Question about 4% withdrawal rate in retirement

[doneat54]

Haven't seen it mentioned yet, so I will -- when you input spending into FIRECalc, you must gross up for taxes. For example, if you anticipate actually spending $125k per year, and you are drawing it from a taxable IRA or 401k, you will actually need to draw $160k per year, because you'll be in the federal 22% tax bracket. So, Draw = 160; tax = (0.22 x 160) = ~35; Net to spend = 160 - 35 = 125. If you have state tax, you need to account for that too.

The formula for grossing up is this:

Desired actual spend/ (1 - marginal tax rate). So $125k/(1.00 - 0.22) = $160,256.00 draw from account.

You should use the $160k in FIRECalc, because it is tracking draws on your portfolio, whether that actually goes to taxes or vacation is irrelevant to FIRECalc.

Not all of the $160k will be taxed at 22%. It is a graduated tax scale. Only the last $76k or so would be taxed at 22%. For federal only, with no deductions used, actual fed tax rate on $160K would be 16.52%. I wrote a tax calculator in Excel for this. Results for $160K would be:

 

[G-Man]

Not all of the $160k will be taxed at 22%. It is a graduated tax scale. Only the last $76k or so would be taxed at 22%. For federal only, with no deductions used, actual fed tax rate on $160K would be 16.52%. I wrote a tax calculator in Excel for this. Results for $160K would be:

Can you share the tax calculator.

 

[doneat54]

Can you share the tax calculator.

Happy to. How to share and Excel Spreadsheet though? Some way to attach it here?

 

[Gumby]

I believe that if you hit "Go advanced", then the "manage attachments" buttons below the quick reply box, you can attach a .xls file

 

[G-Man]

Happy to. How to share and Excel Spreadsheet though? Some way to attach it here?

Can you PM me.

 

[doneat54]

Let me know if that works. Enter annual income in cell B2.

 

[Gumby]

Not all of the $160k will be taxed at 22%. It is a graduated tax scale. Only the last $76k or so would be taxed at 22%. For federal only, with no deductions used, actual fed tax rate on $160K would be 16.52%. I wrote a tax calculator in Excel for this. Results for $160K would be:

As I acknowledged above, I was typing fast and thinking slow when I wrote that.

 

[CRLLS]

I don't understand the problem. Anyone can "open" a Roth IRA. It is paperwork done by you, not your employer. It doesn't even need to be funded at the time it is opened. Just open it. It starts the clock ticking. Whether an IRA conversion or backdoor conversion is used is independent on the employer. These are your accounts not your employer's. You are essentially moving from an IRA to the Roth (and paying the taxes on the conversion). It does get a bit more complicated it you are trying to convert from a 401K or Roth 401k while still working. Some 401k plans allow for in-service withdrawals, some do not.

 

[Jeffman52]

If there is a prolonged bear market and I have to sell while the market is lower and early in my retirement, that will have a significant impact on me for the rest of my life. (I'm very glad I had a fairly good cash cushion and that I am not locked into spending what I had planned to spend.) Just like it's important to start saving for retirement earlier in life so that you can compound returns, it's important not to be selling a lot early in retirement.

There also is an inflation component similar to SORR. Inflation is very high right now, but impacts people differently. (I have a smallish pension that is not inflation adjusted, and some of the things currently hit hardest by inflation are having a significant impact on me.) FIRECALC's default is an inflation rate that is much lower than the current rate. A common recommendation here is to look at your spending over the last few years when figuring out costs in retirement, but that doesn't necessarily work when you're entering a period of high inflation. You may have to make cuts in spending plans to stay within your planned 4%. If you're going to have to spend more, that will impact you permanently going forward just as SORR does.

This is how DW and I have our financial plan. We are not retired just yet, but we have a certain amount of money not tied to the market (yes those can be eaten by inflation to some degree). When the market is down, rather than "selling low" we live off those non-market monies. When the market recovers, we draw from retirement accounts again and slowly refill the non-market monies. Its not perfect but we plan to have enough to weather a three year market crisis based on our budget. That could get eaten and become less than three years due to inflation (if it remains high for that long of a period)



If a market crisis lasts longer than 3 years then I guess we are screwed and we will meet everyone at the poor house when its all gone...

 

[NYC1967]

This is how DW and I have our financial plan. We are not retired just yet, but we have a certain amount of money not tied to the market (yes those can be eaten by inflation to some degree). When the market is down, rather than "selling low" we live off those non-market monies. When the market recovers, we draw from retirement accounts again and slowly refill the non-market monies. Its not perfect but we plan to have enough to weather a three year market crisis based on our budget. That could get eaten and become less than three years due to inflation (if it remains high for that long of a period)



If a market crisis lasts longer than 3 years then I guess we are screwed and we will meet everyone at the poor house when its all gone...

