How to calculate WR?

[Scuba]

This may sound like a dumb question but I would like to confirm the mechanics of calculating our withdrawal rate. We are in our first year of ER and our spending is about where we expected so far but I realized I'm not sure how the calculation works. Is it as simple as:
Amount of cash expended for all purposes for the year including taxes/beginning of year portfolio balance?

Assuming your portfolio contains tax deferred assets, do you use the net expected after-tax value for those assets, or the gross value in your calculation?

I tried searching prior posts for this info but there are so many posts about WR's, I couldn't easily find this info. Thanks!

[Blue Collar Guy]

Withdrawal rate is the amount of money you withdraw from the portfolio. If On January 1st you have 1 million bucks and your WR is 5 % you can take out 50,000. Whether you use that to pay taxes or on dinner doesnt matter. If you take from a roth its 50k for dinner.

[Scuba]

Thanks BCG. So if you have $1M in your example, is that as of the beginning of the year? And if $400K of the $1M is in tax deferred accounts, do you net taxes out of the $1M since the $400K will be taxed as ordinary income?

[pb4uski]

No, taxes is the same as spending on dinner or peanuts.

It is a Withdrawal Rate so it measures withdrawals as a percent of your original, retirement date portfolio.... it doesn't matter what you spend the withdrawal on or even if you spend it at all (for example, if a portion of it ends up sitting in your checking account assuming that you don't consider your checking account to be part of your retirement savings).

Another thing to keep in mind is that if you are an early retiree then your WR may change over time as SS starts and pensions start. In our plan, our initial WR before my pension started was ~5%, decreased to ~4% when my pension started and will be ~2% once SS starts.

[Ronstar]

I calculate it as others stated above. Total amount withdrawn from portfolio divided by beginning of year portfolio value. I also do monthly checks where I divide the monthly withdrawal from the beginning monthly balance.

[Perryinva]

This is something I also wondered about! When people say thay have a million invested, what if $400k is a Roth, and $600k is pretax? That's certainly different from all pretax. Ones WR should always strictly be a percentage of invested money withdrawn, right? But the reality is one needs to draw much less if one pays no tax on it. But that is not the same as a SWR. And what if all income is from all after tax where only the earnings are taxed? So is the WR tied to your expenses? (I wouldn't think so), but if most of your income is tax free, your expenses are lower, so WR is lower. And doesn't the WR rate go out the window once RMDs are mandatory at age 70.5? Or do the majority of FIRE people here NOT use pre tax accounts because access is harder pre age 59.5? It can be very confusing, especially since many here are not from the US, so I don't know if they have such a thing as pre tax or tax free accounts. Or something like RMDs.

And while we are on this subject, when we talk about an SWR, it is based on a 50/50 (or whatever) ration, so how is that affected when a solid portion, like 15-20% is cash, as in money market accounts? I assume the SWR drops, simce it just drops faster with inflation. So I guess it is more realistic to only count actual funds invested in equities and bonds then. I didn't notice a cash section in Firecalc.

For me personally, I am not worried about my WR, since it funds entirely discretionary spending after SS is collected. My savings will fund my ability to delay filing, so it will only have a high WR for a few years, then become whatever RMDs are, since my retirement date is not really early.

BTW, I don't expect anyone to answer these questions. Too many and likely should be a new thread.

[RunningBum]

I handle taxes differently, though I know that I'm in the minority. I use the net expected after-tax value of my tax deferred account, and also taking into account capital gains in my taxable account, in my withdrawal rate calculation.

If I sell/withdraw those assets during the year, I do NOT include the taxes on that as part of the withdrawal amount--because I've already accounted for those taxes. However, I DO include taxes on dividends from my taxable account.

My reasons are historical, from when the bulk of my portfolio was stock options that were going to be heavily taxed, and I wanted a truer picture of where I'd be once I cashed out. Since I was treating those assets that way, it followed that I'd treat all of them that way.

I've continued that for the reason I think you hint at. If my SWR tells me I can take $40,000 out, it doesn't seem right that I have to adjust my non-tax spending based on whether I withdraw from a tax deferred account or not. Instead, I recognize that $40K in a tIRA isn't worth as much as $40K in a Roth, so I discount the tIRA.

So, I wouldn't track withdrawing $40K, I'd track spending $40K. This makes further sense because I have dividends and interest already going into my checking account, so I'll withdraw as needed to support my spending.

Do what makes sense for you. Nobody here gets to audit your books.

