Cash flow and taxes

Open Cash flow & taxes in the left menu to see the open scenario year by year: what you spend, where the money comes from, and the tax that results. It follows one path where the markets earn their average return every year, so the numbers are steady and easy to follow. The score on the overview still comes from the thousand varied paths.

Every amount is in today’s dollars.

How taxes are worked out

You file jointly as California residents. Each year the planner adds up what’s taxable: pensions, withdrawals from the traditional IRAs, the gain part of anything sold from the taxable accounts, dividends and interest, and the taxable part of Social Security. It then works out:

• Federal income tax, with long-term gains at their lower rates.
• California income tax, which treats gains as ordinary income and doesn’t tax Social Security.
• The 3.8% investment-income tax, on investment income once total income passes $250,000.
• The Medicare surcharge, an extra premium for each of you on Medicare, set by your income two years earlier.

Each year’s tax is paid the following April, out of the next year’s withdrawals. While Bradley consults, the tax on his pay is already taken out of what he brings in, so the tax figures show only what everything else adds.

From 75, the IRS requires a withdrawal from each traditional IRA every year. The planner takes it whether or not you need the money; anything not spent is invested in the taxable account.

What the page shows

• Six figures at the top: income tax over the whole plan, Medicare surcharges over the whole plan, the advisor’s fees over the whole plan (and this year’s), the highest-tax year, what’s left at the end, and how much of that is still in IRAs, where it will be taxed when it comes out.
• Where each year’s money comes from: a bar for each year, split into income (Social Security, pensions, consulting), cash and taxable accounts, IRAs and Roth IRAs. Point at a bar for the amounts.
• Taxes each year: federal, California, the 3.8% tax and the Medicare surcharge.
• Roth conversions: the same plan with no conversions and with each bracket you could fill, side by side. See the next section.
• Year by year: the full table. Into SEP-IRA is Bradley’s contribution while he consults. Scroll sideways for the tax columns, the advisor’s fee and the year-end total. The fee comes straight out of the accounts it’s charged to, so it lowers what’s left rather than counting as spending. The row for Bradley’s first retired year is highlighted.

Deciding on Roth conversions

A Roth conversion moves money from a traditional IRA to a Roth IRA. You pay income tax on it that year, and from then on it grows and comes out tax-free, with no required withdrawals. The years between Bradley’s retirement and 75, before required withdrawals start, are usually the cheapest years to do it.

The table compares, for each choice, the chance of success, how much is converted, the taxes and surcharges paid over the plan, and what’s left at the end. After tax, estimated takes off the tax still owed on the IRAs left at the end, as if they were withdrawn over ten years, which is the rule for most heirs. Compare that column rather than the plain total.

What you do to turn conversions on for a scenario:

1. Open Plan settings.
2. Under Taxes, check Convert IRAs to Roth each retired year.
3. Choose the bracket in Up to the top of the federal bracket.
4. Open Cash flow & taxes again. The row marked (this scenario) is the one now in use.

Try it in a copy of the scenario first (Duplicate on the overview) so you can compare the two on Compare scenarios.

The settings behind it

All of these are under Taxes on Plan settings, and belong to the open scenario:

• Calculate federal and California tax: on for every scenario unless you turn it off. Off, the scenario takes a flat percentage of withdrawals instead, the way the planner worked before.
• Spend from: cash and taxable accounts first, then IRAs, then Roth (the usual order), or every account in proportion to its size.
• Convert IRAs to Roth each retired year and the bracket to fill.
• Dividends and interest, % a year: what the taxable and cash accounts pay out each year.

The cost basis of each taxable account (what was paid for what’s in it) decides how much of a sale is taxable gain. It’s entered on Net worth & accounts; see that page’s guide.

What isn’t counted yet

• The temporary extra deduction for those 65 and older and the higher limit on deducting state and local taxes, both in effect only through 2028.
• Itemized deductions: the planner uses the standard deduction.
• A move out of California, and single filing after one of you dies.