended rate approach I mentioned earlier, even though I don't actually use it to reduce tax-deferred balances.

To me, even more interesting is that personal NW is based on a liquidation assumption, as if you were dead on the statement date. And not just taxes; real estate is to be valued net of estimated selling costs and commissions. Corporations use a going-concern assumption so the deferred tax assets and liabilities you referred to arise from timing differences between GAAP and tax, not some goofy assumption that all assets are liquidated as of each balance sheet date.

I may not be the healthiest person, but I like to think of myself as a "going-concern," whose gross assets represent future earning power, sufficient to cover all spending, including future tax liabilities as they come due. If I was on my death bed, or had no cash left like Sears, then liquidation accounting becomes appropriate.

 

[Refresher]

If an estate leaves 100k in face value ibonds currently worth 150k where an inheritance tax is due, the tax is due on 150K. If the estate liquidated them the day before and paid the tax it may be worth 140k which is the real worth of the estate.

 

[Whisper66]

I don't include future taxes in today's NW number.
Similarly, I don't include future capital gains or dividend payments in NW number.
All I include are current assets / liabilities.

 

[RunningBum]

For my purposes I don't worry about immediate liquidation. I estimate taxes as if I'll liquidate assets over time rather than dump the whole tIRA at once with much of it taxed in a higher bracket. Chances are good I won't liquidate all of my estate before I go, but I'm not concerned with figuring the dollar amount I'll leave to my heirs. It's well under the current estate limit unless that changes.

 

[RunningBum]

I don't include future taxes in today's NW number.
Similarly, I don't include future capital gains or dividend payments in NW number.
All I include are current assets / liabilities.

Future capital gains and dividend payments are in no way similar to 401K/tIRA income you've deferred taxes on. If you want to handle the tax on the deferred income as an expense when you incur it, that's perfectly fine, but to compare it to possible gains that may never come is absurd.

 

[pb4uski]

I agree, although SOP 82-1 is pretty clear and it's the only standard I'm aware of that deals directly with personal NW. What you described is exactly the blended rate approach I mentioned earlier, even though I don't actually use it to reduce tax-deferred balances.

To me, even more interesting is that personal NW is based on a liquidation assumption, as if you were dead on the statement date. And not just taxes; real estate is to be valued net of estimated selling costs and commissions. Corporations use a going-concern assumption so the deferred tax assets and liabilities you referred to arise from timing differences between GAAP and tax, not some goofy assumption that all assets are liquidated as of each balance sheet date.

I may not be the healthiest person, but I like to think of myself as a "going-concern," whose gross assets represent future earning power, sufficient to cover all spending, including future tax liabilities as they come due. If I was on my death bed, or had no cash left like Sears, then liquidation accounting becomes appropriate.

Yes, it is definitely an antiquated standard... I worked on the corporate side and never ran across personal financial statements... the really odd part is that when you die the DTLs on unrealized gains go "poof" because heirs get a stepped-up basis and the DTLs on tax-deferred get passed on.

I guess perhaps the guidance's focus on liquidation value derives from the use of personal financial statements mostly for credit decisions, where liquidation value to pay off a loan is arguably relevant... but it makes no sense in a going-concern world.