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Author: mrsoftware Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75642  
Subject: Paying the Tax on your Portfolio Date: 4/20/2000 8:06 AM
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I just completed reading the "Stay Foolishly Retired" article. I'm wondering how people pay the taxes on the income generated from their portfolio when they are withdrawing some regular amount (like 6%). Do they pay the tax on the entire portfolio income from the 6% they withdraw? Do they pay tax on the 6% from the 6%, and then let the portfolio pay the tax on it's own earnings? Do they count the amount paid in tax by the portfolio to be part of the yearly 6% withdrawl amount?

I just have a hard time trying to decide how to pay the tax. I currently pay the taxes on my portfolio with income from my current employment. I look upon that as a little extra "savings" contribution to the portfolio. But, when I retire and want to draw from the portfolio, I won't have any other income to use for taxes. So, if I start drawing 6% from the portfolio, am I drawing out pretax money or aftertax money?

Shucks, it shouldn't be so hard to retire.

Thanks

Don
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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21388 of 75642
Subject: Re: Paying the Tax on your Portfolio Date: 4/20/2000 8:51 AM
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Greetings, Don, and welcome. You asked:

<<I currently pay the taxes on my portfolio with income from my current employment. I look upon that as a little extra "savings" contribution to the portfolio. But, when I retire and want to draw from the portfolio, I won't have any other income to use for taxes. So, if I start drawing 6% from the portfolio, am I drawing out pretax money or aftertax money?>>

Whatever taxes are due would be paid from the 6% you withdraw in that example. Consider any withdrawal as gross income.

Regards..Pixy

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Author: mrsoftware Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21389 of 75642
Subject: Re: Paying the Tax on your Portfolio Date: 4/20/2000 9:02 AM
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<<Whatever taxes are due would be paid from the 6% you withdraw in that example. Consider any withdrawal as gross income.>>

I can certainly understand paying the taxes on the 6% withdrawl from the 6%. But, what about any taxes due on earnings within the portfolio? You would likely need to use some of those earnings to pay taxes. So, do you just consider that money as the cost of maintaining your portfolio, or do you consider that money to be part of the 6% amount that you can withdraw from your portfolio?

I suppose I am asking if I should look upon the portfolio as sustaining itself by paying its own taxes on earnings, and still feel comfortable about withdrawing the "safe" 6% amount. It was not clear to me in the "Stay Foolishly Retired" article how taxes on the portfolio were handled. Perhaps I should just assume that I structure the portfolio to aviod taxes as much as possible. But, with a significant allocation in securities, there will likely be dividend income that requires tax treatment.

Thanks

Don

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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21395 of 75642
Subject: Re: Paying the Tax on your Portfolio Date: 4/20/2000 10:38 AM
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The only way the portfolio can cause taxable events is if it throws off income (the likeliest exception being zero coupon bonds). That income can be used to pay the tax.

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21396 of 75642
Subject: Re: Paying the Tax on your Portfolio Date: 4/20/2000 10:48 AM
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Don writes:

<<I suppose I am asking if I should look upon the portfolio as sustaining itself by paying its own taxes on earnings, and still feel comfortable about withdrawing the "safe" 6% amount. It was not clear to me in the "Stay Foolishly Retired" article how taxes on the portfolio were handled. >>

The various rates of withdrawal were established based on the historical success rates found in the article on Foolish Payouts and my subjective judgment on the risks involved in each. Income taxes vary from person to person and are far too difficult to model as a general example. Therefore, the withdrawals did not consider the impact of taxes.

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Author: Mark0Young Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21410 of 75642
Subject: Re: Paying the Tax on your Portfolio Date: 4/20/2000 4:09 PM
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There are several considerations.

If the investment is tax free (e.g., in a Roth IRA), there are no tax considerations.

If the investments are "tax deferred" (401(k), 403(b), annuities or variable annuities, conventional IRA), there are no taxes on the gains in the investments as long as those gains remain within the account. In those cases, the money becomes taxable only when it is withdrawn. So in the scenario where you are drawing out 6%, you would be paying taxes on that 6% at ordinary income tax rates.

If the investments are in a taxable account, then you would be responsible for taxes on all income (dividends and capital gains) thrown off by those investments. In this case, taxes on all dividends and realized capital gains should be paid out of that 6% that you are taking out of the investments. (The numbers in the various simulations assume different withdraw rates, and the dollars withdrawn reduce the portfolio--it doesn't matter if it is for food, shelter, cat food, or taxes, it still reduces the portfolio and thus counts towards the amount being withdrawn.)

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Author: mrsoftware Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21419 of 75642
Subject: Re: Paying the Tax on your Portfolio Date: 4/21/2000 7:41 AM
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Seems to me that many times (certain in my case), most of one's portfolio may come from sources other than 401K or IRA. In such a case, the portfolio is constantly generating taxable income (like dividends). So, the dividends, which are an important piece of the growth of the portfolio, are often used to pay their own taxes. This reduces the growth rate of the portfolio, but 'ya gotta pay the taxes'.

So, once I start drawing my 6% out of the portfolio, this 6% must pay tax on the 6%, plus any tax required on the taxable income generated by the portfolio? Say you take out $100,000 a year from your portfolio. You would pay maybe $25,000 in taxes on the $100,000. Then, maybe your portfolio generates another $50,000 in taxable dividends or other events. In that case, you would pay maybe $20,000 in taxes on that $50,000.

So, you have a total tax bill of $45,000. Suddenly, your $100,000 is now $55,000. I can really see that I would want the portfolio to pay its own taxes (the tax on the extra $50,000).

It seems that this is a common enough question that some analyst would have already included some treatment of taxes in building the set of tables used to determine the 'safe' withdrawl amount. Maybe I can do that if I eventually learn enough about this stuff.

Don


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Author: ptsurmr Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21427 of 75642
Subject: Re: Paying the Tax on your Portfolio Date: 4/21/2000 3:11 PM
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mrsoftware writes:
<snip>
It seems that this is a common enough question that some analyst would have already included some treatment of taxes in building the set of tables used to determine the 'safe' withdrawl amount. Maybe I can do that if I eventually learn enough about this stuff.


You may want to take a look at a recent thread I started on the Retire Early Home Page board. This thread, "Tax Projections for Early Retirement", looks in depth at a couple of different scenarios.

Here is the link:
http://boards.fool.com/Message.asp?id=1380025000952000&sort=id

PtSurMr

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Author: auntpat Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21430 of 75642
Subject: Re: Paying the Tax on your Portfolio Date: 4/21/2000 6:25 PM
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I withdrew $100K last December and sent $20K to the IRS as estimated payment #4. Turbo Tax figured that I owed them an additional $9K, and now my new estimated tax payments increased to $9K per quarter.

Of the $80K remaining, I gave $23K to charity and the rest to my kids and grandkids. Now that my estimated payments are way up, I have figured that I must take $150K this year to pay all of the taxes, plus cover the estimated taxes in 2001, and repay my non-IRA savings that I'm using this year to pay the taxes.

The only way to look at this is that "spending down" at a normal tax rate is better than your beneficiaries having to pay an additional 55%in estate taxes on top of regular income tax.

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Author: mrsoftware Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 21448 of 75642
Subject: Re: Paying the Tax on your Portfolio Date: 4/23/2000 10:30 AM
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I certainly agree that spending down your saved portfolio from all of your hard work over the years is the right thing to do. I just want to feel 'comfortable' that the amount I need to withdraw will not deplete the portfolio in the 'later' years.

I just need to compute a realistic amount of money that I will likely spend on a yearly basis after retirement. That's not easy.

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