High Income, High Spend Retirement Analysis

[PaloAlto]

Been lurking on this forum for about a year. Lots of helpful information here but wanted to get some feedback on my own situation from the forum.

DW and I are both early 40's, married 13 years and have 2 young kids (7 & 4). Both highly educated, so our current income levels have only been in place since the last 7-8 years.

Current gross family income is ~$650K, almost equally split. DW's income is steady and dependable, my income fluctuates (up and down) and subject to layoff etc. So from the start we tried to live within DW's income, trying to bank mine. With 2 young kids and the resulting childcare expenses (~40K per year) this has not always been possible, but we still save over $150K in pretax and aftertax for retirement each year. We live in Palo Alto, California so high housing costs (our home is valued at $2M and we have $1.2M equity in the home).

We have grown our investable assets from $400K in 2006 to around $3M at present thanks to continued investing and market appreciation. This does not include home equity.

We anticipate paying off the home in the next 13 years, which is also the timeframe for retirement. Actually I am not sure either DW or I will retire, but this is the timeframe after which we would like to work without regard to what the financial rewards are. We expect to continue living in our current home, and also expect that this would be the time when our kids would have left home (our younger one would be starting college).

Our financial goals are to have sufficient funds to enjoy a luxurious retirement, pay our kids college expenses so they start life without debt, and possibly help them with their initial home purchases.

FIRECalc analysis tells me that we have 100% success rate of living a comfortable retirement of 50 years i.e. until age 105 (I use annual expense of $280K from 2027 onwards and annual savings of $150K until 2027 with a $3M initial portfolio).

One of my key concerns is that since FIRECalc does not account for taxes, and because taxes are big ticket item for us each year - how do I take this into account? The $280K living expenses for example include a component of income taxes - i estimated at 20% but that is just a guess. If i were to use our current tax rates (~40% total, 54% marginal) then success rate drop significantly.

Any idea how to deal with this uncertainty in planning?

Any other insight into a high income, high spend retirement analysis would be welcome.

Thanks!

PA

 

[LOL!]

You will have to include taxes in your expenses when using FIRECalc.

Do you do your own taxes now? Can you use your copy of TurboTax to see what your taxes would be in retirement? Don't forget that return of capital is not taxed* and that long-term capital gains are tax at a relatively low rate. Also, tax-exempt muni bond income, is generally, well, tax-exempt.

Example: I sell $300K of index mutual funds to pay my $280K of expenses. Of that $300K I sell, the basis is $200K, so that I have a long-term cap gain of only $100K to put on my tax return. I pay no more than $15K in taxes, but I have other income from dividends, etc that I offset with my deductions, exemptions, etc.

 

[WannabeRetired]

You might find this useful.

TurboTax Estimator (2013)
https://turbotax.intuit.com/tax-tools/calculators/taxcaster/

 

[jerome len]

Taxes are a problem for high earners! And, it will get worse.....especially in California.

So, take a hard look at muni bonds as an important part of your portfolio. Vanguard has a great tax managed balanced fund that is about half in muni bonds.....very low taxes but you will still have to pay California State tax.

So, what you can control is portfolio expenses and taxes via muni bonds. You've got a great start, I'd relax, look at your progress each year and adjust what and when you have to. Good Luck.....I'm fortunate and have many of the same concerns about the future that you have.....but, I'll do my best and adjust when I have to.

 

[Animorph]

You may be able to estimate taxes for a few different situations in retirement. Your early years are probably funded off of your taxable accounts (capital gains and dividends), with Roth conversions filling up probably the 25% tax bracket or AMT threshold. After that you may be withdrawing from an IRA up to the 25% tax bracket and filling in with Roth withdrawals. At age 70, RMD's may have you withdrawing more than you need (>25% tax bracket). And SS hits in there somewhere. You're trying to draw down the IRA at 25% so that the RMD's don't bump you into a higher bracket. Plus state taxes of course.

You may or may not look like that, but give it a rough guess and figure out what the taxes would be. You can probably add them in as additional expenses in FIRECalc.

The complexity of this tax problem is why FIRECalc doesn't do it for you.