[pb4uski]

We have had many discussions on this so I'll try to hit the high points. What you are referring to is deferred income taxes in the case of the tax-deferred accounts. I would say that there is a minority of folks who provide for them when measuring how much they have, but that most people just include in their spending an estimate for taxes that will be due.

Most would not advocate "strictly" following a SWR (though some do)... there is more an emphasis on flexibility... tightening your belt some in tough times and splurging more in good times.

The Trinity Study presented various AA's but the 4% "rule" was based on a 50/50 AA and 95% survival over 30 years. OTOH, we know from Firecalc that AAs in the 35/65 to 65/35 range for 4% WR over 30 years have similar success rates.

If you have a high allocation to cash, you might be able to use the mixed portfolio section on the Your Pofolio tab in FireCalc to model it.

[sengsational]

The purpose of using a withdrawal rate is to level spending across retirement, but, as indicated by the differing tax treatments that might make up the portfolio, that single percentage is quite a blunt object. In other words, it doesn't model reality very precisely.

If you would like a model that considers more of reality, such as income tax expense, the introduction of Social Security, and RMD's, you could try https://www.i-orp.com/ORPparms.html . The purpose of i-orp is to model level-spending*, but rather than just a single percentage, it gives you a dollar amount that, theoretically, you can spend every year all the way to the plan horizon. That amount will grow in nominal dollars every year by the inflation rate.

So, in answer to your (OP's) original question for how to calculate WR, you could take the dollar i-orp result and divide that by your portfolio amount.

One of the things people don't like about i-orp is that it assumes smooth capital appreciation (no booms and busts). This is a legitimate concern, but if you assume the busts will be reasonably short (matching recent historical experience), and you can tighten your belt a little during those times, I think the level spend output from i-orp is a reasonable number.

* You can also model several other retiree spending "shapes". The papers supporting the other spending patterns are referenced in the help text.

[CherylGrrl]

i-ORP can be re-run every year and the year 1 withdrawal taken each time. That brings reality into the process.

[Scuba]

Thanks for your responses. I've never tried I-orp so will check that out.

[Independent]

Quote:

Originally Posted by Scuba This may sound like a dumb question but I would like to confirm the mechanics of calculating our withdrawal rate. We are in our first year of ER and our spending is about where we expected so far but I realized I'm not sure how the calculation works. Is it as simple as: Amount of cash expended for all purposes for the year including taxes/beginning of year portfolio balance? Assuming your portfolio contains tax deferred assets, do you use the net expected after-tax value for those assets, or the gross value in your calculation?

I always have the same response to this question:

Why do you want to calculate a withdrawal rate?

I think once you can explain that, you're well on your way to answering the question.

[pj.mask]

Few thoughts.

1) to me a SWR has to do with the max you can take out per year and says nothing about how that amount will meet your spending needs. If you have $1mil @ 4%SWR, you can take out $40k from any accounts you want (pre/post tax or Roth). The only change is how much you have to spend after taxes are applied to your SWR.

2) The best approach: take everything as a percent (15% Roth, 60% 401k, & 25% taxable) means you would take out your SWR $ value from each account weighted by their %. Alternatively you could run the tax numbers and find out the best strategy (assuming you know future tax changes) like maybe taking more taxable income now and saving more Roth for when you get pension/ssi.

To me the SWR is based on projections of how much you have and what risk you are comfortable with. You may want to shift spending between sources to better balance your spending (more Roth when you buy a car and more taxable when you have low expenses) but the dollar amount should be set.

You can adjust if you have room but I plan to use a strategy that minimizes taxes and use any extra room in my taxes to convert to Roth or increase capital gains basis.

[Blue Collar Guy]

Quote:

Originally Posted by Scuba Thanks BCG. So if you have $1M in your example, is that as of the beginning of the year? And if $400K of the $1M is in tax deferred accounts, do you net taxes out of the $1M since the $400K will be taxed as ordinary income?

Yes, the value as of closing business on new years eve, since the markets are closed on Jan 1st thats the value the calculators usually use,. So it doesn't matter if they are 400k in tax deferred and 600k in after tax. if your using a 5 % WR then you take 50 K from what ever you want. You will have more disposable probably from the after tax accounts but you start out with the same 50k.

[Blue Collar Guy]

Quote:

Originally Posted by Perryinva . Ones WR should always strictly be a percentage of invested money withdrawn, right? .

