Net worth calculation for retirement purposes

[Retireatee1]

I have a net worth calculation in my Retireator tool.  Although not used in the simulation results per se, I find it to be an interesting metric.  The calculation is as follows:

1) All portfolio before-tax balances are included with estimated taxes subtracted
2) All portfolio after-tax balances are included
3) 100% of any home value is included
4) 100% of any annuity balance is included
5) Debt is subtracted

This is a hybrid between total net worth and liquid net worth.  Total net worth typically would not account for any tax liability.  However, for retirement planning purposes, an IRA and Roth IRA with the same balance should not be valued the same.  The estimated tax uses the forecast years from the simulation.  So that is similar to LNW in some ways, however a true LWN calculation isn't terribly useful here in my opinion.  To get that, you'd need to estimate the equivalent cash value if converted all at once subtracting taxes and fees and other losses.

One thing I do not include is Social Security benefits.  Although it is entirely possible to estimate the value, it requires running the annuity calculation backwards which is complicated.  That might be useful, but I don't include it.

Thoughts?

[SwordGuy]

Net Worth has a specific financial meaning.  It means assets minus liabilities.  Nothing more, nothing less.

Trying to make net worth be something else is just conceptually wrong.

What you want to calculate is "Passive Income over Time vs Expenses over Time."

When you look at the problem this way, it becomes much easier to understand.

What passive income will I have, from what sources, and when will I get it?   How much could each of those sources vary over time?    Do they vary up and down in concert or do they each have their own economic boom and bust cycle?

This gives you the ability to predict best case, worst likely case (i.e. ignoring nuclear armageddon, etc.), and the most likely case for income projections.

What expenses will I have and when will I have them?  Which are essential and which are optional?   How much could each of those vary over time and why?   What big expenses will (or may) come up and will I be able to handle them if they come early or late in my retirement timespan?  Example: I know I will need a new roof in 20 years, plus or minus 5 years.

This gives you the ability to predict typical and likely worst case expenses (again ignoring for example both spouses getting horribly expensive, long-lasting diseases on day two of retirement).

Comparing both on a timeline lets you know when you'll have a sequencing risk, i.e., you might need money you don't yet have.

That's my two cents.

[Retireatee1]

OK I may not have stated the purpose of the question very clearly.  The Retireator has a full cash-flow analysis simulation for up to 80 years.  So income streams are fully modeled.  In the process of designing this and entering my financial information, I threw in a net worth calculation.  This is calculated each year as well, although it has no effect on the simulation.  It's just interesting.  The difficult part is determining the average tax rate to use.  So it is still assets minus liabilities, I'm just trying to define what "assets" and "liabilities" are in this context.

I may work on the Social Security problem.  Basically you want to find an equivalent life annuity at street prices that pays roughly the same benefits.  Whatever that annuity would cost up-front is what your SS insurance benefits would be valued at in that year.  It's tricky though because SS has some odd qualities, especially where spousal benefits are concerned.  It just needs to be a good approximation.

[rmorris50]

Agree with swordguy, NW is NW. I do a cash flow analysis in excel for my husband’s and mine projected lifetime to see how much longer we have to work, and I include taxes as part of our expenses.  I actually take net cash flow each year and add/subtract to our cash cushion. As long as cash cushion stays above a certain level I’m comfortable.


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[SwordGuy]

1) All portfolio before-tax balances are included with estimated taxes subtracted

I disagree.  Taking out all your money at one time is unrealistic and therefore the tax rate would be much too high.    Just calculate it at what it's worth.

2) All portfolio after-tax balances are included

Agreed, but you are totally inconsistent with #1 above.   To be consistent with #1, you would need to subtract capital gains taxes.

3) 100% of any home value is included

Agreed, but again, you are inconsistent with #1 above.   To be consistent with #1 above, you would need to subtract out sales costs such as realtor commissions, repairs, fees, etc.

4) 100% of any annuity balance is included

Do you mean net present value of the annuity?   Or cash-out balance?  (Do annuities have such a thing?)  Or purchase cost?

5) Debt is subtracted

Absolutely.

Social Security benefits.

This is tricky.  My social security benefit is higher than my wife's.   If I die first, she loses "her" benefits and has them replaced by "mine".   But if she dies first, I just lose her benefits.     That's an extra complication on top of all the other annuity value calculation problems.

