Annual expenses to include Income Taxes?

[CuriousJoe]

This may sound stupid, but let me ask anyway!

While still working, when someone says she/he has saved 50X annual expenses, does that include PRESENT income taxes she/he is paying, or estimated future income taxes after the person retires, which may be significantly lower.

I hope I am clear. If not, pardon me

 

[COcheesehead]

For me expenses are all in - everything and are based on known amounts.

 

[Koolau]

Yeah, it gets a bit iffy to predict future taxes, but they are a "cost" of retirement living, as much as food or gasoline. So, yes. s/he needs to include taxes in any estimated future retirement costs.

 

[Souschef]

Taxes are indeed a annual expense. In my case, my RMD's push me into higher brackets.

 

[disneysteve]

Yes, taxes have to be paid so they count as expenses for planning purposes.

 

[CuriousJoe]

I was looking at some examples of high income professionals earning say, over 300k. While working, their income taxes may exceed 100k per year. When they retire, and if RMD's are considerably lower, taxes may drop considerably

 

[Koolau]

I was looking at some examples of high income professionals earning say, over 300k. While working, their income taxes may exceed 100k per year. When they retire, and if RMD's are considerably lower, taxes may drop considerably

Certainly Payroll taxes (SS, MC, unemployment taxes) disappear upon retirement. That is very significant.

 

[disneysteve]

I was looking at some examples of high income professionals earning say, over 300k. While working, their income taxes may exceed 100k per year. When they retire, and if RMD's are considerably lower, taxes may drop considerably

Sure. In retirement some life expenses may decrease. Others may increase. Part of the planning process is coming up with the best estimates for all of that.

 

[MichaelB]

This may sound stupid, but let me ask anyway!

While still working, when someone says she/he has saved 50X annual expenses, does that include PRESENT income taxes she/he is paying, or estimated future income taxes after the person retires, which may be significantly lower.

I hope I am clear. If not, pardon me

I think members here will tell you that RMDs push their tax rates up in a way that makes it difficult to manage and many feel their tax rates in retirement are higher than they expected.

A favorite Yogi-ism: "It's tough to make predictions, especially about the future.

The risk of underestimating taxes is that one has less money to spend. The risk of overestimating is that one saved more than needed. We all must choose which risk we will face.

 

[dunkelblau]

Savings as a multiple of annual expenses is usually meant to suggest the ability of investment income alone to cover expenses. If you include income taxes in your annual expenses, I think it should be estimated future income taxes to go along with estimated future expenses. For most people income taxes will drop once their W2 stops, but other costs like medical insurance may rise substantially.

I question whether it's appropriate to lump income taxes with other living expenses because it's conditional on taxable income while most living expenses are not. I'm no accountant, but I see income taxes as a variable/direct cost of revenue (taxable portfolio income) while living expenses are a fixed/indirect cost. With recent stock market returns I imagine many retirees are seeing their income taxes rise above their SWR, and I don't think they need to go back to work as a consequence! So my take would be that saving 50x annual living expenses excluding income taxes would be plenty.

 

[Koolau]

I think members here will tell you that RMDs push their tax rates up in a way that makes it difficult to manage and many feel their tax rates in retirement are higher than they expected.

A favorite Yogi-ism: "It's tough to make predictions, especially about the future.

The risk of underestimating taxes is that one has less money to spend. The risk of overestimating is that one saved more than needed. We all must choose which risk we will face.

Yes, over the years since ER, I've spent more mental energy (and planning time) attempting to dull the effects of coming (and now actual) RMD effects. There are cliffs to avoid as well as potentially ever increasing tax rates. We are also in the dark about future tax-law changes. In short, not all our RMD planning is linear. But for many here, RMD planning is right at the top of tax planning and should never be ignored.

 

[RunningBum]

You'd have to ask them. If they've told you 50x, it's fair to ask them what that means.

If you yourself are looking at retiring, you would want to factor in future taxes and future expenses, both of which are likely different from current.

 

[Montecfo]

If I were making that claim it would include expected future taxes in under current law.

