FIRECalc and the 4% withdraws - Tax Consequences

[Shabber]

I am running some scenarious as usual to stay on track, but have an easy question. When I run Firecalc and hear about people using a 4% withdrawl rate, are they saying take out 4% a year and that is taxed? Or are they assuming a tax rate depending on the amount it is?

Ex) 4% withdrawl on $1,000,000 is $$40K/year
If that is taxed at 15% that leaves me $34K a year to live on?

- Shabber

 

[REWahoo]

Ex) 4% withdrawl on $1,000,000 is $$40K/year
If that is taxed at 15% that leaves me $34K a year to live on?

Correct. FIRECalc does not take taxes into consideration.

 

[Cut-Throat]

I am running some scenarious as usual to stay on track, but have an easy question. When I run Firecalc and hear about people using a 4% withdrawl rate, are they saying take out 4% a year and that is taxed? Or are they assuming a tax rate depending on the amount it is?

Ex) 4% withdrawl on $1,000,000 is $$40K/year
If that is taxed at 15% that leaves me $34K a year to live on?

- Shabber

Not exactly! - Let's say that your $1 Million was in taxable accounts, You would not be taxed on the money you withdrew, but only on the money that was being thrown off as dividends, interest and realized capital gains.

So, it's a bit more complicated than that. Most people have money in taxable and sheltered accounts. If the $1 Million was all in sheltered accounts, you would be taxed on the amount you withdrew.

 

[Martha]

You might look at the I-orp calculator to help you decide how to take withdrawals to minimize taxes: http://www.i-orp.com/TaxCutForm.html

The difficulty is that what you live on may not have a one to one relationship with what income your portfolio generates.  It might if you have a pension or live on a 401k or IRA, but once you throw in after tax accounts it gets complicated.

 

[youbet]

I find it makes the most sense to me to look at fed and state taxes as an expense item in my retirement budget.  For example, I'm just beginning my first year of ER.  In planning for tax expenses for this year, I opened last year's TurboTax and adjusted the numbers to my estimate of how they will look this year, including investment income.  TurboTax then gives me an estimate for this year which I include as an expense item in my budget and make quarterly payment to accomodate.

C-T's and Martha's points are excellent.  Indeed, it's unlikely that you'll be able to think of taxes as a constant percentage reduction to your income steam as your income varies from source to source over time.  The exception to this would be if your retirement income is taxed predominatly as ordinary income such as DFB pensions or TraditionalIRA withdrawals.

 

[SteveR]

Taxes on retirement income streams are unique to each of us. We each have a different mix of income streams that creates a unique set of taxation conditions. There is no one formula or spreadsheet or retirement calculator (at least I have not seen one yet) that will take all your income streams into account at the time you want to use them and calculate the projected tax on each stream individually so you can model different projections to minimize your taxes.

Someone with income from rents, pension, SS, IRA, 40X, after tax equities, interest, dividends, inheritance, and maybe even, gulp, a job, will have a unique set of variables with different taxation rates and rules so one size does not fit all.

About all you can do, short of developing your own spreadsheet, is do find the model that most closely matches your situation and use that as an estimate. Take with several grains of salt and then keep a close eye on it over time.

 

[Shabber]

That's what I was afraid of! Geesh, seems every time I try and get things straight and find out my target savings goal, something comes up to add more money required (and time). So one day it's inflation, the next it's healthcare, the next taxes.

Current thoughts are I need $4500 a month NET. No state taxes in WA, - need 54K a year net, which is 64K taxable, which means about $1.3 million needed. Seems crazy.

- Shab

 

[GolferAndy]

Wouldn't that actually be 1.6 million required?

$1,600,000.00
             x.04
  = $64,000.00

minus taxes = approx $54,000.00 or $4,500.00 /month spendable income.

 

[Scrooge]

That's what I was afraid of! Geesh, seems every time I try and get things straight and find out my target savings goal, something comes up to add more money required (and time). So one day it's inflation, the next it's healthcare, the next taxes.

It gets worse, much worse We dont' know what inflation (or deflation, for that matter) will be like over the next few decades and on top of that you personal inflation may be significantly different from the CPI/PPI.

Similarly, health care costs are hard to predict. There have been so many changes and attempted changes in the last 40+ years -- the introduction of Medicare, Nixon's and Clinton's failed attempts, the rise of HMOs, the 1997 reform, etc -- that I wouldn't venture to make any guesses except that it's quite likely that the system will be different 40 years from now.

Finally, taxes are also hard to predict. The top marginal rate was 91% just 42 years ago. 22 years later it was down to 28%. Over the last 15 years, it has fluctuated between 30% and 40%, but who knows where it will be 30 years from now?

That's why I ended up writing my own personalized retirement calculator and running it a few hundred times for different scenarios. It's sobering to see how different the projected bottom line ca. 2056 can be if you make even minor changes to your assumptions...

 

[Gone4Good]

That's what I was afraid of! Geesh, seems every time I try and get things straight and find out my target savings goal, something comes up to add more money required (and time). So one day it's inflation, the next it's healthcare, the next taxes.

Well, in the "small consolation" department, it is better to learn these things before retirement, then after.