do you include taxes from investments in your budget for SWR?

[gadgetdog]

Hi,

I've included things like property taxes in the budget for the SWR (safe withdrawal rate). But what do I do with the tax payment needed for things like, dividends, interest, capital gains, etc...

The tax payment amount would be different each year. Also, this amount could be substantial.

So, do you include include the tax payment for investment returns in your SWR budget?

This makes a difference in if I pass the FIREcalc test or not. Thanks!

 

[W2R]

Yes, tax payments have to come out of the money I withdraw so it counts as part of the withdrawal rate (SWR).

I am retired, and have a pretty good idea from year to year as to about what my dividends will be, and I need to estimate it each year for my quarterly estimated tax payments.

Edited to add: Before I retired, I just couldn't believe how low everyone here said their taxes were after retirement. So, for planning purposes I assumed my taxes would be 30% of my retirement income. In reality, federal+state income taxes have been about 14%, for me. That leaves about 16% that I *thought* I'd be spending on taxes, but instead get to keep. It's nice to have some "fun money" so I'm glad I erred on the side of caution.

 

[justplainbll]

Guess you're not talking about standing wave ratios or Southwestern Rundfunk, but one approach to retirement planning is to calculate disposable (after tax) income and to include any taxes, other than income taxes, as expenses that need to be paid out of disposable income.

 

[growing_older]

Guess you're not talking about standing wave ratios or Southwestern Rundfunk, but one approach to retirement planning is to calculate disposable (after tax) income and to include any taxes, other than income taxes, as expenses that need to be paid out of disposable income.

That works fine for calculating income needs in retirement, but those "expenses" are part of the expected return of the investments. You cannot plan to take 4% out of a portfolio and expect it to last the same way that the studies predicted when they included all the expenses in the 4%, not 4% net of all expenses.

 

[gadgetdog]

Guess you're not talking about standing wave ratios or Southwestern Rundfunk, but one approach to retirement planning is to calculate disposable (after tax) income and to include any taxes, other than income taxes, as expenses that need to be paid out of disposable income.

sorry, I am asking from the point of view that SWR = safe withdrawal rate (ex: 4%)

ok, so you would not include investment tax into the budget for SWR testing, thanks!

 

[W2R]

Your SWR must include enough to pay your income taxes.

If your SWR is 4%, then that 4% must include your income taxes.

 

[Ed_The_Gypsy]

Be careful no to get confused about this. (I wondered about it myself until I finally understood what SWR means.)

Taxes have nothing to do with Safe Withdrawal Rates. SWR is an estimate of how much you can withdraw from a given producing portfolio on a regular basis and still have the portfolio survive. This tells you how much money you have to spend in a year.

Taxes are an expense, just like food, mortgage and gasoline. Tax is a budget item, but it must be the first item on the list.

It will be up to you how to spend your 4% per annum wisely. 4% is your gross pre-tax income. You need to have a realistic budget to tell you what you can do. Start with 4% and start subtracting your basic expenses, starting with taxes. You do need to know how much capital gains and income taxes will be on XX $ withdrawn from your portfolio every year. What is left after that is what you can spend on food, etc., every year. Your budget may tell you that you you can't run out and buy the Ferrari the day after you retire. It may tell you that you have to downsize your housing or figure out how to live without a car. Or something more drastic (in my case).

Also keep in mind that after 70.5, the Feds will require you to take specific minimums (the percentage gets bigger every year) out of tax-protected accounts (except Roths). By that time, you should be very familiar with the whole business. Vanguard can do that automatically for you, by the way. You do have to take those distributions, but you do not have to spend them. Just put them aside somewhere if they are more than you need.

 

[FIREd]

Yes, income taxes will have to be paid out of your SWR.

 

[jdw_fire]

ok, to all the people who said "yes, income taxes must be paid out of the ER's SWR", what if your taxes due are larger than your SWR? are you going to stiff the IRS and not eat for a year? i dont think so, i think the correct answer is situation dependant. if you are making a large enough taxable return on your money i think it is total appropriate to make the taxes on that large return an investment expense that is not taken out of your SWR. be careful of hard and fast rules.