You also left off other assets.  In my case, that includes rental houses, sharecropped farm land, and mortgage notes others owe us.   

Others may own artwork, vacation homes, unused land, expensive cars or jewelry, etc.

I don't include home furnishings, etc., in my own net worth calculations.   I wouldn't get much for them (relative to other assets) if I was selling the entire house worth of furnishings at one time; and if I did have to do that, I would need to be focused on "where to get next month's rent money?" more than "what's my net worth?"

[Laura33]

If you are looking at this as a specific retirement-planning tool, you should not include the value of your home.  You are always going to need somewhere to live, and so the value of that home is not an asset that can support your future expenses.  Unless you plan to sell and downsize -- then you can use the net profit -- or plan to take out a reverse mortgage (which, again, is limited to a percentage of the home value).  Or sell and rent, but that then increases your necessary future expenses. 

I think trying to convert the SS payments into some kind of NPV over-complicates things.  To my mind, it's much easier just to subtract the estimated SS from our estimated future expenses and so lower the size of the 'stache I need to cover the rest. 

[Retireatee1]

1) All portfolio before-tax balances are included with estimated taxes subtracted

I disagree.  Taking out all your money at one time is unrealistic and therefore the tax rate would be much too high.    Just calculate it at what it's worth.

2) All portfolio after-tax balances are included

Agreed, but you are totally inconsistent with #1 above.   To be consistent with #1, you would need to subtract capital gains taxes.

3) 100% of any home value is included

Agreed, but again, you are inconsistent with #1 above.   To be consistent with #1 above, you would need to subtract out sales costs such as realtor commissions, repairs, fees, etc.

4) 100% of any annuity balance is included

Do you mean net present value of the annuity?   Or cash-out balance?  (Do annuities have such a thing?)  Or purchase cost?

5) Debt is subtracted

Absolutely.

Social Security benefits.

This is tricky.  My social security benefit is higher than my wife's.   If I die first, she loses "her" benefits and has them replaced by "mine".   But if she dies first, I just lose her benefits.     That's an extra complication on top of all the other annuity value calculation problems.

You also left off other assets.  In my case, that includes rental houses, sharecropped farm land, and mortgage notes others owe us.   

Others may own artwork, vacation homes, unused land, expensive cars or jewelry, etc.

I don't include home furnishings, etc., in my own net worth calculations.   I wouldn't get much for them (relative to other assets) if I was selling the entire house worth of furnishings at one time; and if I did have to do that, I would need to be focused on "where to get next month's rent money?" more than "what's my net worth?"

As I mentioned in the OP, the estimated tax used in #1 is an average effective tax rate from future years in the simulation.  It is not the marginal tax rate in the current year, which would be more in line with a LNW calculation.

For #2, the after-tax and before-tax balances are compartmentalized.  Capital gains from after-tax balances in the non-retirement (core) account will be considered before-tax.  So there isn't a hole here.

#3 is a fair point, I could subtract, say, 6% for realtor fees

#4 is a calculation of the present value of the annuity.

I also have a bucket for additional assets.  These appreciate based on the consumer inflation rate.

[Retireatee1]

I've created and attached Retireator simulations to a handful of case study threads, feel free to pull those down and see the current net worth calculation in action:

https://forum.mrmoneymustache.com/case-studies/too-close-for-comfort/
https://forum.mrmoneymustache.com/case-studies/61-now-fire-6362/
https://forum.mrmoneymustache.com/case-studies/ready-in-three-years/

It is the "Net Worth" column on the Annualizer tab (this is the cash flow analysis).  You can change the filter between (N)ominal and (R)eal dollars.

[The Frugal Expat]

Swordguy is spot on with Net Worth.

It is quite simple. Assets minus liability.

If you are looking for how much you need to retire with. Just use the 4% rule. Take your annual spending multiply it by 25 and that is the number you need to retire on.

For instance if spend $40,000 a year I will need $1,000,000 to retire on. My Net Worth would be $1,000,000 in order to have a 4% safe withdrawal rate.

40,000 x 25= $1,000,000

Who knows what taxes will be in the future. Every couple of years we get new politicians so anything can happen.

Don't worry about Social Security. It is expected to run out in the 2030s. Unless, somethings are changed social security is going to run out within 10-15 years.