But not sure what others figure.

 

[TheWizard]

I think members here will tell you that RMDs push their tax rates up in a way that makes it difficult to manage and many feel their tax rates in retirement are higher than they expected...

Perhaps.
But with planning, once RMDs start, they just replace a similar dollar amount that you've been Roth converting annually in pre-RMD years, so your AGI stays roughly the same, or even lower if you do significant QCDs.

Regarding income taxes, I arranged things so that my net retirement income hitting my checking account was roughly the same amount as my previous employment income, adjusted for inflation a bit. With that frame of mind, I don't recall spending a lot of time trying to predict my retirement income taxes as an expense. I focused mainly on expenses after tax...

 

[MarieIG]

I include income tax in my expenses. As for your co-worker, simply ask.

 

[RetiredHappy]

I include estimated income tax within my retirement expenses. When we were working we paid around 50% in Fed income tax and state income tax, so I don't use pre-retirement income for X times of income saved. If we were to use pre-retirement income, I think we would never retire.

 

[COcheesehead]

It’s a simple calculation for me and it’s included in my financial dashboard spreadsheet.
I take the total of my expenses from the prior year and divide it into my portfolio value. I also calculate a value based on the addition of social security which will reduce the withdrawals from the portfolio.

I currently sit at 120 years of expenses so the tolerance is so big that it really doesn’t matter if taxes increase or decrease.

 

[MarieIG]

Perhaps.
But with planning, once RMDs start, they just replace a similar dollar amount that you've been Roth converting annually in pre-RMD years, so your AGI stays roughly the same, or even lower if you do significant QCDs.

Regarding income taxes, I arranged things so that my net retirement income hitting my checking account was roughly the same amount as my previous employment income, adjusted for inflation a bit. With that frame of mind, I don't recall spending a lot of time trying to predict my retirement income taxes as an expense. I focused mainly on expenses after tax...

I have some similarities, some differences. My plan is effected by Roth conversions (larger now, less after SS and RMDs).

I still plan out my taxes as part of my expenses as I pay (most of them) out of dividends stemming from my brokerage account. I will be starting income from a SPIA next month, and have the company withholding half of those payments towards income tax (apportioned between federal and state). I have taxes withheld directly from DH's pension and annuity so that he can concentrate on his net income. I pay both my and DH's taxes for Roth conversions out of my dividend income, although if he wants to make a withdrawal out of his fun money IRA, I have those taxes withheld directly.

 

[Koolau]

It’s a simple calculation for me and it’s included in my financial dashboard spreadsheet.
I take the total of my expenses from the prior year and divide it into my portfolio value. I also calculate a value based on the addition of social security which will reduce the withdrawals from the portfolio.

I currently sit at 120 years of expenses so the tolerance is so big that it really doesn’t matter if taxes increase or decrease.

I don't consider SS as part of my portfolio and I only use what I take from my portfolio as the numerator. I guess it's two ways to look at the same issue. In any case, I've only got 50 years of expenses covered. But I think you're right that we (you, I and likely most here) probably don't need to worry too much about the effects of taxes. That's doubly true for someone my age. (But I'm still a bit concerned about inflation!)

Still if one is at 25X and just ER'd, taxes could be a major worry and should be estimated as much as that is possible.

 

[Aggie1999]

It should include future taxes when in retirement. So say your FIRE number is $1m portfolio. That means you get $40k per year, inflation adjusted, to spend. Part of that $40k spending is whatever taxes you owe for that year.

Taxes while working do not make sense to consider, since your taxable income will most likely be very different in retirement.

 

[COcheesehead]

I don't consider SS as part of my portfolio and I only use what I take from my portfolio as the numerator. I guess it's two ways to look at the same issue. In any case, I've only got 50 years of expenses covered. But I think you're right that we (you, I and likely most here) probably don't need to worry too much about the effects of taxes. That's doubly true for someone my age. (But I'm still a bit concerned about inflation!)

Still if one is at 25X and just ER'd, taxes could be a major worry and should be estimated as much as that is possible.