 

[gadgetdog]

ok, to all the people who said "yes, income taxes must be paid out of the ER's SWR", what if your taxes due are larger than your SWR? are you going to stiff the IRS and not eat for a year? i dont think so, i think the correct answer is situation dependant. if you are making a large enough taxable return on your money i think it is total appropriate to make the taxes on that large return an investment expense that is not taken out of your SWR. be careful of hard and fast rules.

yes, that's the situation that I'm worried about, what if my portfolio has very good returns one year or if I make a lot of changes that generate a taxable event? If that happens, I can see my investment related taxes being 2%, which could be half of the SWR of 4%.

During normal years, it seems like my investment taxes would be about 20% of my SWR budget.

Does that seem too high?

 

[W2R]

Just like your budget while working - - you need to set money aside (out of that 4% withdrawal) for an emergency fund, during years when you don't have unusually high expenses. Then you can dip into your emergency fund during years with higher expenses. This is true for higher tax expenses, replacing the roof, plumbing emergencies, and other types of unusually high expenses.

Yes, the 4% SWR has to cover everything you spend, just like your gross salary at work has to cover everything you spend right now.

 

[traineeinvestor]

Not only do I include taxes as an expense in my retirement budget, I have erred on the side of assuming that [-]greedy politicians seeking reelection and pandering to those who don't pay much (if any) taxes will ensure that [/-]tax rates will be higher in the future than they are today

 

[harley]

ok, to all the people who said "yes, income taxes must be paid out of the ER's SWR", what if your taxes due are larger than your SWR? are you going to stiff the IRS and not eat for a year? i dont think so, i think the correct answer is situation dependant. if you are making a large enough taxable return on your money i think it is total appropriate to make the taxes on that large return an investment expense that is not taken out of your SWR. be careful of hard and fast rules.

yes, that's the situation that I'm worried about, what if my portfolio has very good returns one year or if I make a lot of changes that generate a taxable event? If that happens, I can see my investment related taxes being 2%, which could be half of the SWR of 4%.

During normal years, it seems like my investment taxes would be about 20% of my SWR budget.

Does that seem too high?

I don't think this could really happen. If your SWR is, say, $100K (4% of $2.5M), that would be your income for the year. I don't see any realistic way that $2.5M could be manipulated to create a taxable output that would eat up more than the ~15-20% of taxes that $100K income would ordinarily create. Remember, some of that is probably going to be cap gains at a lower rate than ordinary income. Also, with any forethought you should be able to manipulate your drawdown to minimize taxes. It's fun, gives you something to do in retirement.

Maybe if you described a scenario that would realistically create the dilemma you are worried about we could address it better.

 

[jdw_fire]

Just like your budget while working - - you need to set money aside (out of that 4% withdrawal) for an emergency fund, during years when you don't have unusually high expenses. Then you can dip into your emergency fund during years with higher expenses. This is true for higher tax expenses, replacing the roof, plumbing emergencies, and other types of unusually high expenses.

Yes, the 4% SWR has to cover everything you spend, just like your gross salary at work has to cover everything you spend right now.

Not only do I include taxes as an expense in my retirement budget, I have erred on the side of assuming that [-]greedy politicians seeking reelection and pandering to those who don't pay much (if any) taxes will ensure that [/-]tax rates will be higher in the future than they are today

that is all well and good for the majority of people but what if an ERee has most of his non-taxdeferred money invested in hard money loans paying 18%-25% interest? lets look at some hypothetical numbers: ERee has chosen to have a 3% SWR (because he is young and single) and has $1M in investment assets ($250K in tax deferred and the rest in taxable) and a $50k emergency fund. in this scenerio the ERee feels comfy investing all of his taxable funds (except a $50k emergency fund) in several hard money loans paying monthly an average of 20% per annum. well his SWR = $30k but his fed income taxes are (assuming his taxable income is $140K) about $32.8k. (his SWR doesnt even cover the fed taxes due.) since his money is loaned out he doesnt get the principle back for several years and his emergency fund is expended in <2 yrs.

