Avoiding a Tax Spiral?

[pb4uski]

I've thought about this before, but this morning it's not making sense to me.

Let's say you have annual expenses of 40K per year (just an example). So you withdraw 40K from your portfolio. Then you have to pay taxes, I'll say 10% just for ease of calculation. So you withdraw another 4K to pay taxes. That brings your total withdrawal to 44K. So now your taxable income is 44K, so you have to withdraw another .4K to cover the extra taxes. But now your total withdrawal is 44.4K, and so on.

I'm sure I'm being especially dense this morning, but how do you avoid this spiraling situation?

If you withdraw and pay 10% in taxes you get 90% of each $ withdrawn.... 1-10%.... so if you want $40k, withdraw $40k/(1-10%) or $44,444... pay 10% or $4,444 in tax and you have $40k left to spend.

 

[meekie]

The chart in this article seems to say you pay the least amt. of taxes married filing joint returns. Do I understand this correctly?
https://www.forbes.com/sites/kellyp...dard-deduction-amounts-and-more/#43c2c9ee7930

I'm not seeing that at all. Married Filing Separate or Single thresholds are 50% of Married Filing Joint, so there isn't a marriage penalty anymore.

 

[mountainsoft]

Just to clarify a point in your example: you say withdraw 40K from your portfolio and then calculate tax on the entire amount. In your example your portfolio must be a tIRA or some other tax deferred account. Right?

If not from a tIRA, then the taxable portion is likely much smaller and could be zero if coming from a Roth.

My post was just an example to work with. In reality most of our retirement income will come from my wife's pension and social security. Any remainder will come from our IRA's. Wife just started a Roth, I have both a traditional and Roth. I'm hoping to have the traditional fully converted to a Roth by the time we retire.

 

[2retireearly]

Think of it this way. You know you need 40000 to live. You don't want to be hit with the tax at the end of the year filing. So take 40000 * .10/(1-.1) = 44,444.44 gross. and give 4444.44 to taxes, so you only get 40000. So, you are right. You are taxed on the gross 44444.44 at 10%. which = 4444.44
So you let the portfolio company pay the 4444.44 to gov, which is on your tax record. so at tax time, you are whole..you paid your taxes on 44444.44

 

[Focus]

We do not do this, we take what we need, when we need it, then worry about taxes at tax time, and again take what we need to pay them (at that time).

Glad I'm not the only one who keeps things super simple.

 

[2retireearly]

We do not do this, we take what we need, when we need it, then worry about taxes at tax time, and again take what we need to pay them (at that time).

But by doing it this way, you are entering the spiral that was asked about. Now, you owe taxes on the money you took out for taxes..(of course having a deduction at tax time makes yours all work out..).
But, if one takes out the whole gross 44444.44,and removes the tax of 44444.44*.1 = 4444.44...then they would have the exact net of 40000,which is the amount they needed. The formula for gross is always Net wanted *tax rate / (1-tax rate) .
This takes me back to my Actuarial Job days...ahhh love math!

 

[pb4uski]

But by doing it this way, you are entering the spiral that was asked about. Now, you owe taxes on the money you took out for taxes..(of course having a deduction at tax time makes yours all work out..).
But, if one takes out the whole gross 44444.44,and removes the tax of 44444.44*.1 = 4444.44...then they would have the exact net of 40000,which is the amount they needed. The formula for gross is always Net wanted *tax rate / (1-tax rate) .
This takes me back to my Actuarial Job days...ahhh love math! (emphasis added)

No, the gross = net wanted/(1-t).... in our example 44,444 = 40,000/(1-10%).

What you wrote would be 40,000*10%/(1-10%) = 4,444 and would just be the grossup for taxes, not the total gross.

Math is hard, eh?

 

[donheff]

Thus you can never withdraw enough! It's a paradox!

-Zeno

I was about to pop in with the same thing. You can never get to your goal, if you progress half way with each step.

 

[2retireearly]

No, the gross = net wanted/(1-t).... in our example 44,444 = 40,000/(1-10%).

What you wrote would be 40,000*10%/(1-10%) = 4,444 and would just be the grossup for taxes, not the total gross.

Math is hard, eh?

Ah..no wonder I retired early! Yes, you are right!
I was trying to show the 'whys' of what is going on..so it wouldn't look like mumbojumbo:
So:
Gross = net wanted + net wanted*taxrate/(1-taxrate)...
Which you so correctly algebraically reduced to
Gross=
Netrequest/(1-taxrate)
Ok..I'm done...thanks, and math is fun!

 

[gerntz]

I've thought about this before, but this morning it's not making sense to me.

Let's say you have annual expenses of 40K per year (just an example). So you withdraw 40K from your portfolio. Then you have to pay taxes, I'll say 10% just for ease of calculation. So you withdraw another 4K to pay taxes. That brings your total withdrawal to 44K. So now your taxable income is 44K, so you have to withdraw another .4K to cover the extra taxes. But now your total withdrawal is 44.4K, and so on.

I'm sure I'm being especially dense this morning, but how do you avoid this spiraling situation?

Taking money from your portfolio doesn't cost any taxes unless it's from a tIRA, a 401k, or you create net Cap Gains.

 

[RunningBum]

I'd pay taxes from taxable. At least on the extra $4000. If you can't come up with $400,that's another problem.