Let's be honest your house is not an income producing asset unless you sell it, rent it out, or house hacking. If you sell it you most likely will have to pay a realtor's fee.

That's my 2 cents worth.

[GoCubsGo]

Don't worry about Social Security. It is expected to run out in the 2030s. Unless, somethings are changed social security is going to run out within 10-15 years. 

Umm, what if you are slated to start SS in the 2020's.  That's potentially $60K plus a year for a high earning couple.  Do you actually think they would completely stop paying out SS in 2030's ?  I think you need to do some reading before making a blanket statement like that. 64 Million people are currently on Social Security.  It is absolutely worth modelling.

[RWD]

Swordguy is spot on with Net Worth.

It is quite simple. Assets minus liability.

If you are looking for how much you need to retire with. Just use the 4% rule. Take your annual spending multiply it by 25 and that is the number you need to retire on.

For instance if spend $40,000 a year I will need $1,000,000 to retire on. My Net Worth would be $1,000,000 in order to have a 4% safe withdrawal rate.

40,000 x 25= $1,000,000

The 4% rule is for invested assets, not for net worth.

[Retireatee1]

OK so I'm getting a sense of what's important here.  So if there are two individuals with the same expenses, the individual with the higher net worth should be able to retire sooner.  Where there may be a thousand scenarios where this isn't the case in the real world, there is regardless going to be a strong correlation between net worth and ability to retire.  To that end, I feel the net worth calculation should include ALL assets and subtract ALL liabilities including taxes.  There may be fudge factors with appraising the value of assets, but I can't think of any exclusions that would be universally good (this is an open source tool and I have no idea how people are going to use it).

To that end, I'm going to hammer out that Social Security valuation.  As I think about it, I don't think it will be that difficult.

[Laura33]

OK so I'm getting a sense of what's important here.  So if there are two individuals with the same expenses, the individual with the higher net worth should be able to retire sooner.  Where there may be a thousand scenarios where this isn't the case in the real world, there is regardless going to be a strong correlation between net worth and ability to retire.  To that end, I feel the net worth calculation should include ALL assets and subtract ALL liabilities including taxes.  There may be fudge factors with appraising the value of assets, but I can't think of any exclusions that would be universally good (this is an open source tool and I have no idea how people are going to use it).

To that end, I'm going to hammer out that Social Security valuation.  As I think about it, I don't think it will be that difficult.

I don't get why you are so determined to redefine a well-known term and then use that as the "retirement readiness" metric, when that term is imprecise at best as a retirement-readiness indicator and misleading at worst.  It's just a simple way to say "mine's bigger than yours" among people who care about that sort of thing.

Net worth is often far too tied to home values to be a useful indicator of retirement readiness (unless, again, you expect everyone to sell and rent).  Time to retirement is based on savings rate; the value of your home has little to nothing to do with that (and in fact can be negatively correlated in HCOL areas). 

[slappy]

OK so I'm getting a sense of what's important here.  So if there are two individuals with the same expenses, the individual with the higher net worth should be able to retire sooner.  Where there may be a thousand scenarios where this isn't the case in the real world, there is regardless going to be a strong correlation between net worth and ability to retire.  To that end, I feel the net worth calculation should include ALL assets and subtract ALL liabilities including taxes.  There may be fudge factors with appraising the value of assets, but I can't think of any exclusions that would be universally good (this is an open source tool and I have no idea how people are going to use it).

To that end, I'm going to hammer out that Social Security valuation.  As I think about it, I don't think it will be that difficult.

I don't think that is the case actually. Two people could have equal net worth, but one is house poor, with all the net worth caught up in the value of the home. The other has liquid assets that they can withdraw from to fund expenses. The one with liquid assets is the one who be able to retire sooner. I don't really think new worth has much to do with ability to retire.

I think this might have been mentioned, but why are you subtracting taxes from the retirement accounts? Taxes are generally accounted for on the expense side of things.

[Retireatee1]

I don't get why you are so determined to redefine a well-known term and then use that as the "retirement readiness" metric, when that term is imprecise at best as a retirement-readiness indicator and misleading at worst.  It's just a simple way to say "mine's bigger than yours" among people who care about that sort of thing.