Have you purchased any ibonds? Those keep up with inflation. We started purchasing a few years ago.

 

[Jeffman52]

Have you purchased any ibonds? Those keep up with inflation. We started purchasing a few years ago.

We have not. I will look into it today

 

[Koolau]

It's better to state this as a dollar amount rather than as a percentage. Don't say "100% at 4%." State it as "100% at some $xxx dollar amount." Generally, calculators based on the Trinity Study, such as FireCalc, will always give you a 95%+ survival rate when you enter a spend amount equal to 4% of your initial portfolio.

I'm not certain I understand your point. If I say 100% at 4%, I KNOW what the 4% is applied to (my stash). Maybe my DW would prefer that I do the math, but other than that, I don't see the issue you are presenting. Thanks.

 

[FIYes]

Done at 54, I like your spreadsheet. It is a good visual representation of tax rates. While I knew and understood this, I like a neat clean presentation like this.

 

[Yipper]

Let me know if that works. Enter annual income in cell B2.

Thanks for sharing this. I built something similar and included my state taxes as well so I can more accurately estimate future taxes. One thing I included that I don't see in yours is the Federal standard deduction. For a MFJ couple that comes out to $25,100 right? Taxable income would likely be less than what's in cell B2 whether taking standard deduction or itemized.

Update - I see for 2022 the standard deduction is $25,900.

 

[Rianne]

Do a little reading about SORR - Sequence of Return Risk.

We spoke with a fee-only FA yesterday. We turn 65 this year and plan to start WD in the next 2 years. He could not stress the importance of SORR, especially now. His advice was similar to the advice and guidance on this forum. Other than our conversation with the FA, we'll DIY WD.

 

[NW-Bound]

While I wish my son was earning more, ($50k) only 9 months on the job, hoping to move up after a retirement. He is living with us and will put 19k in his 401, $6k in a Roth and $3,650 in an HSA and probably have some more in a taxable account.

That's quite good. I just checked the income limit for Roth contribution, and my son's pay is about there, but he has 401k deduction and mortgage deduction which should bring it down to allow him to put some money in Roth. When my son said he already opened a Roth, I stopped pressing. I only want to alert my children to things that they might not be aware of.

 

[NW-Bound]

About the Roth, come to think about it, we did OK without it for our after-tax savings.

The advantage of a Roth account is that your investment gains are tax-free. But then, your cap gains in regular brokerage accounts are also tax free if your income is low, which is the case when I ER'ed.

For me, the years of ER prior to 59-1/2, I was able to realize close to $100K of cap gains each year. I sold to realize the gains which were tax-free, then bought back the same shares to raise the basis. Nice. Heh heh heh...

Eventually, the after-tax account was nearly drained due to withdrawals for living expenses. In this way, regular tax savings are even better than Roth, because both principal and gain can be withdrawn, while with Roth you cannot touch the investment gain before 59-1/2.

So, I did not miss anything not having a big Roth for ER. Heh heh heh...

 

[target2019]

Thanks for sharing this. I built something similar and included my state taxes as well so I can more accurately estimate future taxes. One thing I included that I don't see in yours is the Federal standard deduction. For a MFJ couple that comes out to $25,100 right? Taxable income would likely be less than what's in cell B2 whether taking standard deduction or itemized.

Update - I see for 2022 the standard deduction is $25,900.

Yes, thanks to doneat54 for that spreadsheet.
I also noticed some calculations refer to a fixed location in the sheet's hidden column G ($B$2) and if you copy or move the calculated cells there may be a problem.
I did move this and update a few calcs in my own calculation worksheet, so thanks!

 

[Koolau]

About the Roth, come to think about it, we did OK without it for our after-tax savings.

The advantage of a Roth account is that your investment gains are tax-free. But then, your cap gains in a regular brokerage accounts are also tax free if your income is low, which is the case when I ER'ed.

For me, the years of ER prior to 59-1/2, I was able to realize close to $100K of cap gains each year. I sold to realize the gains which were tax-free, then bought back the same shares to raise the basis. Nice. Heh heh heh...

Eventually, the after-tax account was nearly drained due to withdrawals for living expenses. In this way, regular tax savings are even better than Roth, because both principal and gain can be withdrawn, while with Roth you cannot touch the investment gain before 59-1/2.

So, I did not miss anything not having a big Roth for ER. Heh heh heh...

Heh, heh, wait until RMDs kicking in. THEN you'll no longer have low income to shield cap-gains. YMMV

 

[NW-Bound]

Heh, heh, wait until RMDs kicking in. THEN you'll no longer have low income to shield cap-gains. YMMV

Of course. RMD and my SS at 70 too. Mucho income, mucho taxes.

