Lifetime Planner IDEA: Add a Comprehensive Tax Model in LTP as a User-Selected Option

Scooterlam
Scooterlam SuperUser, Windows Beta Beta
Lifetime Planner IDEA: Add a Comprehensive Tax Model in LTP as a User-Selected Option

Implement a user-selectable OPTION, in Lifetime Planner, to calculate federal and state tax expenses based on a comprehensive tax model (high fidelity tax model) similar to that used in Quicken's Tax Planner.  Incorporate a simplified state tax model as part of this enhansement.   The user should still retain the option of using the current average tax assumption v. new comprehensive model.


Please  consider voting for this IDEA.  Add your comments and thoughts as well.


THE ISSUE:

Currently, Lifetime Planner uses an average tax rate assumption, set by the user, to calculate tax expenses for salary, benefits, other income(s) and investment income (RMDs, dividends, interest, LT/ST capital gains et al).   This average tax rate assumption can be estimated and entered in LTP for both before and after retirement time horizons. Image 1.


The challenge...estimating the anticipated average tax rate in the years leading up to retirement and the years after retirement.   Time frames, during these accumulation and decumulation phases, can each range up to 30+ years, in the case of younger planners.  Even a current retiree may have up to 20-30 years of "runway".  Of course income changes and events that are planned in LTP, tax-deferred v taxable account balances, tax law changes, along with the progressive tax structure contribute to the challenge of using an average tax rate assumption.


As a result, the current tax rate estimate method may produce considerable, forecasted "in-plan" cash flow and "end of plan" balance differences, either to the high side or low side.   For less experienced planners, these plan differences could be substantial, giving a false sense of security or insecurity.  


To illustrate the challenge any user has in estimating average tax rate in LTP, image 2 and 3 shows what a fairly simple, real-world tax-forecast looks like - both average and marginal rate views.   Compare in image 2,  average tax rate assumption currently used in LTP v. a comprehensive tax model.


Keep in mind that the user will likely NOT HAVE the benefit of this sort of tax illustration before them when deciding on their own setting for LTP average tax rate!


When faced with this question of how to set average tax rate,  the user may base it off their today's total income and taxes paid, or not.   Perhaps they will mistake marginal rates for average rates?    Perhaps they will have knowledge of the RMD "tax torpedo" impact at age 72, given their large (or small) forecasted, tax deferred (IRA, 401K) balance subject to ordinary income tax?  Perhaps they adjust their post-retirement average tax rated downward, because that is what the experts say?   Or in the end....perhaps their plan is very simple and an average tax rate suffices. It goes on....


THE BENEFIT:

Given an option to select a more refined tax model;  there is less chance of user-error when deciding on an average tax rate assumption and may bolster user confidence in plan results by producing a more refined overall plan and "What-if" scenarios, for better decision making.  A more quantitative, financial illustration showing the two methods is WIP.... :)


Looking to the future, given LTP's existing rich planning model,
  implementing a comprehensive tax model enhances more advanced features,  increases the tool's potential for existing / potential Quicken users and possibly a good start for entry into the professional planning space.... :o  Some examples....


THE CHANGE:

1.   Implement a user-selectable OPTION, in Lifetime Planner, to calculate federal and state tax expenses based on a new comprehensive tax model (high fidelity tax model) similar to that used in Quicken's Tax Planner  Image 4.  


2.   Leverage LTP user inputs, to the extent possible,  found in the assumptions menu.   Implement new LTP user inputs, if necessary, to "improve"  new tax calculation.     
Image 5.


3.  Leverage Tax Planner features, to the extent possible, to avoid inconsistencies, confusion,  duplication of efforts either by the user (input and results) or by developers (future dev and maintenance).   Consider a "simplified" tax planner model than that found in Tax Planner.    Avoid, making this new LTP tax feature dependent upon use of Tax Planner - but be smart in leveraging user data between the two, when using both features.


4.  Distinguish and apply ordinary income, investment and LT capital gains rates based upon current and future years forecasted taxable income.  Use appropriate indexing methods for future marginal tax rates et al.


5.  Include a method and calculation for state taxes.  Leverage use of any state tax calculations currently implemented in the Average Tax Rate Dialog estimation model.  Or, buy/license/build new functionality to achieve this.
  

6.  Ensure tax calculation provisions are made for state to state moves when selling / buying homes in the plan.


7.   Provide graphs and tables illustrating yearly tax expense in $, average tax %, and tax bracket % over the plan's time horizon.   Breakout Fed / state tax expenses in plan result tables.  User should be able to view / switch between today's v. future $ in graphs and tables. 


8.  Maintain comprehensive tax model per changes in tax law and ensure consistency with Tax Planner changes.


9.  Update Help content to include illustration / description as to:  inputs and input considerations or context, model assumptions/limitations and output and output interpretations.


A last thought.....alternatively, Quicken could take the current feature (image 1) and expand it beyond 2 time frames (pre/post retirement) to many more, user-defined time frames (like Expense Adjustments).  But, I am not so sure this improves plan results as it just introduces more user variables (year and associated rates) and errors.   This idea takes the timeframe and average tax rate assumption out of the users hands and the calculation then performed in each year in the plan.

Lots of moving parts but many higher fidelity consumer and all professional planners (that I have used or reviewed) employ a comprehensive tax model.   So should LTP.  My take. 

I've shared this reference in a past idea... an interesting study on tax-efficient withdrawal planning using a comprehensive tax model.   A bit of a read, but gives you a sense of this idea's utility to chart your best path for this one particular use case.  


Please Consider Voting for this IDEA.  Lots of tax savvy folks here....add your comments and thoughts as well!


IMAGE 1  -  Current Average Tax Rate Input




IMAGE 2  -  Average (Effective) Tax Rate Forecast of a Real-world Retirement Plan using a Comprehensive Tax Model (Quicken's average tax rate assumption overlaid for comparison)



IMAGE 3  -  Federal Tax Bracket Forecast of a Real-world Retirement Plan using a Comprehensive Tax Model



IMAGE 4  -  Leverage Current Tax Planner Basic Structure for Use in Lifetime Planner





IMAGE 5 - Leverage Current LTP Assumptions on Incomes, Mapped to a Comprehensive Tax Model





IMAGE 6  -   Use Tax Planner, Tax Tables and Indexing Assumptions For Future Tax Forecasting




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