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% in different tax buckets and effect on 25x savings

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  • % in different tax buckets and effect on 25x savings

    When looking toward achieving financial independence, most would say we should be striving to build 25x-33x (for 4% annual withdrawal versus 3%) one's annual expenses in our savings/investments to achieve financial independence. Wondering how the tax treatment of different savings/investment buckets might affect these numbers. Consider a drastic example that if an individual had the entire 25x-33x all in a Roth account, one would be in a much better situation for becoming financially independent versus one with 100% of assets in a tax-deferred account. Obviously, most will have some mix of both types of accounts as well as taxable investment accounts, but how does the distribution of the total savings/investment pot based on these buckets with very different tax treatment in retirement, impact the 25x-33x? Is there some calculation one can perform based on different percentages in the three different buckets to provide one with a more accurate estimate, other than just utilizing the general 25x-33x across the board?

  • #2
    PoF wrote about this recently. It all kind of depends on the overall amounts, but you can get some pretty good tax treatments even up to 100k.

    https://www.physicianonfire.com/the-...ly-retirement/

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    • #3
      “When looking toward achieving financial independence, most would say we should be striving to build 25x-33x”

      Unfortunately the devil is in the definition you are using. Times what? Those expenses INCLUDE income taxes. Just like it includes real estate taxes and sales tax. Gross income in retirement needed to pay all expenses.

      ROT works until it doesn’t. To solve the riddle you need to run numbers.
      The Vanguard planner ignores taxes.
      The Fidelity planner uses one effective tax rate for all years.
      You can tax effect pretax balances. But at what effective rate? Depends on the source of the funds which impact taxable income and the gross needed to pay income taxes. The kicker is the annual tax will no longer be invested, none of the planners comprehend that.
      Taxes in the accumulation stage are much easier than in the drawdown stage.

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      • #4
        Yes, you need to account for taxes when you actually plan your retirement spending. The 25X and 33X thumb rules are how long the invested money will last if withdrawn at that rate, not how much you can spend. The next step is to look at expenditures. This can be done as either a gross amount or net of taxes. Say you keep track for a few months and decide you can live today on $10K a month after taxes are paid. Adjust it if you want for differences in retirement (no longer saving for retirement, no longer saving for kids’ college, etc.) For this example keep it simple. Assuming the spend requirement is net, select a marginal tax rate the retirement income would be subject to, and apply that factor. 25% seems reasonable to me. So, your investments need to throw off $160K to net you $120k. Apply your 25X to that.

        Could you break down the location of the money (Roth, tax deferred, “taxable”)? Sure, but those amounts are driven by available space in the account types more than your future need. Here is another viewpoint: https://www.whitecoatinvestor.com/pof-my-money/ Personally, I think you will do fine by maximizing your tax free and tax deferred space, then saving in taxable towards a goal: X amount by Y date, where the amount takes into account your after tax spending.

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        • #5
          Originally posted by BuildingWealth View Post
          When looking toward achieving financial independence, most would say we should be striving to build 25x-33x (for 4% annual withdrawal versus 3%) one's annual expenses in our savings/investments to achieve financial independence.
          I don't. It depends upon your planned lifestyle and goals in retirement, how much cushion you want so as not to worry about spending on an extra vacation or treating your friends to a nice restaurant, and how much you want to leave behind.

          Readers of this site should realize that those models are simply ROTs developed for the mass markets of retirees. I do not think they are necessarily appropriate for physician families, much less financially astute physician families. So much more to consider than a number to target for - are you the same as a school principal with a pension? A factory worker who drives Uber on the side? A farmer with a wife who works in an insurance office? A couple without a LTCI policy with a history of dementia or Alzheimer's in one or both spouse's family tree?

          Why do we try to fit ourselves into those square holes? Simply because it's easier or someone told you it works for everyone or it gives you something to latch on to? How do you know this is appropriate for you? Not knowing the answers to these questions can be a very expensive mistake - working years of your lives longer than necessary or spending too much today.
          Our passion is protecting clients and others from predatory advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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          • #6
            Yes, you must consider the tax implications. Up to $80,000 per annum, this might be trivial. In my case, I am guessing an average of 25% per year for taxes, and I account for that in my spending estimates. If RMDs get out of control, tax rates go higher, or living expenses are higher than I expect, this percent may have to be adjusted higher.
            Last edited by VagabondMD; 10-14-2021, 07:19 AM.

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            • #7
              I think the 25-33X is a good goal. If you are far from retirement do not get bogged down with details. I would figure out my yearly spending. This is the figure you need. To be paranoid I mentally doubled this number to account for taxes and surprises. If you have 25-33X your doubled spending then you are ok. This was my pre-retirement thinking anyway.

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              • #8
                Originally posted by Hatton View Post
                I think the 25-33X is a good goal. If you are far from retirement do not get bogged down with details. I would figure out my yearly spending. This is the figure you need. To be paranoid I mentally doubled this number to account for taxes and surprises. If you have 25-33X your doubled spending then you are ok. This was my pre-retirement thinking anyway.
                50-66X! You are going to continue to have a lot of money for a long time!

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                • #9
                  Originally posted by Hatton View Post
                  I think the 25-33X is a good goal. If you are far from retirement do not get bogged down with details. I would figure out my yearly spending. This is the figure you need. To be paranoid I mentally doubled this number to account for taxes and surprises. If you have 25-33X your doubled spending then you are ok. This was my pre-retirement thinking anyway.
                  This is a behavioral finance technique
                  At almost any income or asset level, the emotional response for “security” is almost always “double”. A 100% increase seems to be the line that relieves emotional stress.

                  Translation:
                  50x-66x will be a huge emotional comfort.
                  For most, constructing a plan to actually achieve
                  that will be difficult if not stressful. Double is a lot of cushion.
                  Reality is don’t confuse precision with accuracy.
                  Saving 20-30% is a balance between current vs deferred spending. That takes the emotions out.
                  100% correct about not getting sidetracked by the details. I wouldn’t suggest starting out saving 40-60% as a goal. Enjoy the journey, but not too much. Much is beyond control. Don’t stress about that. Worrying about RMD’s and taxes is a good problem.

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