We established this page to keep everyone
informed of the discussions we are having with the user community.
If you have something to add, please
email us.
Last update 02/01/2008
Savings Projection
How about having ORP calculate how much to save given a desired annual spending of $X?
First run a base case as the situation is now. If the amount available for spending
is too low then increase the annual after-tax savings and run again.
The amount of savings required to meet a spending goal will soon be homed in on.
The answer to this question is that the objective can be achieved by
making a succession of ORP runs.
Estate Change
I changed the amount of my estate but it didn't make any difference in amount available for spending.
ORP does its computations in thousand of dollars. A relatively small change in your
estate spread across a long retirement will get lost in the noise.
Roth IRA Rollover
Would it be beneficial for me to rollover my IRA into a Roth IRA?
This is a question that can address by making two ORP runs.
- The base case is an ORP run as the situation is now, with your assets in an IRA. Your base case grows your IRA without paying taxes and taxes are paid at the time of withdrawal. Note that part of each annual withdrawal is at your marginal tax rate with the remaining withdrawal taxed at lower rates. This is a property of the graduated income tax.
- The second run simulates the situation after the roll over has been accomplished. Your IRA balance is set to zero. The new Roth IRA balance is set to your former IRA balance multiplied by one minus your marginal tax rate, yielding a substantially smaller number. In this case most or all of your IRA withdrawal is taxed at your marginal tax rate.
Comparing the results of the two runs will offer some insight into the issue.
IRS Form 590 (www.irs.gov) defines who is qualified to make such a roll over.
ORP Withdrawal Plan
ORP shows withdrawals from my tax-deferred accounts beginning at age 52 (early retirement) but professional advice I have received recommends first withdrawing from taxable accounts, and then later in retirement spending from tax-deferred. Why does ORP begin drawing down the tax-deferred accounts so early?
This is what separates ORP from retirement calculators!
Retirement plans with relatively large tax-deferred and after-tax accounts will show simultaneous distributions from both accounts from the start of retirement. ORP's optimizer maximizes the money available for spending throughout retirement by minimizing personal income taxes paid, among other things.
Conventional wisdom wants to keep the money in the tax-deferred account for a long as possible, for the sake of tax-deferred compounding while distributing after-tax money which is paying annual taxes on its returns. For plans with small to mid sized account balances the conventional wisdom is correct and that is the way will ORP do it.
However, for plans with larger account balances the situation changes. Later in the plan larger tax-deferred distributions are made at the highest income tax rates. By making some of these distributions right from the get-go a portion of them are taxed in lower income tax brackets. This assertion is backed up with solid academic research; see Horan or Spitzer and Singh
Balancing the desire to hang on to the tax-deferred money for as long as possible against distributions in lower personal income tax brackets is what linear optimization is all about.
Trouble With Browsers
Why does the ORP form screen not restore my parameters from a previous session?
Users are reporting problems with restoring the form page parameters and with ORP's management of solution windows.
Both problems are attributed to new security features showing up in the newer browsers, especially Internet Explorer.
The saving and restoring of the input parameters is done with the use of a cookie on the client computer. If the client's browser is restricting cookie storage then this feature won't work. Restrictions on cookies appear in the Privacy area of Tool/Internet Options or something similar.
An active popup blocker is responsible for the partial failure of ORP solution screens. The idea is for ORP to put the solution results for each run in a small window and leave them up so that run results can be compared .to each other. When the browser's popup blocker is on it cancels these attempts. The symptoms are that the latest solution appears, full screen, in the window that formerly held the parameters. The popup blocker will also disable some of the options available from the solution report.
Browser upgrades sometimes cause the security parameters to be restored to their default values, thereby disabling these two features.
Variable Annuities
Why does the ORP model not include variable annuities?
The tax consequences are that capital gains and dividend tax rates are
lower than personal income tax rates, which is the tax rate on the withdrawal of
investment returns of the variable annuity.
Insurance company charges are a significant drawback to variable annuities.
Most ORP users are sophisticated and manage their own retirement plans.