 

[pb4uski]

The best thing I can think of is to look at the yearly detail implicit in your plan for years in retirement and then do a tax calculation based on that data to get a notion as to what your tax burden will be.

What you could do is output your firecalc results to a spreadsheet (checkbox on the Investigae tab and then a link to year-by-year output on the results page) and then do a tax calculation based on the results.

I favor Quicken Lifetime Planner and just look at the detail of my retirement years and do an estimated tax calculation based on that detail.

 

[MooreBonds]

FIRECalc analysis tells me that we have 100% success rate of living a comfortable retirement of 50 years i.e. until age 105 (I use annual expense of $280K from 2027 onwards and annual savings of $150K until 2027 with a $3M initial portfolio).

Warning - don't overlook the fact that using an ultra-long period can result in perverse FireCALC results!

Because there are fewer 50-year periods vs 30-year periods, AND because several of the time periods that result in portfolio failure started in the 60s/early 70s, 50 years starting in 1969 will have not yet transpired, so FireCALC won't include results for a 50 year period starting in the late 60s or later - so while a 30 year retirement starting in 1969 might have historically yielded a 3.9% SWR to avoid running out before 30 years, a 3.9% SWR starting in 1969 and running for 50 years might end in certain failure. (just an example, not an actual FireCALC result).

One of my key concerns is that since FIRECalc does not account for taxes, and because taxes are big ticket item for us each year - how do I take this into account? The $280K living expenses for example include a component of income taxes - i estimated at 20% but that is just a guess. If i were to use our current tax rates (~40% total, 54% marginal) then success rate drop significantly.

Any idea how to deal with this uncertainty in planning?

PA

The only thing you can do is simply fill out a sample tax return. It isn't that difficult - presumably, your only income would be capital gains, interest and dividends...and eventually withdrawals from IRAs. Just think about what your portfolio might look like, use some estimates for dividend/interest yields, fill in a few boxes on Form 1040, and see what your estimated total tax owed is.

One item to not overlook is the 3.8% Net Investment Income tax if your total income exceeds a certain level.

Another item to keep in mind is that if a large part of your portfolio is in taxable accounts, and you use a low withdrawal rate, your total income from all taxable account sources might be higher than your withdrawal rate. If you intend to only spend your withdrawal rate number, you'll still owe taxes on the excess that your taxable portfolio generated, so your tax bill will be higher than just what you assumed your budget would be.

Because of the difference in tax rates between qualified dividends and interest, make sure you're optimizing your current portfolios by keeping lower paying dividends in your taxable accounts, and putting higher dividend payers and all REITs and any taxable bonds into your tax-deferred accounts.

 

[2B]

Any idea how to deal with this uncertainty in planning?

Any other insight into a high income, high spend retirement analysis would be welcome.

That's the problem with the future. You really never know how it will turn out.

You are doing the right thing. You are living below your means and saving substantially. You have enough right now to retire if you would be willing to reduce your lifestyle and get by on the pathetic sum of $100,000 per year. Continuing to save will continue to grow this.

I think trying to figure out the dirty details of a retirement plan over a decade away is not particuarly productive. There are too many unknowns about market returns, inflation, health, tax rates, government interference, etc.....

By the way, welcome to the forum.

 

[donheff]

Run some scenarios based on best guesses as to what your portfolio might look like in today's dollars when you start retirement. Put upper and lower bounds on it to set the likely high and low starting points. How much in after tax, how much capital gains, how much in tax advantaged. Make your high, medium and low guesstimates about what the tax situation might be. Then run a few turbo tax estimates to see what your tax would be - all in today's dollars. Based on what you describe, you would probably be in a relatively low tax situation until you hit RMDs. CG taxes might well go up (even to regular tax rates) but probably not until high adjusted gross levels which you won't be at. No way you will know what will really happen but you can get a feel for whether you are on target or off by an order of magnitude.

 

[robertf57]

Despite the decimal point output of retirement calculators, retirement prediction is not even close to a certainty. And like predicting the weather, where we can be very accurate at predicting what conditions will be in the short term, i.e. the next hour's weather. Trying to predict decades into the future is very problematic. Given your time horizon is so far off, I wouldn't be wrapped up in trying to predict anything. I would be focused solely on maximizing my accumulation and on how I need to allocate my portfolio.

