Standard Tax Deduction

A retirement planning tool is only as good as its assumptions and inputs. Share your thoughts or ask questions about the internals of the simulation, built in planner assumptions, or planner inputs.
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gg80108
Posts: 9
Joined: Sat Oct 18, 2014 3:07 pm

Standard Tax Deduction

Post by gg80108 » Sun Mar 17, 2019 10:30 am

How do I enter the standard tax deduction?

jimr
Posts: 518
Joined: Thu Feb 28, 2008 6:48 pm

Re: Standard Tax Deduction

Post by jimr » Sun Mar 17, 2019 11:13 am

For most people, the best approach is to enter the AVERAGE tax rate (combining federal and state) that you expect to pay in retirement. The planner's tax model is very crude and doesn't understand deductions or other special tax situations. It leaves it to you to figure all that out based on your circumstances and boil it down into an average overall income tax rate.

This is good example of where sensitivity analysis can help. If you're worried about the reliability of your tax rate estimate, try doubling the rate (or halving it) to see how much it impacts things. If the difference in the success rate is significant, try a 50% increase rather than doubling it and see how much that matters.

For most people a few percent difference in tax rate either way probably won't matter much, but every case is different so you have to test it out for yourself.

joerob58
Posts: 7
Joined: Fri May 03, 2019 8:17 am

Re: Standard Tax Deduction

Post by joerob58 » Wed May 08, 2019 6:18 am

Good Morning Jim,
I have spent the last few days getting to know another program for retirement planning. That software was good but extremely complicated and not very friendly. I had used FRA a few days before that software and was trying to determine which was best for me and FRA has won the battle - so far. :D
I came across this question on Standard Tax Deduction and thought to throw in my 2 cents worth. Something the other software did was to utilize my Adjusted Gross Income as a starting point and then the software doesn't need to consider income following the STD. Especially now, with the STD as high as it is, it makes sense to start with the AGI and not with the Gross Income. This also provides for utilizing the "effective" tax rates that some tax software, like TurboTax, provides after the return is done.
Joe

rcbrown04
Posts: 1
Joined: Thu Jul 11, 2019 8:44 pm

Re: Standard Tax Deduction

Post by rcbrown04 » Sat Jul 13, 2019 1:03 pm

If I understand the tax mechanics of FRP correctly, the input for income tax rate should be the effective tax rate paid on income, not the marginal tax rate. In instances where retirees may have very little taxable income, the marginal rate and the effective rate can be substantially different.

For example, a married retiree filing jointly with $45,000 in income from various sources has a marginal tax rate of 12% under current tax law. The generous standard deduction of $24,000 reduces the retirees taxable income to $21,000, with tax due of $2,142, or an effective tax rate of 2.14%. A similar retiree with $100,000 in income, taking the standard deduction, has taxable income of $76,000, translating to a marginal tax rate of 12% and an effective tax rate of 8.75%. Two distinct cases, same marginal tax rate, substantially different effective tax rates. (Note: figures based on federal taxes only; do not reflect state tax rates.)

There is a very useful tool available to assist users in determining their proforma effective tax rate: a simplified tax forecasting tool from Intuit called TaxCaster (https://turbotax.intuit.com/tax-tools/c ... /taxcaster). Working with the detailed output from FRP, TaxCaster can help approximate the effective tax rate based on income flows of the plan. With that knowledge, you build a custom effective tax rate profile for various periods of the plan. A typical profile might show that the effective tax rate is low prior to taking RMDs, and then rises with mandatory RMDs as the annual income stream increases, or is stepped up in a year where there is substantial income from a one-time event.

Thoughts and/or feedback always appreciated.

jimr
Posts: 518
Joined: Thu Feb 28, 2008 6:48 pm

Re: Standard Tax Deduction

Post by jimr » Sat Jul 13, 2019 1:14 pm

rcbrown04 wrote:
Sat Jul 13, 2019 1:03 pm
If I understand the tax mechanics of FRP correctly, the input for income tax rate should be the effective tax rate paid on income, not the marginal tax rate. In instances where retirees may have very little taxable income, the marginal rate and the effective rate can be substantially different.
Yes. That's correct.
There is a very useful tool available to assist users in determining their proforma effective tax rate: a simplified tax forecasting tool from Intuit called TaxCaster (https://turbotax.intuit.com/tax-tools/c ... /taxcaster). Working with the detailed output from FRP, TaxCaster can help approximate the effective tax rate based on income flows of the plan. With that knowledge, you build a custom effective tax rate profile for various periods of the plan. A typical profile might show that the effective tax rate is low prior to taking RMDs, and then rises with mandatory RMDs as the annual income stream increases, or is stepped up in a year where there is substantial income from a one-time event
Taxcaster does seem like it could be useful for this. Another approach is to use last year's version of whatever tax program you use to model what-if scenarios. Whether this is necessary depends a lot on how complicated your tax situation might be.

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