How do I handle taxes on withdrawals I make at retirement?

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

How do I handle taxes on withdrawals I make at retirement?

Post by frp user »

Hi Jim,

Thanks for developing this great tool….and for making it available! I found out about it from Retired Investor. I am recently retired and nearly all of my retirement has been rolled over into a tax deferred IRA. I have a couple questions about using the flexible Retirement Planner.

Since the spending estimate is not to include income taxes, how do I handle a situation where a substantial amount of the spending (and hence income) is not taxable? Do I adjust the tax rate?

What do you think of using the tool to help decide when to take social security?
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admin
Site Admin
Posts: 79
Joined: Thu Feb 28, 2008 5:27 pm

Re: How do I handle taxes on withdrawals I make at retirement?

Post by admin »

Hi,

I'm not sure I fully understand your question about taxes but I'll take a shot at it.

If your assets are in a tax deferred IRA, annual withdrawals are typically taxed at your income tax rate. If the IRA is a ROTH, then the withdrawals are tax free (and you can enter it as a tax-free IRA in the planner).

The way the planner works is that each year, a withdrawal is made in an amount sufficient to cover unfunded expenses expenses and taxes due on any needed withdrawals from tax deferred accounts.

One caveat is that the planner doesn't know the tax basis of your IRA and assumes it to be zero. That works out fine for 401k's but it could yield an overly pessimistic result on an IRA that was funded with after tax dollars if your basis is quite high.

As far as using the planner to explore when to take ss payments, I think it could give you some insights. On the other hand, the answer is mostly dependent on how long you live, so it's tough to model that.

I have seen some data showing probabilities and life expectancy at various web sites that you might be able to find by googling social security and longevity. Here's one article that seemed on target:
http://www.nysscpa.org/cpajournal/2006/ ... ls/p42.htm

Please don't hesitate to write again if the tax thing is still unclear.

Regards,

Jim
frp user
Posts: 65
Joined: Fri Feb 29, 2008 12:55 pm

Re: How do I handle taxes on withdrawals I make at retirement?

Post by frp user »

Thanks for the quick reply, Jim. The social security article is quite good. Concerning taxes, here is my situation. Nearly all of my assets are in tax deferred 401-k’s and IRA’s with very little tax basis, so it is essentially all taxable income as I make withdrawals. Let’s say I withdraw $100,000 per year and have $40,000 of deductions so my taxable income is $60,000. I guess I would need to adjust the tax rate to reflect this.

Is that correct?
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admin
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Posts: 79
Joined: Thu Feb 28, 2008 5:27 pm

Re: How do I handle taxes on withdrawals I make at retirement?

Post by admin »

Now I think I understand your question. In the case you describe, yes, you could make an adjustment to the tax rate to make it work out correctly.

This raises an important issue w.r.t taxes in the planner. Your example demonstrates nicely that the planner can give only a very rough guestimate on taxes (like everything else). Predicting tax rates 5 years away is tough, let alone 35 years away.

It might be interesting to use the additional inputs section to simulation an increase in marginal tax rates at some point in the future to see how that affects your plan. You may find that even 5 or 10 percentage points of difference in the tax rate can make a big difference.

Thanks again for the feedback,

Jim
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