For Those Who Calculate Their Net Worth

[disneysteve]

Hmmm... I don't know. I actually like the idea of discounting the value of the taxable investments, but not of accounting for taxes and penalties as if I were withdrawing the 401k money today.

When you calculate "the number" that you need to retire and use the 25x expenses calculation, do you account for taxes?

Let's say you expect your annual expenses to be $50,000.
25 times that is $1,250,000.
But if you use that as your target figure, you'll come up short because you need $50,000 after taxes.
Assuming 25% taxes, your target really needs to be $1,666,666.
If you use that as your target, then when you calculate your net worth, no adjustments are necessary because you've already accounted for them when setting your goal.

[snshijuptr]

Similar to Steve's point about calculating the retirement number, I view my net worth always as a multiple of my expenses so taxes would be included in expenses. My net worth is currently .9 times my expenses. It really doesn't matter how much either my expenses or assets are if 25-35 is my goal.

[jpg7n16]

When you calculate "the number" that you need to retire and use the 25x expenses calculation, do you account for taxes?

Let's say you expect your annual expenses to be $50,000.
25 times that is $1,250,000.
But if you use that as your target figure, you'll come up short because you need $50,000 after taxes.
Assuming 25% taxes, your target really needs to be $1,666,666.
If you use that as your target, then when you calculate your net worth, no adjustments are necessary because you've already accounted for them when setting your goal.

Darn you scfr for opening this can of worms!!!! haha


Well DS, I usually get around that problem by including taxes in the expenses

So if you're trying to live off $50k income today, you're being taxed on that $50k. And I usually consider the 25x figure as '25x what income I'd like to have in retirement' (note to clarify: this is not the same as my current income)

Or if the expenses were actually $50k, then I think I'd determine what amount must be withdrawn to provide that $50k. Meaning if I thought the average tax burden was 25%, I'd need to withdraw $66,666.66/year to provide enough for the $50k expenses. And I'd take 25x the $66k for $1,666,666.67.

Because you can't cover $50k in expenses by withdrawing $50k from a 401k.


Personally, I usually use the 25x as a rule of thumb. And I figure the real amount using my financial calculator.

Similar to the quick rule of thumb for buying a home - 25x is a quick rule of thumb for 45 years of withdrawals from investments earning 6% in a 3% inflation world. (actual result 24.9x withdrawal amount)

[feh]

Do you discount the value of your tax-deferred savings (non-Roth IRAs, 401Ks, etc) to account for the fact that, when you start making withdrawals, you will probably have to pay taxes on those savings?

I don't. Although, if 100% of my retirement money was in tax-deferred accounts, maybe I would (around 35-40% of our retirement money is tax-deferred).

I also don't count what money I'll receive from Social Security, which should more than offset the taxes.

[disneysteve]

I also don't count what money I'll receive from Social Security, which should more than offset the taxes.

Good point. I don't include SS in my planning at all.

I also don't include any inheritance even though I am the sole heir of both my mother's estate and my cousin's estate.

[bjl584]

Good point. I don't include SS in my planning at all.

I also don't include any inheritance even though I am the sole heir of both my mother's estate and my cousin's estate.

I also don't take into account SS or inheritance money into my planning. I too am the sole heir of my Mom's estate which is worth several million dollars. It's nice to know that it's there and it's coming my way, but I dread the day that I get the check, for it will mean that my Mom is no longer with me.

[scfr]

Lots of great, thought-provoking comments.

Bottom line: For now, as a resident of a state with no income tax, I will use 15%. If I lived in a state that had income tax, I think 20% would be reasonable.

While I agree that it's better to estimate conservatively and be pleasantly surprised, and I know MM really knows her stuff (which is why I'm bumping my number up) my effective tax rate isn't even 20% now, so it's a stretch to think it will be that at a time when I have no earned income.

I'm sticking with effective tax rate, not marginal. Income is income, and I don't see a need to try to assign different sources of retirement income to different tax brackets.

As far as whether it is a wasted effort, for me it absolutely is not. If I have $100K in a post-tax CD it's definitely worth more than $100K in a pre-tax IRA. Besides, I'm a bit of a numbers geek and this is not a hard calculation to make.

Regarding factoring in inflation, yes, I do that (as well as expected return on investments and other forecasts) when I do retirement planning. But that's not what I'm talking about here. I'm talking about net worth calculation. Not exactly what DisneySteve said (what I would get were I to liquidate all of my holdings today) because I don't factor in penalties for cashing out CDs early or cashing out the IRAs right now for example, but very close to that.

And as far as "opening a can of worms" I'm very glad to do it!!
Seriously, this is not a "PF101" type of question. No rules of thumb to go by, no recycled words of wisdom from David Ramsey or Suze Orman, no recycled Money magazine advice. There are bound to be differences of opinions. I really enjoy this sort of discussion because it stretches my thinking. Looking at who participated in this thread, I know it's the "seasoned PF folks" here at SA and even tho I may come to a different conclusion than some of you, I respect all of the opnions expressed and understand the thinking behind them. So thank you!

[scfr]

FWIW, for retirement planning purposes, I play it conservatively with the numbers there too. I use the same number for expected rate of inflation and expected rate of return on investments even tho up until now (KNOCKING REALLY HARD ON WOOD HERE) our returns have always outpaced inflation. I don't ask a lot of our investments ... just that they don't lose ground to inflation.