Right

[Eagle43]

My withdrawal rate is the required minimum distribution rate. If I live to 95, I should still have money. So Uncle Sam tells me. 😎

[JustCurious]

Quote:

Originally Posted by Blue Collar Guy Withdrawal rate is the amount of money you withdraw from the portfolio.

I disagree. In order to calculate a withdrawal rate, you need to know at least two numbers, 1) the amount of money you withdraw from your portfolio, and 2) the portfolio value. Simply knowing number 1) is not enough. So, your withdrawal rate is not just the amount you withdraw from your portfolio, that is your withdrawal, to get your withdrawal rate you need more information.

When calculating your withdrawal rate, I've always wondered what number should be used for the portfolio value. For example, if you start with 1 million on January 1 and you withdraw $50,000 during the year and your portfolio value falls to $920,000 by December 31, what number do you use for portfolio value? Would it matter if you withdrew $30,000 of the $50,000 on December 1?

[Blue Collar Guy]

Quote:

Originally Posted by JustCurious I disagree. In order to calculate a withdrawal rate, you need to know at least two numbers, 1) the amount of money you withdraw from your portfolio, and 2) the portfolio value. Simply knowing number 1) is not enough. So, your withdrawal rate is not just the amount you withdraw from your portfolio, that is your withdrawal, to get your withdrawal rate you need more information. When calculating your withdrawal rate, I've always wondered what number should be used for the portfolio value. For example, if you start with 1 million on January 1 and you withdraw $50,000 during the year and your portfolio value falls to $920,000 by December 31, what number do you use for portfolio value? Would it matter if you withdrew $30,000 of the $50,000 on December 1?

OK you lost me , In my example I gave both numbers, I said 1 million portfolio and 5 % withdrawal. Thats 50k. Your supposed to take the money out on January 1st thats how most of the calculators work.

[rodi]

Quote:

Originally Posted by JustCurious I disagree. In order to calculate a withdrawal rate, you need to know at least two numbers, 1) the amount of money you withdraw from your portfolio, and 2) the portfolio value. Simply knowing number 1) is not enough. So, your withdrawal rate is not just the amount you withdraw from your portfolio, that is your withdrawal, to get your withdrawal rate you need more information. When calculating your withdrawal rate, I've always wondered what number should be used for the portfolio value. For example, if you start with 1 million on January 1 and you withdraw $50,000 during the year and your portfolio value falls to $920,000 by December 31, what number do you use for portfolio value? Would it matter if you withdrew $30,000 of the $50,000 on December 1?

There are different withdrawal strategies. The 2 most frequently discussed here are:
1) Percent of starting value of portfolio, adjusted for inflation. The trinity study is based on this. So if you start with $1M and are using 4% - the first year you'd withdraw $40k, the second year you'd withdraw $40k * (1+cpi). Regardless of CURRENT portfolio value. This is the much discussed 4% SWR that survives a 30 year retirement in 95% of the historical cases.

2) Percent of remaining portfolio. Several members here follow this rule (notably Audreyh, and I think W2R). They take their WR (call it 4% for the example). They multiply 0.04 * their CURRENT portfolio and withdraw it - regardless of portfolio size. It can provide more money following "up" years - and less spending money following "down" years. If you're ok with some variation in your annual available spending - you will never run out of money.

Me - I made sure my "plan" would support a 3.5% WR following the first method... but in reality - I'm only withdrawing what I need... which is under 3% using either method.

[W2R]

Quote:

Originally Posted by rodi 2) Percent of remaining portfolio. Several members here follow this rule (notably Audreyh, and I think W2R). They take their WR (call it 4% for the example). They multiply 0.04 * their CURRENT portfolio and withdraw it - regardless of portfolio size. It can provide more money following "up" years - and less spending money following "down" years. If you're ok with some variation in your annual available spending - you will never run out of money.

(bolded emphasis mine)
Yes, I do this too. During the first week in January, I withdraw the spending money for the entire year. I divide that by the 12/31 portfolio balance, to get my WR.

I have been determining the amount to withdraw, based on prior years' spending, a bit of a buffer, and how expansive I feel. But I want the WR to be between 3.0%-3.5%, and if it wasn't, then I'd revise the amount that I wanted to withdraw.

Usually I withdraw more than I end up spending. For example, for 2016 I withdrew 3.15% of my 12/31/2015 balance, but ended up only spending 1.75% of my 12/31/2015 balance during the year. So at the end of the year I returned the excess and re-computed what my WR for that year actually was.

I know this is a bit backwards but it works for me. I think Audrey does not return the excess but puts it in something along the lines of a high yield savings account.