Question on taxation of non-retirement portfolio assets

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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frp user
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Joined: Fri Feb 29, 2008 12:55 pm

Question on taxation of non-retirement portfolio assets

Post by frp user »

It appears that you use the assumption that non-retirement assets have already been taxed, and that they are taxed annually at the investment tax rate. In a case with a portfolio with minimal turnover, neither are true. How can I model that?

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admin
Site Admin
Posts: 79
Joined: Thu Feb 28, 2008 5:27 pm

Re: Question on taxation of non-retirement portfolio assets

Post by admin »

Hello,

You are correct that taxable investment gains are taxed each year at the investment tax rate and taxable investment funds are not taxed when they are withdrawn to fund expenses. So yes, a low turnover portfolio will be "overtaxed" until they are withdrawn.

Usually, the effect of this shortcoming is that the probability of success will be a little lower than it otherwise would have been. The only exception is if at the start of the plan you already have significant deferred gains in your taxable portfolio.

I suppose you could reclassify a percent of the taxable portfolio as tax deferred to simulate the deferral that happens in a low turnover portfolio. One drawback there is that you'd have to accept those funds being taxed at the income tax rate rather than the investment tax rate.

I thought about providing cost basis and turnover inputs to account for this, but in the end I felt it wouldn't improve the overall results enough to be worth the added complexity. It's really a case of striving for more precision than this type of analysis can provide. So many of the inputs are highly uncertain so refining this one to the nth degree just didn't make sense to me.

In any case, I appreciate the feedback and I updated the documentation (user inputs section) to make sure that this issue is documented correctly.

Best Regards,

Jim

Guest

Re: Question on taxation of non-retirement portfolio assets

Post by Guest »

I've been playing with the site for 15 minutes, and this was the very first thing that came to mind.

I think this would be very valuable. You might be able to do it by using a single "gains realization rate" that people could calculate from their mutual funds by adding the dividend rate and the turnover ratio. Just an idea though.

jimr
Posts: 577
Joined: Thu Feb 28, 2008 6:48 pm

Re: Question on taxation of non-retirement portfolio assets

Post by jimr »

One other thing you can try in this case is to reduce the captial gains tax rate to account for a more tax efficient portfolio. Instead of the default 15%, you might try 10% or 12%

Jim

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