so, what you all are saying is this guy should live in poverty because his tax bill is sooo high and he needs to pay it out of his SWR of 3%. or maybe you are saying he should invest in something that doesnt earn so much so that he can afford to live on his SWR after paying his taxes out of it. and you are saying that this guy (who has taxable income of $140k every year for several years) shouldnt consider the $32.8k income taxes owed on that income as an investment expense. doing that would just reduce his effective income to $117K from his current AGI of $150k (making his after tax return around 15%). and you are definately saying that he shouldnt pull his SWR from his portfolio after these taxes have been removed from his investment return, leaving him his whole $30k SWR for living. i dont think you all have thought this thru.

 

[jdw_fire]

I don't think this could really happen. If your SWR is, say, $100K (4% of $2.5M), that would be your income for the year. I don't see any realistic way that $2.5M could be manipulated to create a taxable output that would eat up more than the ~15-20% of taxes that $100K income would ordinarily create. Remember, some of that is probably going to be cap gains at a lower rate than ordinary income. Also, with any forethought you should be able to manipulate your drawdown to minimize taxes. It's fun, gives you something to do in retirement.

Maybe if you described a scenario that would realistically create the dilemma you are worried about we could address it better.

o it could happen. besides the example i gave in my last post i can think of some 1 off events that would do it for 1 year. for example he might win the lottery. extending the logic of what people here seem to be saying, if he were to win $1M in the lottery the taxes should be paid out of his SWR instead of the lottery winnings because all expenses including income taxes MUST be paid out of the SWR.

 

[FIREd]

If you could earn 18-25% on your money, it would make no sense to have a 3% SWR, even you were young and single. The 3% SWR is based on average market returns that are well below the 18-25% range.

Your lottery example is really no good because the lottery is not investment income.

 

[jdw_fire]

If you could earn 18-25% on your money, it would make no sense to have a 3% SWR, even you were young and single. The 3% SWR is based on average market returns that are well below the 18-25% range.

Your lottery example is really no good because the lottery is not investment income.

actually, if the opprotunity to earn 18-25% on your money was only available for a limited time (several years), it would still make sense to have a 3% SWR. just because you would have a higher SWR doesnt mean everybody would, a 3% (or whatever) SWR is a personal decision made the individual. and btw, wrt your "average market returns" i was the one stating that the proper course of action was situation dependant, unlike the rest of you, remember?

my lottery example is right on the money because you all said federal income taxes are expenses and must be taken out of your SWR. the income doesnt have to be investment income to be taxed, therefore you just have to owe taxes for my example to be good.

how bout instead of attacking my examples, you just admit that there might be a case or 2 where y'alls statement that "federal income taxes must be paid out of the SWR" is incorrect and that the proper course of action can be situation dependant?

 

[scrabbler1]

Hi,

I've included things like property taxes in the budget for the SWR (safe withdrawal rate). But what do I do with the tax payment needed for things like, dividends, interest, capital gains, etc...

The tax payment amount would be different each year. Also, this amount could be substantial.

So, do you include include the tax payment for investment returns in your SWR budget?

This makes a difference in if I pass the FIREcalc test or not. Thanks!

My ER budget includes a basic amount for income taxes based on the fairly stable monthly and quarterly dividends I receive from the stock and bond funds in my taxable accounts. I do not include in my ER budget additional income taxes from cap gain distributions because they vary greatly by year (and sometimes I have none). If I do receive a cap gains distribution, then it is from that distribution, either directly or indirectly, I will pay its income taxes due, so it won't interfere with my overall budget and SWR.