I calculate both with & without SS benefits. ("Hope for the best, prepare for the worst.")
I do not factor in receiving an inheritance, but I do factor in LEAVING one.

[kork13]

scfr,
I guess my follow-on thought is this -- When I work my retirement planning, I aim to have assets which will produce a given level of (pre-tax) income. That income is based on the expectation that I will pay taxes, provide for all of my expenses, etc. without draining the actual principle (I see the principle as the eventual inheritance to be left behind).

Do you operate differently? Perhaps you plan based on post-tax, spendable income? If that is the case, I can at least see the reason for discounting your assets for expected future taxes. I still submit that it's unnecessarily complicated, as compared to my aiming for a certain pre-tax income... But perhaps this is where your strategy differs from some of the rest of ours?

[jpg7n16]

Lots of great, thought-provoking comments.

Bottom line: For now, as a resident of a state with no income tax, I will use 15%. If I lived in a state that had income tax, I think 20% would be reasonable.

While I agree that it's better to estimate conservatively and be pleasantly surprised, and I know MM really knows her stuff (which is why I'm bumping my number up) my effective tax rate isn't even 20% now, so it's a stretch to think it will be that at a time when I have no earned income.

The question I keep coming up with, is: since this discount only applies to 401k type and deductible IRAs - and everyone is posting a relatively low expected effective tax rate, should you keep contributing to a Roth? Or at least stop until the rates are more on a parity with each other...

Why not contribute to a traditional IRA instead- to save 25%+ today, and withdraw later at an effective 15-20%?

Or do you only have such a low expected tax because of the Roth?


Sorry in advance guys, my mind is runnin back to my business school classes - since profit is maximized when the Marginal Cost = Marginal Profit, shouldn't we stop contributing to Roth's as long as our highest marginal rate > expected effective rate in retirement? And only contribute to a Roth at the point where the expected effective rate is higher than the current highest marginal one? When they're equal, we should be indifferent.

This discussion may make me turn very pro-401k hah

[disneysteve]

The question I keep coming up with, is: since this discount only applies to 401k type and deductible IRAs - and everyone is posting a relatively low expected effective tax rate, should you keep contributing to a Roth? Or at least stop until the rates are more on a parity with each other...

Why not contribute to a traditional IRA instead- to save 25%+ today, and withdraw later at an effective 15-20%?

1. My job doesn't offer a 401k.
2. My income is too high to get a deduction for funding a traditional IRA.
3. I believe tax rates in the future will be higher than they are today.
4. I'd rather pay tax today at historically low rates and not have to worry about what happens to rates 20 years from now.

[MonkeyMama]

Lots of great, thought-provoking comments.

Bottom line: For now, as a resident of a state with no income tax, I will use 15%. If I lived in a state that had income tax, I think 20% would be reasonable.

While I agree that it's better to estimate conservatively and be pleasantly surprised, and I know MM really knows her stuff (which is why I'm bumping my number up) my effective tax rate isn't even 20% now, so it's a stretch to think it will be that at a time when I have no earned income.

I threw out 20% knowing you were in a no-income-tax state. Just FYI.

To anyone in a state with taxes, I'd probably estimate more.

[jpg7n16]

1. My job doesn't offer a 401k.
2. My income is too high to get a deduction for funding a traditional IRA.
3. I believe tax rates in the future will be higher than they are today.
4. I'd rather pay tax today at historically low rates and not have to worry about what happens to rates 20 years from now.

1 and 2 are fair for the discussion, but not common. Most employees will have a 401k or 403b or something similar. Definitely makes sense for you though Though if you don't qualify for a traditional, how do you qualify for a Roth? Or do you do the non-deductible and instant conversion? If you're not covered by a plan at work, and earn less than $169-179k, you can deduct. (2011 Deduction Limit - Effect of Modified AGI on Deduction if You Are NOT Covered by a Retirement Plan at Work) Which is virtually identical to the 167-177k for a Roth.

Though I guess if you're covered by some qualified plan that's just not a 401k or 403b, you'd fall in the gap. That's a unique place to be in though.


#3 would indicate that your expected effective tax rate is > your current marginal rate, so that should lead you to the Roth decision. I was more asking for others where that scenario is flipped, but that still fund a Roth.

#4 - for someone who wants complete immunity against the uncertainty income tax rates, the best solution would always be a 50/50 split (if possible). If the future rates are higher, withdraw from the Roth. If lower, from the 401k type investment.

I threw out 20% knowing you were in a no-income-tax state. Just FYI.

To anyone in a state with taxes, I'd probably estimate more.

I think you and I have just about the same outlook on future rates

[MonkeyMama]

I am talking current rates. Future rates will be much worse.

I prepare taxes for a lot of retirees. It's pretty much a myth that your taxes go down in retirement. It depends of course on what kind of income you are living off of, but since the tax code changes every 5 minutes, I wouldn't waste much of my own time planning on how to lower my taxes in retirement (30 years+) based on the current tax code. What a waste of time that would be!

[disneysteve]

1 and 2 are fair for the discussion, but not common. Most employees will have a 401k or 403b or something similar.

I've read that only about half of all workers in the US are covered by a 401k-type plan. Despite all of the talk about them, they aren't as common as most people think.