Net worth is often far too tied to home values to be a useful indicator of retirement readiness (unless, again, you expect everyone to sell and rent).  Time to retirement is based on savings rate; the value of your home has little to nothing to do with that (and in fact can be negatively correlated in HCOL areas).

My simulation actually predicts net worth each year in the future, up to 80 years.  So you can adjust your simulation variables and see the effect on the net worth trend.  In that context, it is useful.  I wouldn't frame it as a "retirement readiness" metric in the tool, however.  That is provided by the Annualizer tab which scores the simulation.

EDIT: As I explain below, my calculation is a hybrid between TNW and LNW.  I'd be open to using a different term if you have any ideas.

[Retireatee1]

I think this might have been mentioned, but why are you subtracting taxes from the retirement accounts? Taxes are generally accounted for on the expense side of things.

Good question, I see the necessity of entering in your tax "expenses" as a major failing of most retirement simulators.  The Retireator is much more sophisticated, it is driven strictly by living expenses.  It basically runs the federal and state tax brackets backwards to determine the amount of taxable (and non-taxable) gross income necessary to precisely cover those.  Cost bases are tracked and non-retirement accounts are taxed accordingly, including LTCG and dividend rates.

Again the example is one individual has $1,000,000 in an IRA, while another has $1,000,000 in a Roth IRA.  Do they have the same net worth?  Of course not, however Total Net Worth suggests they do.  But how do you normalize these amounts?  The Liquid Net Worth calculation does it, however it unfairly punishes the IRA holder due to penalties and taxes all in one year.  So applying an effective tax rate assuming a normal drawdown during the distribution phase seems to be a reasonable middle ground.

So it's just another data point to look at, but not a singular one to hang your hat on.  There are odd artifacts that can happen though, as you change your retirement date and affect your tax rates in the future, you will see your net worth in the current year rise and fall.  This just shows the difficulties inherent in such a calculation.  However, I see no reason to abandon it.  There are a LOT of threads here regarding TNW and LNW.

[SwordGuy]

You keep trying to bastardize a standard financial term to mean something else.    That's bass-ackwards.   

What you appear to be trying to do is determining whether someone is making FI progress or its opposite.

If so, what you need to do is calculate a %FI.    If your passive income equals your retired expenses (including taxes), then you are 100% FI.   If your passive income is only 80% of that expense number, you're only 80% FI.   

If your investments THAT PRODUCE PASSIVE INCOME now produce MORE passive income (and your expenses remain the same or don't grow as much), then your %FI number rises. 

If your expenses grow more than your passive income does, then your %FI drops.

The sale value of an asset is no no consequence for a %FI calculation except where its sale will be used to provide passive income.   So, a standard stock/bond portfolio would use the 4% rule.    A rental property's resale value is of no consequence until it's sold, until then the only thing that matters is how much passive income in profit it provides.

https://forum.mrmoneymustache.com/throw-down-the-gauntlet/race-to-100-fi!/   has more examples.

Net worth -- calculated properly as net worth and not some bastardized version of it -- should also be calculated.   It also provides a measure of wealth over time.   If net worth is going up but %FI is not, then it's a clue that some assets should be turned into better  passive income streams.

Anyway, it's your tool, do what you want.

But if your goal is to provide a truly useful financial tool for the FIRE community, that's what you should be doing.    This approach also has the advantage that you can track what assets aren't pulling their weight in producing passive income to support FIRE.

[Retireatee1]

Swordguy, thanks for the replies.  You are kind of laying out an overall strategy for the tool which is beyond the scope here.  I'm trying to define a very specific data point on one report here.

I went looking for a second opinion and came up with this:

https://www.bogleheads.org/forum/viewtopic.php?t=44062

So the feeling there is that tax liability is a liability like any other, but typically isn't subtracted from TNW because of the difficulties involved.  However, I have all of the modeling worked out which makes it possible to do this. 

Taxes have some qualities of liabilities and some qualities of expenses.  But I've found the accounting is much cleaner when treated as liabilities, and conceptually they are more like liabilities in my opinion as well.  I don't see it as "bastardization" at all.

[The Frugal Expat]

Don't worry about Social Security. It is expected to run out in the 2030s. Unless, somethings are changed social security is going to run out within 10-15 years. 