I don’t consider SS as part of the portfolio, but it reduces the withdrawal amount.

 

[Gumby]

My tax bracket when I was working was higher than it is now that I'm retired (by a lot). So this is what I did while I was planning my exit. Note that I used today's dollars for everything, assuming that inflation will generally move all the income, taxes and other expenses at approximately the same rate.

1. Based on tracking my actual spending, select an annual spending number for retirement. Be conservative and include sinking fund amounts for large, lumpy expenses.

2. Assume that all of that spending will be paid for by receiving ordinary income.

3. Run the taxes on that level of income, gross up at the marginal rate, then add that amount to the spending number.

4. Now that I know "all in" actual spending, including taxes, it's time to figure out where the income to pay that will come from.

5. Subtract out annual gross expected pension income. Subtract out annual gross expected social security income.

6. What's left must come from the portfolio annually. Multiply by 25 for a 30 year expected retirement. When I hit that portfolio number, I could feel confident that I had enough to retire.


You may well ask, what about the fact that no more than 85% of your social security is taxable? What about the fact that some of your money is in a Roth IRA and won't be taxed? What about the fact that some of your income is capital gains and not ordinary income, and so will be taxed at 15% max. To which, I say - yes, that's true, and I certainly employ many strategies to reduce my tax load, but that's also what gave me a margin for error. It is my considered opinion that when it comes to money, I would much rather have and not need it, than need and not have it.

 

[Dalton]

All my taxes either withheld when I take a distribution or sell shares of something, and that is a line item on my spreadsheet and 1040 form, or if I still owe more come April, that is paid with my credit card, which is also a line item in my spreadsheet and is included as a portion of my income on my 1040 form.

So yes, income taxes (and sales taxes, and property taxes, and local use and service taxes) are included in my spending budget.

That's now, as a retiree, of course, but likewise, the spreadsheets I used to track and project expenses included a conservative guess of income taxes (and property taxes). Prior to retiring, I picked some key years (62 to start SS, 65 to start Medicare (and alt SS start), 73 (at the time) to start RMDs, 80 if I make it that long) and did the taxes by hand, based on current tax law, and tweaked my spreadsheet calcs to add or subtract as appropriate. Doing it this way eliminated payroll taxes for FICA and SS.

 

[copyright1997reloaded]

I think the answer is more complicated than "I include them" or "I don't." Short answer: I don't include taxes in my day to day budget. I do include tax considerations in terms of long term expenses and allocation/investment decisions/timing.

Let's take an example: Assume your non-tax operating budget is 100K/year. Will you need to also have to account for taxes on how that 100K is sourced? Of course so. Does the tax depend on how it is sourced? Of course so. The money can come from wages (e.g. j*b), dividend income, interest income, capital gains, collectibles, tIRA/traditional 401k/403b/457 distributions, Roths, traditional pensions, social security and so on. Each of these have differing tax consequences. I would maintain that when there are a variety of choices the amount of tax you pay may be adjustable. Thus, I want to make my budget (what it takes to live each year) as independent as possible for taxes on that income. As a result, while I ALSO track expenses w/taxes, it is not my primary tracking mechanism.

For example, using the 100k expenses above. Let's say my tIRA account is doing well and will be a potential RMD landmine at some point. So, I decide to up my Roth conversions - to make it simple let's say I decide to up my Roth conversion from 0k to 150k. So now I have taxes that have to be paid on that additional 150K of income. Should that impact my thoughts/view on ongoing expenses? No.

Another approach to this is to adjust your net worth based on expected future taxes. Assume a rate on LTCG's, ordinary income, etc. Discount all of your holdings (hey, that's what spreadsheets are for) based on your expected tax impact for that item. Now, while not perfect, you can look at your overall net worth / annual operating expenses to get that ratio. Me? I don't bother (although I did do this in the distant past when I was trying to determine if I had "enough" to retire early.

 

[aaronc879]

In your example of someone waying they have 50X expenses in savings. I would assume they are referring to anticipated retirement expenses including the taxes they will owe in retirement. not the taxes they currently owe while working which may be higher or lower.