 

[Travelwanted]

This may help some:

long-term capital gains/ qualified dividends taxes for 2014:

income of 0-74k = 0%
74k-458k = 15%
458k+ = 20%

for married filing jointly there is a 3.8% additional tax above income of 250k

 

[pb4uski]

This may help some:

long-term capital gains/ qualified dividends taxes for 2014:

income of 0-74k = 0%
74k-458k = 15%
458k+ = 20%

for married filing jointly there is a 3.8% additional tax above income of 250k

and to be clear, the income is taxable income, so the actual amount of LTCG/qualified dividends that can be realized and subject to 0% tax for MFJ would be the $74k of taxable income plus 2 exemptions (~$8k) plus deductions (at least $12k) so up to $94k of LTCG/qualified dividends and owe no federal tax.

 

[PaloAlto]

Thanks all. I didn't expect so many responses in such a short time. I used the 20% as a rule of thumb but it sounds like it could be between 25-30% when I include state taxes.

It seems like the tax efficient way is to tap the taxable portfolio first and pay cap gains (anyway we would be too young to tap 401k and Ira's). I have also started putting my retirement $s into Roth accounts (DW deposits into normal pretax and she has generous retirement matching - around $33K each year)

Also we have around $1.5M in taxable accounts which yields $30K in dividends. If the portfolio grew to $5M in the next 13 years that would be around 100K in dividends alone - which I guess we could start cashing instead of reinvesting as we pay taxes on it anyway.

My thinking is as we slow down we supplement income with dividends for a few years and leave our stock investments alone.

Good suggestions on the tax estimators.

Thanks all and also thanks for the warm welcome

PA



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[mpeirce]

Another thing to consider is will you stay in California?

When fund your 401(k)/IRA you avoid paying California income taxes on that money. If you move out of state before you withdrawal the fund, you avoid paying the high California income tax rates completely (that's what we did).

It's a different dynamic for ROTH IRAs...

 

[gregory r.]

I'm curious as to how your qualifying for a ROTH with that income level? Are you doing a backdoor conversion?

 

[PaloAlto]

I'm curious as to how your qualifying for a ROTH with that income level? Are you doing a backdoor conversion?

Sorry I was not specific. It's a ROTH 401K, and I also rolled over my previous ROTH 401K into a ROTH IRA (opened in the days that I qualified for a ROTH).

Sometimes it bothers me to see our income tax bill exceed what DW and I used to gross in the early days of marriage and our property tax bill exceed what we used to pay for rent for our first apartment... the only thing changed from those days is the expenses for kids and housing. Fortunately our incomes started to accelerate before we had the kids

 

[PaloAlto]

You might find this useful.

TurboTax Estimator (2013)
https://turbotax.intuit.com/tax-tools/calculators/taxcaster/

Very useful. Thanks to the deduction provided by Real Estate taxes, the Federal taxes for $100K in Dividends and $180K in LTCG were only around 8%

Feeling much better about my 20% plug now (California will take the other 10-12% i guess)

To answer a previous question - not sure if we will retire in CA (most likely will) but the other potential retirement location is New York City so not sure it's better from a tax perspective

Thanks all.

 

[Golden sunsets]

Spent the weekend in Palo Alto last weekend and the week before travelled through Napa Sonoma and San Francisco. Lovely area. DS is a software engineer in a start up in Boston and is threatening to relocate to Silicon Valley as his income potential (already very high) would increase that much more. I must admit we could see the allure. Weather is fantastic and a vibrant cultural scene. You are clearly living in an income bubble and therefore are in an expense bubble. That being said everything is relative: high income-high expense may be no different than lower income lower expense. I don't think your analysis would be any different than the lower income lower expense retiree. High income and assets is only an advantage if one can wisely curtail expenses. Once your kids are launched and your mortgage is paid off you should be able to reduce expenses. College costs however are significant. If you are planning on 3 kids attending private universities and perhaps advanced degrees without merit scholarships you are talking some serious money. 4 years x 60,000/yr x 3 kids equals $720,000 in today's dollars, not including living allowances and grad school adds that much more.