Many people use ORP to plan their withdrawals in such a
manner as to simulate an annuity without the charges.
Thus up to this point there has been no demand to add the complexity of variable annuities to the model.
The SEC provides a readable description of
variable annuities.
A variability annuity is an after-tax investment providing tax-deferred returns.
Insurance companies are custodians for and promote variable annuities.
Quicken
What are the differences between ORP and Quicken?
Some of the fundamental differences between ORP and Quicken are:
To illustrate comparison runs were made between the two systems. A typical ORP run was made that maximized the money available for spending with a fixed estate.
Only the parameters shared between ORP and Quicken were set. The resulting after-tax, retirement income was $142,000. Then both Quicken and ORP were run with spending fixed at $140,000 with the objective to compute the estate at the end of the plan.
There are substantive differences between the two sets of results:
In theory these results should have been identical. However, there are some considerations that makes it difficult to compare ORP's output to Quicken's:
ORP's numbers are more credible because, as noted above, ORP's model is more detailed and
has more flexible in computing its answers. In particular, ORP made some moves to increase the size of the estate.
ORP moved money from the Tax-deferred Account to the After-tax Account during the final years of the plan,
to reduce income taxes on withdrawals. ORP computes a marginal tax rate of 15% during the early years of the plan,
28% during the mid years, and 31% during the final years. This contrasts to Quicken's 21% assumed for the life
of the plan.
The Quicken Retirement Planner is available on the
Quicken web site. There is no charge for the basic planner.
AOL Access Problems
How come ORP doesn't always work from AOL?
AOL uses a custom browser, and this creates problems for AOL users trying to surf
outside the AOL world. If you are having difficulties running ORP via AOL, try
the full version of Netscape Navigator or Internet Explorer. You can download both
these browsers for free (see below), and both will work with AOL.
Simply log on to AOL as usual, but instead of using the AOL browser, launch the standard browser.
To do this, minimize AOL and look for the "e" icon on your desktop and double click
to launch the browser. If you do not see an icon on the desktop, go to the "Start" menu
located in the lower left-hand corner of your screen, choose "Programs" and
look for Internet Explorer or Netscape Navigator. Launch the browser and go to
http://www.i-orp.com and proceed as normal.
Internet Explorer is available at
Use of Average Returns
A March 5, 2000 St. Petersburg Times article shows an example of a successful retirement plan calculation that uses average asset returns and inflation rates. But alternate calculations using randomly generated returns, etc. shows the money running out early. Does ORP have the same problem?
This is fundamental question for all retirement planning. The shortfalls in the article occurred when the stock market plunged at the beginning of retirement while the retiree was withdrawing at a constant rate. The withdrawal of funds on top of the lower prices of the retiree's stock meant that was no catching up after the first year.
The unspecified assumption of this result is that the retiree's account is unmanaged. If the account is managed, then a couple of years prior to retirement, the retiree moves 2 years of budgeted withdrawals to a money market or short term bond fund. Thereafter, when the market falls significantly, withdrawals are made from the cash account. When the market goes up, the cash account is replenished and withdrawals are made from the stock part of the portfolio. The effect of this strategy is that the rate of return on the overall portfolio is reduced after retirement, but the portfolio will perform over time as predicted by the model and the retiree is protected from running out of money too early.
The second part of the strategy is for the retiree to keep her fixed costs (mortgage, auto expenses, etc.) low. Then during good times in the market money can be withdrawn for discretionary spending (cruises, home remodeling, etc.).
The key is to run ORP annually with updated asset balances and economic environment estimates to keep withdrawals in line with the model's results and to shift money between accounts as needed.
For a very good discussion of actively managing your retirement savings after retirement see Part III of Dow 100,000 Fact or Fiction, by Charles W. Kadlec, New York Institute of Finance, 1999.
Spouse Retirement Age
Why is there no Spouse retirement age?
Retirement Age applies to the couple as a single entity.
