help: odd income jump

[FRPJunkie]

I have the planner set to spend 150,000 in "Annual Retirement Spending" and "Conservative" in the drop down.

In year 3 of retirement, the planner shows $56, 320 in pension income and a median portfolio withdrawal of $109,951, for a total of $166,270.

In year 4, for no apparent reason, the median portfolio withdrawal jumps to $142,699, which, with the pension, totals nearly $200,000. The withdrawals continue in this manner until year 7, when (older) spouse begins collecting SS. At this point median portfolio withdrawal falls back down to about $91,000, with total spending of $166k.

Note that these high withdrawal rates appear no matter what the spending policy is: stable, conservative, or flexible.

Note that this is before RMDs kick in.

What is causing this to happen?

[jimr]

It's tough to guess what could be happening without seeing all the inputs, but I wonder if taxes on portfolio withdrawals could be the culprit.

Investment gains on the taxable portfolio are taxed as they happen, so no taxes are due on withdrawals from the taxable portfolio. The same is true for withdrawals from the tax free portfolio (eg Roth). If you start out withdrawing from taxable and deplete all the taxable funds, the withdrawal rate will suddenly increase to account for the taxes due on tax deferred withdrawals.

Generally, portfolio withdrawals are grossed up to cover any taxes that will be due because of the withdrawals. For example, if spending is $150k and the money to fund that comes from the taxable portfolio, the withdrawal amount will be $150k. If spending is $150k and it gets funded by tax deferred withdrawals with a 20% tax rate, the withdrawal amount will be $150k + $30k + $6k + $1200 + $240... = ~$188k

[FRPJunkie]

It's tough to guess what could be happening without seeing all the inputs, but I wonder if taxes on portfolio withdrawals could be the culprit.

Investment gains on the taxable portfolio are taxed as they happen, so no taxes are due on withdrawals from the taxable portfolio. The same is true for withdrawals from the tax free portfolio (eg Roth). If you start out withdrawing from taxable and deplete all the taxable funds, the withdrawal rate will suddenly increase to account for the taxes due on tax deferred withdrawals.

Generally, portfolio withdrawals are grossed up to cover any taxes that will be due because of the withdrawals. For example, if spending is $150k and the money to fund that comes from the taxable portfolio, the withdrawal amount will be $150k. If spending is $150k and it gets funded by tax deferred withdrawals with a 20% tax rate, the withdrawal amount will be $150k + $30k + $6k + $1200 + $240... = ~$188k

Ahh. That may be it. I do have a 20% rate listed for income and 15% for investments. (There is no income beyond R + 2, because that is year that spouse is projected to stop working.) But what's odd is this is several years into retirement so presumably the rate should be applied equally in every year that money is taken from tax deferred.

[jimr]

Do you have balances in the taxable and/or tax free portfolios?

The default withdrawal order is taxable, tax deferred, tax free. Basically, all withdrawals are taken from taxable until that portfolio is depleted, then all withdrawals are from tax deferred, then once that's depleted, all withdrawals come from tax free. There's an option in settings to change that default behavior.

[FRPJunkie]

Do you have balances in the taxable and/or tax free portfolios?

The default withdrawal order is taxable, tax deferred, tax free. Basically, all withdrawals are taken from taxable until that portfolio is depleted, then all withdrawals are from tax deferred, then once that's depleted, all withdrawals come from tax free. There's an option in settings to change that default behavior.

The order I have is taxable, tax deferred, tax free. By R + 3, the taxable account is depleted. By R + 4 (when the jump from 109k to 142k happens), the money is coming from tax adv, so perhaps that is the issue, since there's a 15 percent tax applied. And then by R+7, when one SS income is applied, the withdrawal goes back down to 92k.

So maybe that's it.

[jimr]

Sounds like it.

As an fyi, withdrawals from tax deferred are taxed at the income tax rate not the investment tax rate.

The investment tax rate applies only to the taxable portfolio. It's used inside the simulation to deduct taxes from portfolio gains before adding the gains back into the portfolio.

[FRPJunkie]

Sounds like it.

As an fyi, withdrawals from tax deferred are taxed at the income tax rate not the investment tax rate.

The investment tax rate applies only to the taxable portfolio. It's used inside the simulation to deduct taxes from portfolio gains before adding the gains back into the portfolio.

That must be it. I assume it's applied marginally? Such that first 20k is untaxed, then 10%, then 15%, up to the 20% income tax rate?

[jimr]

Actually, the tax rates are used as average rates.

So that means all withdrawals from tax deferred get taxed at the same rate.

[FRPJunkie]

Actually, the tax rates are used as average rates.

So that means all withdrawals from tax deferred get taxed at the same rate.

Ok, thanks. Better to be conservative I guess!