Umm, what if you are slated to start SS in the 2020's.  That's potentially $60K plus a year for a high earning couple.  Do you actually think they would completely stop paying out SS in 2030's ?  I think you need to do some reading before making a blanket statement like that. 64 Million people are currently on Social Security.  It is absolutely worth modelling.

If you are completely relying on SS as your retirement then you are making some mistakes in your finances. Most people are not high earners, and most high earners really do not need SSA if they are smart with their investments. As a mustachian, you probably would rely on your own investments instead of relying on the government to help supply your retirement. You would also be frugal as well.

A person making around $60,000 a year will take in about $2100 per month in SS.

According to the SSA website for 2020. Full 100% benefits will run out in 2035, and then the percentage drops to a 79% payout instead of 100%. For people in their 30s need to make plans to not receive these benefits since they will retire in the 2050s.

[shuffler]

According to the SSA website for 2020. Full 100% benefits will run out in 2035, and then the percentage drops to a 79% payout instead of 100%. For people in their 30s need to make plans to not receive these benefits since they will retire in the 2050s.

Around here, we like to show our sources, and also try not to sensationalize.

I believe you are referring to this report on ssa.gov.

After the projected trust fund reserve depletion in 2035, continuing income would be sufficient to pay 79 percent of program cost, declining to 73 percent for 2094.

So instead of "people in their 30s planning to not receive these benefits" as you said,  they should rather expect to receive somewhere in the 79%-73% range of benefits for the rest of their natural lives.


... and of course, that goes without saying how ridiculously easy and popular it would be for congress to fix the funding, so it will indeed get fixed.

[MudPuppy]

I understand your question, OP, but I think you’re trying to make it more complicated than it needs to be (for most of us). For me, I take our post-tax spending and a ballpark healthcare expense estimate (fuck you, US healthcare situation) to get that we’ll need between 1 and 1.2mm to fully FIRE.

We’re only about 120k right now of money v debt net worth. The “real” number is higher but since we don’t plan to downsize homes on retirement because we bought the correct size house to begin with, I include our mortgage debt in the working number but not the house value.  I am also vested in a small defined benefit pension, but it won’t be meaningful enough to be anything other than fun money. I’m not counting SS at all (early 30s here) so if I get it, then I’ll have a nice surprise. I might fine tune my calculations if I was a couple years from my estimated number, but too much can change wrt healthcare costs, etc that sweating more now is counter productive.

[ender]

There are so many relatively easy ways to make SS financially viable that I don't quite know why people seem to think there's a doom/gloom cliff where after that date, the entire program dies and stops functioning.

Just look at the SS wage cap over the last few years. It's going up quickly. It went up over $5k in 2021 vs 2020.

This is all of course assuming Congress gives SS a middle finger for the next decade and a half and doesn't bother fixing it.

[ixtap]

There are so many relatively easy ways to make SS financially viable that I don't quite know why people seem to think there's a doom/gloom cliff where after that date, the entire program dies and stops functioning.

THE WORLD IS BLACK AND WHITE AND DOOMED TO FAILURE

[Steeze]

For me, net worth is all assets - liabilities, without tax consideration.

For my personal residence I use (0.9*appraised value) to account for sales fees.

For FI calc, I exclude my personal residence and include tax as an expense.

[Retireatee1]

I understand your question, OP, but I think you’re trying to make it more complicated than it needs to be (for most of us). For me, I take our post-tax spending and a ballpark healthcare expense estimate (fuck you, US healthcare situation) to get that we’ll need between 1 and 1.2mm to fully FIRE.

Well I've been developing the Retireator since 2015 (currently employing approximately 100,000 Excel calculations), so I'm not that intimidated by complexity.  I already have all the future effective tax rates modeled, so it is only logical to apply it to the net worth calculations.  It is apparent that you can't know your net worth with absolute certainty due to the various estimations and assumptions involved, however I don't let the perfect be the enemy of the good.  The banks are apparently doing something similar.  If they use a specific accounting term for this it would be interesting to learn of it, however I suspect they just call it "net worth".

So I have released the first 2021 version:

https://www.retireator.org/dload/

The net worth calculation does incorporate an appraisal of Social Security benefits now.  You can turn SS on or off.  It is easier than ever to get started in "Basic" mode as I've simplified it quite a bit.  Then you can switch to "Advanced" mode later if desired.