 

[FIREd]

actually, if the opprotunity to earn 18-25% on your money was only available for a limited time (several years), it would still make sense to have a 3% SWR. just because you would have a higher SWR doesnt mean everybody would, a 3% (or whatever) SWR is a personal decision made the individual. and btw, wrt your "average market returns" i was the one stating that the proper course of action was situation dependant, unlike the rest of you, remember?

my lottery example is right on the money because you all said federal income taxes are expenses and must be taken out of your SWR. the income doesnt have to be investment income to be taxed, therefore you just have to owe taxes for my example to be good.

how bout instead of attacking my examples, you just admit that there might be a case or 2 where y'alls statement that "federal income taxes must be paid out of the SWR" is incorrect and that the proper course of action can be situation dependant?

I said all taxes on investment income (which is what the OP is talking about) should be paid out of your SWR. I never said said taxes on inheritance, lottery or W2 income should be paid out of your SWR.

But whatever.

 

[MichaelB]

Some people can argue about anything. SWR are assumed to be pretax income. Taxes are part of the expense. If the portfolio is tax deferred the tax liability is predictable. If the portfolio is taxable, the investor needs to invest in a tax efficient manner, and taxes will vary in any given year.

If expenses + taxes make the withdrawal rate too high you need a bigger portfolio to retire.

 

[rescueme]

SWR are assumed to be pretax income. Taxes are part of the expense....

...If expenses + taxes make the withdrawal rate too high you need a bigger portfolio to retire.

+1.

 

[teejayevans]

Some people can argue about anything. SWR are assumed to be pretax income. Taxes are part of the expense. If the portfolio is tax deferred the tax liability is predictable. If the portfolio is taxable, the investor needs to invest in a tax efficient manner, and taxes will vary in any given year.

If expenses + taxes make the withdrawal rate too high you need a bigger portfolio to retire.

So if you have a financial adviser that charges 1.5%, then you will have a net SWR of 2.5%?!
TJ

 

[Ed_The_Gypsy]

This is too weird. Outside [in Scottish: "outwith"] [Ronnie, are you reading this? Outwith is NOT an English word.] my limited knowledge.

 

[Animorph]

Geez, consider what the calculators are doing, including FIRECalc.

They don't ask what your tax rates are going to be. They don't consider taxes at all. They take your inflation-adjusted 4% from your portfolio balance at the start of the year, apply the portfolio gain for that year minus the investment expenses you specified, and come up with the portfolio balance for the start of the next year. They assume you took that standard withdrawal, not that plus some amount for taxes. You have to pay taxes out of that withdrawal. And yes, if your investment expenses are 4% per year then you pretty much net no income at all.

If you select investments that cost you greater than 4% of your portfolio in taxes each year, then hopefully they are that much better in yearly gains than an average portfolio. Make sure those expected gains are being properly represented by the calculator and you should find that you will be able to withdraw maybe 8% as the SWR. The "4% rule" doesn't apply to alternative investments. Your taxes will have to be paid from that larger SWR.

 

[ERD50]

So if you have a financial adviser that charges 1.5%, then you will have a net SWR of 2.5%?!
TJ

Why the question mark? This is absolutely the case, no question. Just plug that into the expense ratio section of FIRECALC.

To the OP, I'd say you need to look at the tax situation as a long-term average. Sure, you could have one year with high taxes (see realistic example below), and I sure wouldn't cut my expenses by that amount for that year. But your average expected taxes should be part of your average WR.


Realistic example: $1M taxable portfolio. You have held some stock for a long time, it has done well, and now represents 15% of your portfolio. You don't think it looks so good going forward, and you want to divest yourself of the stock and diversify. So you sell it for $150K, your cost basis is (for this example) $50K; that gives a $100K net LT CAP GN, so $15K taxes due that year.

I would not want to cut my $40,000 expenditures down to $25,000 that year to pay my taxes. That would hurt. But there is no way you are going to sell 15% of your portfolio each year, and it is very unlikely that your cost basis on average is so low. So you need to look at those factors and estimate an average amount for taxes.

-ERD50