A few questions about withdrawal assumptions

[PDX Citizen]

Hi all,

I just "discovered" this site this past weekend, and have to say it is pretty awesome.

Anyhow, hopefully I can pester you with a couple of newbie questions.  I'm on my own path to early retirement (or semi-retirement) and have basically been calculating everything with my own spreadsheet.  There are some nice guidelines put forth here, including using the 4% withdrawal rate to reach a savings goal.  I'm wondering about a couple of the assumptions that go into this, though:

(1) When coming up with your annual spending target, which the withdrawal rate is based on, are you including taxes?
For example, if I spend $25,000/year but get taxed 10% on the income used for this spending, should I consider my total spending to be $25,000 or $27,500?

(2) It seems like the withdrawal rate throws out any consideration of social security benefits.  I know these may not be as generous in the future as they are now, but I expect to get something if I reach 67 or 70 - is this not the case for most?

(3) Is anyone using or considering Substantially Equal Periodic Payments as a means of financing part of early retirement?  A 401(k) is my primary savings tool, and this seems like a good way to tap into it before age 59 1/2 without paying a penalty.

Thanks for any comments!
Dave

[matchewed]

1) You do, but you have to understand how to work your taxes to minimize it. It probably won't be as smooth as a 10% taxation but you have to start thinking of how to withdraw with tax minimization in mind. At a $25K scenario I could envision many paths to make your tax bill $0.

2) Given the concept of FIRE it will apply to some but not all. I view it this way; social security is rather far down my life. I'm not factoring it into my plan and that allows me some buffer for when it does kick in as there may be unanticipated costs associated with old age (medical expenses and the like). It all depends on how you structure your plan.

3) The SEPP is good for those close to traditional retirement age. The Roth Pipeline is a better method for those further out.

[PDX Citizen]

Thanks for the quick response! As a follow up:

(1) I'd be really interested in some of these strategies.  I know it's not a smooth rate but the standard deduction is obviously below $25k so I have been assuming that I'll be paying some taxes.

(2) That makes sense.  However, it seems like a lot of the saving that has to be done is to allow for a comfortable old age.  It doesn't seem that difficult (at least from where I'm at - age 41) to save enough to make it to 65...it's the years afterwards (65...) that seem to require working much longer.

[Catbert]

1)  You'll need to include taxes in your annual spending.  That's one of the reasons that it's good to have a variety of income sources and to understand the differences in how they are taxed.  Distributions from traditional IRA are taxed as income.  Distributions from Roth IRAs are not taxed.  For withdrawals from brokerage accounts you're taxed only on the capital gains.   Especially if you are early in your saving for ER assuming 10% Federal income tax is probably a good assumption.  Refine as you get closer.
2) I except that SS will be there even for you younger folks (less generous tho).  If you FIRE your benefit may be pretty small since you'll have far fewer than 35 years of work.
3)In addition to Substantially Equal payments also look around for discussion/explanation of "Roth pipeline" which has more flexibility.   

[matchewed]

Thanks for the quick response! As a follow up:

(1) I'd be really interested in some of these strategies.  I know it's not a smooth rate but the standard deduction is obviously below $25k so I have been assuming that I'll be paying some taxes.

(2) That makes sense.  However, it seems like a lot of the saving that has to be done is to allow for a comfortable old age.  It doesn't seem that difficult (at least from where I'm at - age 41) to save enough to make it to 65...it's the years afterwards (65...) that seem to require working much longer.

Well any sort of deduction or credit, mortgage, children, charitable giving...etc. There are all sorts of ways to reduce your tax bill.

Remember that most of the backtesting will show that your portfolio will outgrow your expenses. You'll be hitting pretty high numbers if the future is anything like the past by the time you hit 65.

[ch12]

1)  You'll need to include taxes in your annual spending.  That's one of the reasons that it's good to have a variety of income sources and to understand the differences in how they are taxed.  Distributions from traditional IRA are taxed as income.  Distributions from Roth IRAs are not taxed.  For withdrawals from brokerage accounts you're taxed only on the capital gains.   Especially if you are early in your saving for ER assuming 10% Federal income tax is probably a good assumption.  Refine as you get closer.
2) I except that SS will be there even for you younger folks (less generous tho).  If you FIRE your benefit may be pretty small since you'll have far fewer than 35 years of work.
3)In addition to Substantially Equal payments also look around for discussion/explanation of "Roth pipeline" which has more flexibility.

+1
1. yep, taxes have to be accounted for - you definitely don't want those to be a surprise - with $25,000 in spending, you can fairly easily get to $0 in taxes. You just have to optimize.
http://www.gocurrycracker.com/never-pay-taxes-again/
BONUS: http://blog.personalcapital.com/financial-planning-2/average-american-pay-no-taxes/
EDIT: http://www.gocurrycracker.com/the-go-curry-cracker-2013-taxes/
One way is to stay in the 15% bracket (up to $36,250 for single) while getting your income from capital gains and qualified dividends, which are taxed at 0% in that bracket.

2. most people who are not close to SS discount any SS income heavily. Mr. Money Mustache regards it as a layer of safety, but not much more. http://www.mrmoneymustache.com/2011/10/17/its-all-about-the-safety-margin/
I'm in my 20s, and I personally think that there will be a trickle of money - I doubt it will be what the SSA says it will be in my annual letter, though.

3. Read http://www.madfientist.com/retire-even-earlier/ to learn about Roth conversion ladders

[Eric]

3. Read http://www.madfientist.com/retire-even-earlier/ to learn about Roth conversion ladders

Also see the Mad Fientist's guest post on Jim Collins's site, where I think he explains it even better than on his own site:

http://jlcollinsnh.com/2013/12/05/stocks-part-xx-early-retirement-withdrawal-strategies-and-roth-conversion-ladders-from-a-mad-fientist/

[PDX Citizen]

Awesome - thanks very much for the replies, those are all very helpful.