Add'l Withdrawal with taxes - Detailed View

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witheld3
Posts: 1
Joined: Tue Dec 17, 2013 12:41 pm

Add'l Withdrawal with taxes - Detailed View

Post by witheld3 » Thu Dec 19, 2013 1:11 am

I will making withdrawals from tax differed accounts for college expense before retirement age. The detailed view shows the tax amount on the withdrawal, but does not show the additional withdrawal necessary to cover the taxes or deduct that additional sum. How can I model this additional input expense to add the taxes to the desired withdrawal?

Also, if the withdrawal is from taxable savings, is there a way to model the capital gains tax that will be incurred on those withdrawals as well.

BTW, great program!!

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

Re: Add'l Withdrawal with taxes - Detailed View

Post by admin » Thu Dec 19, 2013 9:13 am

It looks like that last column (additional withdrawal w/taxes) doesn't get populated in years before retirement has started. I'll have to look into the code to see why, but I believe this is only a problem with the output and not a problem with the simulation engine. I'm pretty confident that the full withdrawal is correctly being deducted from the portfolio balance.

You can verify this by doing a quick experiment. Set the Investment Style to custom, the Avg Return to the inflation rate, and the std deviation to zero. After you run the planner, you can verify that the total portfolio value decreases by the exact amount of the expected total withdrawal in the year of the special college withdrawal (including taxes).

As far as capital gains taxes go, the way the model works, the basis of the taxable portfolio is assumed to be 100% and the simulation automatically deducts investment taxes on each year's gains before adding the gains back into the portfolio. The model doesn't understand that capital gains can be deferred. This imprecision is close enough for most retirees since requiring immediate tax payment on all investment gains is more conservative than reality, where some gains can be deferred.

If you're close to retirement and have a large deferred gain in your taxable portfolio, you may want reduce its value to account for your reduced basis, since the model always assumes your taxable portfolio basis is 100%. For example, if your taxable portfolio basis is 50% of its value and all of the gain is long term capital gains taxed at 15%, you may want to reduce the taxable portfolio value by 7.5% to true it up with the model.

On the other hand, I like to remind folks that long term planning tools like this planner are full of imprecision and uncertainty that's ultimately impossible to completely eliminate. The best guess is that given the inherent unreliability in any model like this one, probability of success results that are within 20% of each other are essentially the same, given the model's overall margin of error.

That said, I completely understand the desire to eliminate the known imprecision as much as possible.

howieb
Posts: 1
Joined: Fri Mar 21, 2014 7:48 pm

Re: Add'l Withdrawal with taxes - Detailed View

Post by howieb » Fri Mar 21, 2014 8:22 pm

New to the board. Great tool. I didn't post the original question, but had a similar issue. I just tried out what you suggested in your post and I'm wondering if you meant to say that the model assumes a 50% basis (at least that's how it appears to behave) rather than 100% basis. For example to meet 100,000 in expenses it appears to withdraw around 7.5% more, rather than 15% more, to cover expenses. I'm looking at the difference between the end of year balances, with inflation = return, 0 std, and no other income.

So if a portfolio is closer to 100% basis (a taxable account with substantial gains), I would understand reducing the portfolio size by 7.5% to compensate. Unless I'm just not understanding the lingo properly.

Edit: Maybe what I mean to say is closer to 0% basis?

Thanks

jimr
Posts: 514
Joined: Thu Feb 28, 2008 6:48 pm

Re: Add'l Withdrawal with taxes - Detailed View

Post by jimr » Fri Mar 21, 2014 8:30 pm

For the taxable portfolio, taxes are deducted from the gains each year and the basis is carried at 100%, so withdrawals from taxable shouldn't have any extra taxes deducted at all.

The taxes on additional withdrawal column has to do with withdrawals from tax deferred accounts. In that case, the basis is assumed to be 0% and full taxes should be deducted from the withdrawal at the income tax rate. Of course, if part of the withdrawal is coming from the tax free portfolio (ROTH), then there would be no taxes on that part.

jimr
Posts: 514
Joined: Thu Feb 28, 2008 6:48 pm

Re: Add'l Withdrawal with taxes - Detailed View

Post by jimr » Fri Mar 21, 2014 10:12 pm

After re-reading your post, I think I might understand what's causing the confusion.

The extra reduction in portfolio value isn't from taxes related to withdrawals, but from investment taxes on the portfolio gains for each year. Again, since the taxable portfolio basis is carried at 100%, there are no taxes due on the withdrawal. However, portfolio gains are taxed each year at the investment tax rate (default 15%). If the portfolio earns a return exactly equal to inflation each year, even with no withdrawals its real value will decline annually because of the taxes due on the portfolio gains.

To separate out this effect, you might try delaying withdrawals for one year to see what happens to the portfolio value without withdrawals. For example, starting with the default inputs, set the current age to 65 and retirement age to 66 and the taxable portfolio value at $1m. Next, set the return to 3% (default inflation) and the std dev to 0. After the first year, the portfolio value will drop from $1m to $995,500. That's because a 3% return on $1m produces $30k of portfolio gains. The taxes due on that gain, at 15%, would be $4,500.

Hope that makes sense.

Jim

mitosis
Posts: 1
Joined: Wed May 21, 2014 6:25 pm

Re: Add'l Withdrawal with taxes - Detailed View

Post by mitosis » Wed May 21, 2014 8:12 pm

I'm a new user, and so far, I'm finding the program very promising compared to other calculators out there. I appreciate the transparency and flexibility of inputs, and I particularly like the downloadable version, and the ability to save. Thank you for making this available to the community.

If I were to make a teensy criticism, it's that some of the inputs might seem a bit cryptic or ambiguous to a newbie, with the consequent potential to model things wrong. As a case in point, I too ran into the same question as others in this thread on an early model of my situation. Seeing the "Taxes on Withdrawal" column right after the "Additional Withdrawal", and knowing that the withdrawal must have come from a taxable account, I also expected this entry to show that tax. But now I think I understand it would only be from tax-deferred accounts, the way it is set up. How about titling it, say, "Deferred taxes on withdrawal" in order to distinguish them from those that are internally accounted for? Also, to reinforce the notion that it is not modelling taxes on initially unrealised capital gains, how about titling the entry on the main page "Taxable Portfolio Value/Basis" and/or making the point in the "Starting Portfolio Balances" section of the documentation?

Thanks again for a great resource!

jimr
Posts: 514
Joined: Thu Feb 28, 2008 6:48 pm

Re: Add'l Withdrawal with taxes - Detailed View

Post by jimr » Thu May 22, 2014 6:19 am

Thanks for the feedback. As you say, you're not the only one that had trouble deciphering these things. I'm glad you found the forum and were able to get it figured out.

My sense is that we're probably past the point where slight wording tweaks to column headers or labels will help very much. Mentioning portfolio basis on the main page could confuse some people. Instead, I'm thinking about adding more detailed popup tips that would appear when you mouse-over the title or column header text. This would allow more than just a couple of words of additional explanation. It'll take a bit of coding, but I think it may be worth it as a way to describe the more important subtleties of these inputs.

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