Different stages in life, different situations, different strategies.

Doing mucho Roth conversion now while I still can. Heh heh heh...

 

[Koolau]

Of course. RMD and my SS at 70 too. Mucho income, mucho taxes.

Different stages in life, different situations, different strategies.

Doing mucho Roth conversion now while I still can. Heh heh heh...

And the bad news: We (here) all started too late to head off the inevitable 1st world problems of high RMDs. That's why I urge the young'uns here to ROTH to the max and minimize the 401(k) - or at least do the math as they make their plans. YMMV

 

[skibum]

Not all of the $160k will be taxed at 22%. It is a graduated tax scale. Only the last $76k or so would be taxed at 22%. For federal only, with no deductions used, actual fed tax rate on $160K would be 16.52%. I wrote a tax calculator in Excel for this. Results for $160K would be:

The "tax bracket", or marginal tax rate while working vs retirement is important to consider w/r to advantages of tIRA vs Roth. As I see it, a better comparison is the marginal tax rate typically saved on pre-tax contributions in the working years, vs the effective tax rate often paid during retirement when withdrawing pre-tax funds. The attached screen shot of my tax history spanning working/retirement years shows pre-tax contributions saving taxes at the marginal rate of 25%, and withdrawals with an effective tax rate of 0-3%. My retirement income income was managed to just under $100k AGI by the ACA cliff. I would certainly have converted funds into Roth at the 15% marginal rate, or taken advantage of the 0% LTCGs w/o the ACA cap.

The lower income during early retirement, (ACA limited), lowers the effective taxes paid during withdrawal greatly from the marginal taxes saved on the pre-tax contributions. But even during the working years in the 25% tax bracket, the effective tax rate was only 11%, while tax savings on the pre-tax contributions was at the 25% marginal rate. So when comparing taxes saved on tIRA contributions, vs taxes paid on Roth contributions, vs taxes paid on retirement withdrawals, do not assume that taxes on withdrawals are paid at the marginal tax rate.

As fixed income sources such as pensions, SS, and eventually RMDs come into the picture, this will push the tax rate of tIRA withdrawals from the lower brackets and effective tax rate, up into the marginal tax rate, and potentially into higher tax brackets. Hence, the great opportunity for early retirees to withdraw or convert funds at a lower tax rate (both effective and marginal), before the fixed income drives up taxable income.

 

[NW-Bound]

Yes, it's all about the marginal tax rate while you are working, vs. what it is when you retire.

The problem is that we don't really know what the future brings. I did not plan to have so much in 401k/IRA, and the market god has been so generous that my RMD will be in the 6-figure. But what would I do differently?

We had to max out 401k contributions to get the 50% match from our employers. No brainer there. And I also saved in after-tax accounts, which turned out to be better than Roth, for us to tide over until 59-1/2 to get IRA distributions without penalty.

I initially thought I would have to do 72(t), and did look into it at the age of 50. By working part-time till 55, I was able to live off after-tax accounts till 59-1/2. When your expenses run 6-figure due to kids in college, man, your stash goes down fast. You look at your growing retirement accounts, but cannot touch it. And then, when you can withdraw at will, you find out that you no longer need to.

Life is full of the unexpected. Not all of them are in the bad sense. One does get lucky.

 

[G-Man]

And the bad news: We (here) all started too late to head off the inevitable 1st world problems of high RMDs. That's why I urge the young'uns here to ROTH to the max and minimize the 401(k) - or at least do the math as they make their plans. YMMV

I agree. I wish all or most of my retirement investment was in a Roth IRA.

 

[Time2]

And the bad news: We (here) all started too late to head off the inevitable 1st world problems of high RMDs. That's why I urge the young'uns here to ROTH to the max and minimize the 401(k) - or at least do the math as they make their plans. YMMV

This was a good reminder to do a checkup on our tax deferred accounts.
I'm 67, my wife is 63. I have been Roth Converting my accounts for several years while staying in a low tax bracket, figuring she has more years to convert. I'm down to $200k, while my wife has $562k. Looks to me like we are good to stay in the 12% bracket even with some pretty good market returns. I'm figuring $55k in SS, $13k of dividends and $37k of RMDs.
However, the RMDs goes up every year and hopefully the value of our Mutual funds will increase, so this year I will Roth convert on my wife's accounts, to bad I already did some of mine during the dip. Wanting to do as much in conversions as I can in the next 2 yrs 7 months, before I'm 70 and we collect SS. Now wondering if I should defer her SS and eliminate $20k of income and do an additional $20k of Roth Conversions. And let her check get a little bigger. Calculators always say take mine at 70 hers at 62, I'm not sure it is that simple.


Hoping the secure act 2.0 passing and she will have 3 extra years before RMDs.