Include Taxes on unrealized gains in net worth?

[BlessedLife224]

I have quite a bit of unrealized gains in my investment portfolio balance.

When you enter your figures to firecalc, do you exclude the $$ owed to uncle sam out of the calculations?

 

[OnTheBeach]

I always calculate my net worth as "after tax". I calculate the tax (mix of LT and ST+3.8
% tax on investment income) on the unrealized and deduct the liability from my investment "pre tax" amount. That way, you won't over inflate your assets.

 

[audreyh1]

Some people do. Most of us don’t. Taxes are so complicated and change depending circumstances including after death etc. Surviving spouse can get stepped up basis in some states. Heirs usually get stepped up basis. Tax treatment of tax deferred accounts versus taxable accounts is wildly different.

 

[GenXguy]

Taxes are just another expense when they are actually paid.

 

[dmpi]

I calculate both values, net worth before and after taxes. Tax liability is just a rough estimate, it depends on when your gains are realized. Right now I think I will owe 7.5% of my net worth to pay off my taxes.

 

[Exchme]

FireCalc is to answer "can I retire, even if the market does poorly?"

If the market does poorly, you won't have so many gains and if your portfolio is getting small, you may be below the start of the LTCG tax phase-in altogether and your ordinary income taxes would be reduced as well. Plus, as others mentioned, when a spouse passes, half of the gains get a step-up basis. So I would vote with those that say it's not necessary.

 

[audreyh1]

I have quite a bit of unrealized gains in my investment portfolio balance.

When you enter your figures to firecalc, do you exclude the $$ owed to uncle sam out of the calculations?

Taxes are just another expense when they are actually paid.

Exactly - you include expected taxes as an expense included in your annual spending when you use FIREcalc. Not the other way around. The FIREcalc models assume all expenses including taxes are in your spending.

 

[BlessedLife224]

Thanks everyone for your perspectives. I agree there are several levers to pull when it comes to minimizing taxes on gains, so it’s not straightforward to factor that in.

Including taxes in your yearly expenses seems like the way to go.

 

[TheWizard]

Most of my larger unrealized gains will get stepped up basis in a few decades so why would I worry about these on them?

 

[DrRoy]

I do not. I count the taxes as an expense.

 

[FLSUnFIRE]

I do not discount my net worth by potential taxes. Taxes are an expense I try to minimize.

Tax policy changes and the amount I'll pay ranges a lot depending on other income and how I manage my affairs. I am very cognizant of the tax liability and very roughly account for taxes in my long term cashflow projection sheet... not so much a budget but a prospective look at where I'm thinking I'll draw from in the coming years.

 

[LateToFIRE]

+1 to include taxes as an expense. FYI, OP mentions entering NW into FIRECalc, maybe worth noting only securities is relevant for FIRECalc "portfolio". For other assets, like investment real estate, the net cash flow would be entered under "other income" and if plan to sell at some point in the future, the net after-tax proceeds would be entered under "portfolio changes".

 

[Closet_Gamer]

I treat taxes as an expense for retirement planning.

When I do my balance sheet/net worth calculation I have always included an estimate of future taxes on my 401k and non-qualified deferred compensation. I also carry the planned cost of my kids education as an offset to the college funds.

For the 401k and NQDC, the only way I can get to a single dollar of those funds is by paying ordinary income tax. I’m in a high bracket and I always felt it was easy to feel wealthier than I actually am if I didn’t make those future tax obligations visible. Similarly, I had/have substantial funds for kids education and wanted to make visible that those funds were spoken for … particularly when the future obligation was larger than the educational savings.

I did not put a future tax cost on the balance sheet for brokerage accounts. Like others, I’m not really intending to ever sell those assets and don’t expect to incur those taxes at any material level.

The outcome is that the way I think about my net worth results in a substantially lower number than a straight Assets-Debt = Net Worth calculation.

It’s a hack but since it was my own accounting, it always made sense to me.

 

[sengsational]

I'm "lucky". I don't have long term capital gains to "worry about".

 

[MarieIG]

I do not. I also treat taxes as an expense.

 

[RunningBum]

This has come up a number of times, but I'm not sure what you could search on. I do subtract the deferred liability from my net worth for purposed of knowing how much I can spend. For estate purchases, I do not subtract since heirs would get stepped up basis.

Yes, I have to estimate taxes and they could change, but trying to estimate expenses for a budget has the same challenge. If one is looking to retire one of the first things suggested is to determine your budget in retirement. How do you include taxes for LTCGs in a yearly budget when you don't know the tax rate and amount of gains will probably vary each year.

I suspect many people here ignore them since they probably will never sell most of their holdings with taxable LTCGs. I prefer to have an overall picture of how much I can spend if I do sell off all my assets, in an orderly tax efficient manor. That's better than ignoring them, if that's what people really do.

 

[Rianne]

If you include taxes, does it change the outcome of your result? I guess over time it might, but taxes change from year to year. In 2025 we will pay $0 taxes. In 2023 we paid about $8K in taxes.

