Planit:Why do you use an after tax goal for retirement income in Planit?

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When setting a goal for retirement income, understanding what your client’s actually will spend in retirement is critical. Some software programs use a pre-tax retirement goal, but this approach is not as accurate as using an after tax goal. Let’s see why this is the case. When you start to withdraw money from your investment accounts, where the money comes from will totally affect your after tax spendable income. Using extremes to illustrate, let’s say you are drawing from open non-registered accounts to fund your goal in one year . . . and in a later year you are drawing primarily from registered accounts. Here’s how the after tax spendable income is impacted.

Pretax.jpg

If you set your goal for $50,000 the actual spendable income you have will vary depending on the source of your withdrawals. So even though you have set a goal that is consistent, the spendable income you have is not consistent. When you set an after tax goal, then you withdraw what is needed to have consistent spendable income.

Aftertax.jpg

So in looking at the above, a client who sets their goal using a pre-tax goal will have fluctuating spendable income depending on the source of their income. However, when you set your goal using an after tax spendable goal, you are creating a goal that give your client a consistent level of spendable income regardless of where the withdrawals are coming from to fund the goal.

So how do you identify your client’s after tax spendable income goal? There are two ways to do this easily. First is to look at your client’s current cash flow (prior to retirement) and determine what their current after tax spendable income is. This is calculated simply using the following formula:

Total Family Income: $150,000 Minus Total Family Taxes: $ 35,000 Minus Total Family Savings: $ 15,000 Current After Tax Lifestyle $100,000

Then the next step is to determine what expenses you have today that will end in retirement, such as your mortgage, child care expenses etc. You also need to consider new expenses that you will have in retirement, such as extra travel expenses or golf fees! When you add these in you now have a realistic after tax spendable income goal. PlanPlus actually has a spreadsheet tool available in Planipedia to help you calculate this.

To download our audit spreadsheet which will walk you through the audit process, click here 

Another option is for your client to provide an estimate of their after tax income requirement by doing a budget to identify cash flow needed to fund their living expenses in retirement. You would think this is the best way to do this, but in fact clients will often underestimate their expenses. So the first method is likely the best.


Conclusion

When you look at the examples above, these are the extremes, but the math gets more difficult when you start adding in a spouse and various sources of income. While you may endeavor to keep tax rates level during retirement and thus take a mixture of non-registered and registered withdrawals, it still is more consistent to set your goal using a net after tax number.