No suggestions here-just observations.

 

[PaloAlto]

Thanks Golden Sunsets. Yes the weather is indeed a big draw as is the diversity

You make a good point about college. We have budgeted $100K per year, per Child (x2) for college - factoring in tuition inflation etc. and allowing that they might attend private schools without scholarships. They each have UGMA accounts to cover tuition. Fortunately DW works at Stanford and one of the benefits she gets is they cover up to 50% of Stanford's tuition for any accredited 4 year university - which gives us a 50% or more discount on tuition and a good tuition inflation hedge. this is also why we have UGMA accounts and not 529s because if they go to a school that costs less than 50% of Stanford , or if they get merit scholarships for part, the entire remaining tuition is paid by Stanford!

Thanks for the observation though. Btw we were in napa valley last weekend as well, reminding ourselves why we pay high taxes

PA


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[pb4uski]

Very useful. Thanks to the deduction provided by Real Estate taxes, the Federal taxes for $100K in Dividends and $180K in LTCG were only around 8%

Feeling much better about my 20% plug now (California will take the other 10-12% i guess)

To answer a previous question - not sure if we will retire in CA (most likely will) but the other potential retirement location is New York City so not sure it's better from a tax perspective

Thanks all.

This link will do state taxes as well.

Income Tax Calculator - Tax-Rates.org

 

[PaloAlto]

This link will do state taxes as well.

Income Tax Calculator - Tax-Rates.org

Thanks - except it does not have a place to enter qualified dividends... It lumps ST Cap Gains, Interest, and Dividends in one column

With this calculator I show about 25% tax rate but I think it overestimates the federal taxes...

 

[45th Birthday]

I like Fidelity's Retirement Income Planner because it does Monte Carlo simulations in addition to taking taxes into account. You need to be a customer to use it I think, but you can open a small account online.

A few things you said makes me wonder if you are adjusting for inflation properly? You "use annual expense of $280K from 2027 onwards and annual savings of $150K until 2027," but later say you "have budgeted $100K per year, per Child (x2) for college - factoring in tuition inflation" The tuition number seems to be adjusted for inflation, but the total spending number doesn't. Best to keep everything either in today's dollars or future dollars. Also, if you are adjusting for inflation, best not to SWAG it but put actual numbers to it. Some costs (medical?) might rise faster than others. Fidelity's RIP also helps adjust for inflation.

 

[PaloAlto]

I like Fidelity's Retirement Income Planner because it does Monte Carlo simulations in addition to taking taxes into account. You need to be a customer to use it I think, but you can open a small account online.

A few things you said makes me wonder if you are adjusting for inflation properly? You "use annual expense of $280K from 2027 onwards and annual savings of $150K until 2027," but later say you "have budgeted $100K per year, per Child (x2) for college - factoring in tuition inflation" The tuition number seems to be adjusted for inflation, but the total spending number doesn't. Best to keep everything either in today's dollars or future dollars. Also, if you are adjusting for inflation, best not to SWAG it but put actual numbers to it. Some costs (medical?) might rise faster than others. Fidelity's RIP also helps adjust for inflation.

Thanks for the suggestion. I have a Fidelity account - both pre-tax and 401K so I will look up the retirement planner.

To answer your question - the college funds ($100K per year) are set aside already - not the entire amount, but enough to grow to that amount assuming a 5% ROI, and not part of our assets calculations. I used $280K as an expense in 2027 because I set up an excel spreadsheet to monitor the last 2-3 years expenses (mainly defining key categories) and tried to forecast expenses out to 2080 using some inflation guesses between 3% for some categories and 5% for other categories (food, fuel, etc.). The 2027 expenses came out to $210K plus kids' college expenses so I assumed $280K (with taxes) for FIRECalc. Not sure how else to account for inflation etc.

Hope that helps clarify my analytical approach. Let's see what the FIdelity calculator tells me...

 

[pb4uski]

Thanks - except it does not have a place to enter qualified dividends... It lumps ST Cap Gains, Interest, and Dividends in one column

With this calculator I show about 25% tax rate but I think it overestimates the federal taxes...

If you put qualified dividends in the long-term capital gains it gives them the preferential rates.