 

[calmloki]

I don't figure taxes on our NW. I do use the property tax statement of "real market value" or "true cash value" as the value of our real estate, which tends to understate value substantially. For instance, our 2004 build house purchased at auction in 2010 is valued at $175k thanks to being originally valued at our purchase price and then having property tax limitations since. Bank accounts or property loans or T-bills are valued at what we have in them. While I much prefer to underestimate resources, taxes on stock gains aren't something I've even considered.

 

[RunningBum]

Sure, if the deferred tax effect is minimal, it's just noise that you can safely ignore.

For me, it was anything but minimal when I first was heading toward FI. I had employee stock options and the company was going like gangbusters in the dotcom boom. I had a limited time frame to exercise the options, so I couldn't spread out the gains, which would be regular income as they were NQ. That meant much of them would be taxed at 39.6% fed and 7.75% state.

In calculating my readiness for retirement, should I value them at ~$4M, or at ~$2M after taxes were paid? It seemed very obvious to use the after tax value, so I made that calculation in my "net worth" spreadsheet for investments. And by the way, I did exercise a good amount of the options before the bubble burst, and even after that some of the grants still had decent value.

Once I did that, I looked at my other investments. My 401K wasn't really going to give me 100% of it's value in 25+ years before I could touch it, so I estimated the tax rate at age 59.5 and beyond, and reduced it's value. And I had lots of gains in some of my taxable investments, so I applied the LTCG rate on them and reduced them. By doing all of this in my spreadsheet, all I had to do was update the values and the unrealized cap gains and the calcs would give me the assumed value I would have when I withdrew from the 401K and sold stocks. This still seems a lot easier than trying to recalculate a retirement budget that included taxes to liquidate those holdings as the value of those holdings change.

Today I still use that logic in my spreadsheets. The effect is about a 10% reduction in my net worth. I have more buffer than that, but I still like seeing a more accurate number reflecting the amount of money available to me.

Another bonus is that it makes Roth conversions more clear. I've seen some posts here where people hesitate conversion because of the tax to be paid. With my spreadsheet I see the same net worth before and after conversions, because the tax money was already factored in.

Someone earlier said it if your investments go up, you probably won't need the money, and if they go down the unrealized gains will decrease and not be such a factor anyway. Well, it's take a heckuva drop to cancel out all of my gains, so the latter isn't true. And as my investments have increased, I've seen that I can "blow that dough" safely without worrying that I haven't considered the tax effect or selling/withdrawing to pay for luxuries.

 

[OnTheBeach]

I don't understand how income taxes are treated as an fixed expense in firecalc. Assume I have a $ 5 million net worth and annual living expenses of $200,000. If my portfolio creates 500,000 of taxable income or $500,000 losses - that is entirely dependent on income. I wish we could put in a tax rate into firecalc. I would prefer putting fixed expenses in firecalc and calculating an after tax income stream - that would be more realistic.

 

[audreyh1]

I don't understand how income taxes are treated as an fixed expense in firecalc. Assume I have a $ 5 million net worth and annual living expenses of $200,000. If my portfolio creates 500,000 of taxable income or $500,000 losses - that is entirely dependent on income. I wish we could put in a tax rate into firecalc. I would prefer putting fixed expenses in firecalc and calculating an after tax income stream - that would be more realistic.

Income taxes are not treated as a fixed expense in FIREcalc. FIREcalc does not compute taxes at all. It’s up to each person to compute as best they can the amount of taxes they will likely pay each year in retirement and cover that amount in their annual spending. Of course taxes will vary year to year, so will spending. You simply have to model your future budget well enough that you know the annual spending you put in FIREcalc covers all of it. Lots of padding recommended.

No one is going to write this model for you. Certainly not for free.

 

[LateToFIRE]

Income taxes are not treated as a fixed expense in FIREcalc. FIREcalc does not compute taxes at all. It’s up to each person to compute as best they can the amount of taxes they will likely pay each year in retirement and cover that amount in their annual spending. Of course taxes will vary year to year, so will spending. You simply have to model your future budget well enough that you know the annual spending you put in FIREcalc covers all of it. Lots of padding recommended.

No one is going to write this model for you. Certainly not for free.

FYI, Retiree Portfolio Model does a bang up job of computing taxes, BUT it is not a historic or Monte Carlo simulation. It's a free downloadable Excel spreadsheet, and it is very densely detailed (i.e. steep learning curve). I found it very useful for giving me a way to estimate future tax expense as a % of budget. And then I take that info and use it to form a starting budget for FIRECalc.

https://www.bogleheads.org/wiki/Retiree_Portfolio_Model

 

[RetiredHappy]

My take on it is that if you need to go down to the level of details of taxes on unrealized gains, then you are probably not ready to retire financially. Otherwise, I would just add your highest tax bracket for taxes and add that amount to expenses.

 

[Al18]

I’ve sold plenty of appreciated stock in the 5 years since retiring and haven’t paid a penny in tax on the capital gains due to being in the 0% bracket.

 

[Dash man]

Taxes are too variable. My purpose in calculating net worth is we’re approaching the estate tax exclusion as it will be beginning in 2026 if current law isn’t changed. Our planning and gifting will be adjusted to stay under the exclusion.