Taxes on Withdrawal

[mjm42]

Thanks for the useful tool.
I seem to be having higher than expected taxes on withdrawals. For example, with 15% entered for tax rate, I get 25% taxes withheld. When I enter 0% for tax rate, I get 10% taxes withheld. It seems there is a built-in additional 10% tax rate in the calculation?

[mjm42]

To answer my own question:
I had entered an age 70 "Min IRA withdrawal age".
I thought this was the age at which required-minimum-withdrawals were to happen.
Instead it is the age below which a 10% IRA withdrawal penalty is applied, which is the mysterious 10% added to the "withdrawal tax" I saw.

[jimr]

Nice - You figured it out before I could type my response.

Thanks for posting just the same, in case someone else runs into this...

Jim

[lbhough]

Hi Jim - I'm afraid I need a little more help on the tax calculations. If I set up age 66 and retirement 66, with a $1,000,000 taxable portfolio, 0 inflation, 0 income, 8% return with 0 SD, 15% investment tax rate, I can see how it calculates the end of year value.
(a million @ 8% gives return of $80,00, which is taxable @ 15% makes $12,000 in taxes. You arrive at end of first year with 1 M + 80,000 - 12,000 which is $1,068,000. Since there is no IRA account here, the minimum age question seems irrelevant.

I'm stuck though when the program says that taxes on the portfolio (for that year) are $12,816. That value you turns out to be the tax calculated on the return for the NEXT year.

(That doesnt even turn out to be correct when you start making expense withdrawals). I did conclude that the expenses affect the calculated tax value, but dont see how and how can you show taxes calculated if they aren't paid ?

Summary: i understand the basis for calculating the end of each year's portfolio value, but cannot figure the stated "taxes on portfolio" - I'm grateful for any help. If you can supply the formula you used, I hope you will explain how expenses affect this (since it's withdrawals from a taxable account). I don't even see where you USE this value. I'm sure I am missing something very obvious. Lindsay Hough

[jimr]

Lindsay,

I think you have a pretty good handle on how this works. The truth is that this value isn't used at all and it doesn't come from the main simulation. The column is populated using an after-the-fact computation and was added just for convenience.

The calculation is: tax on portfolio growth = TaxableBalance * taxableReturnAvg * InvestmentTaxRate

I should have used the previous year's taxablebalance in the above calculation, but I either missed that or was lazy and didn't want to add an extra test to check for the special case of the first year. Again, this column is more of an informational afterthought and isn't in any way incorporated into the simulation data or the other results.

[AllenAndrew]

Investment Tax Rate - I am struggling with this entry. You wrote ..."To compensate for these cases (low turnover or significant am't of deferred taxes) it may be necessary to reclassify some percent of taxable investments as tax deferred investments". Can you explain phrase in a different way?

For example, let's say i have an investment account (not IRA), that is currently valued at $100,000 and is approximately 50% bonds and 50% dividend stocks. The cost basis of this account is $75,000. No turnover in the account. All interest, dividends have been reinvested in the fund. what is your recommendation for the Investment Tax Rate? or how would you recommend i estimate that tax rate based on this info? Thank you for this tool. I sleep better at night since finding it.

[jimr]

First, I have to be clear that I'm not in the financial advice-giving business and I'm not qualified to make case-specific recommendations. So please understand that I'm interpreting your question as a "how does the planner work" question rather than a "what should I do in my specific case" question.

In the hypothetical you described with a $75k basis on a $100k investment, it might be worth adjusting the portfolio value down to account for the future capital gains taxes that will be due eventually. The program assumes that the portfolio starts with a 100% basis (ie no unrealized gains) so an adjustment to the portfolio value at the start should roughly true up that input to the planner assumptions. With a 15% cap gains rate on $25k, that'd mean reducing the portfolio value from $100k down to around $96k and entering that into the planner. This is a very rough adjustment, but it should help to make the result more conservative. In practice you'll probably find that in this scenario the adjustment doesn't impact the result very much.

Reclassifying taxable investment funds as tax deferred would only make sense in cases where the basis is very close to zero and the yearly taxable income thrown off by the portfolio is close to zero. This might possibly apply to a growth stock that doesn't pay any dividends and was acquired a long time ago so the basis is near 0% of its value. The other caveat with this approach is that withdrawals will be taxed at the income tax rate rather than the investment tax rate.

[AllenAndrew]

Was still having some difficulty understanding your response and then found this thread: "Asset Sequencing Retirement" in one of the forums. The discussion there clarified my issue. I have to say the default of using a 100% cost basis for the taxable portfolio caught me by complete surprise. Somehow i never saw that before in the instructions. Thanks for your prompt response.

[jimr]

I'm glad you found some additional clarification. For anyone reading this thread later on, here's a link to that other thread:
http://www.flexibleretirementplanner.co ... 2240#p2238