Retirement age is the age at which tax-deferred contributions and
after-tax savings stop and distributions can begin -- for both husband and wife.
The spouse has separate ages for Social Security benefits, pension income, and
earned income since the spouse is treated separately by the sources of
these income streams.
Why Retirement Calculators?
Why do you need software of any kind to figure out his (or her) retirement? Why not just divide your savings at retirement by the number of years you expect to live to determine annual retirement income?
If you put your retirement funds
under your mattress and do annual withdrawals then your informal
model is entirely accurate. However, if you invest your retirement
funds then your investment returns will give you more money to
spend in retirement. But now you have to deal with taxes, rates
of return, IRS regulations, to say nothing of the consequences
of inflation. If you desire to maximize the amount
of money available during retirement then the model becomes
iterative making the use of computer software mandatory.
After-tax Account tax rate
When I change the After-Tax Account anticipated tax rate there seems to be no effect on the results.
The Anticipated Tax Rate %
applies only to the After-tax Account. It does not apply to the
Tax-deferred Account, social security benefits, or pensions.
These are taxed at the graduated personal income taxes and their
tax rates are computed by ORP. Unless you have a large After-tax
Account the After-tax Account anticipated tax rate would have
little or no effect on ORP's results.
Withdrawal Schedule
Why does ORP begin withdrawals from both the Tax-deferred and the After-tax Accounts until the After-Tax Account is depleted rather than solely from the After-Tax Account until it is depleted?
Taxes! When larger Tax-deferred
withdrawals tend to kick you up to a higher tax bracket, ORP tries
to dampen out the damage by doing parallel distributions from
both accounts. It's a subtle point, but important.
Early Tax-deferred Account withdrawals
Isn't there a tax penalty for early withdrawals from the Tax-deferred Account?
ORP does not fix the amount
of early withdrawals, but allows it to rise with inflation. This
is a model simplification that will contribute an inaccuracy
to the model's results.Once you establish and start
an early withdrawal plan before the age of 59 1/2 you must withdraw
the same amount (no more, no less) for 5 years. However, the way
to add some flexibility to this is to establish multiple IRA's
as the calculation is only applicable on an IRA-by-IRA basis.
Determining How Much to Save
How do I determine how much I need to save to have comfortable retirement?
ORP is a different breed of
calculator. ORP accepts what you have saved and what you feel
you can add to your savings and then projects what you have to
live on in retirement.
ORP can answer this question
through multiple runs. First you should, as all financial advisors
recommend, be contributing the maximum to your Tax-deferred Account,
so this is a fixed parameter. Your account balances as of today
are also fixed. After-tax Account contribution is the one variable
that you have to play with. Make multiple ORP runs with various
setting of After-tax Account contributions until you arrive at a retirement
income that you are comfortable with.Visit a web site with a more
conventional retirement planning calculator, such as
Vanguard
or Fidelity.
These calculators ask you how much money to want to retire on;
they then compute when your assets will be exhausted and tell
you how much you have to save (in their mutual funds) to meet
your retirement needs.
Other Income
How do I treat other sources of income, such as rental income?
Other income, such as rents
or royalties, may be included as part of pension income.
Inheritance Of a Tax-Deferred Account
Have you taken
into account the income tax hit that beneficiaries take upon
the death of the owner of the account? I understand that this,
combined with estate taxes, can approach 93 percent.
The ORP model reflects the
income taxes due on the Tax-Deferred Account distribution at
the termination of the plan. The model does not reflect early terminations,
except as may be shown by running alternative scenarios.
Personal income tax will have
to be paid on distributions at time of death, probably at the
maximum incremental rate for a large plan. The estate tax has
to be paid which increments to past 50%. All in all financial
planners anticipate that the beneficiaries will get about 23%
of the Tax-Deferred Account if your plan terminates early.
If your plan terminates on
schedule then the estate tax will be zero providing your estate is
$1,000,000 or less. But your heirs don't get much anyway because you spent
it all.
Not modeled by ORP but still important is the fact that
bequests from an IRA to a charity are subject to neither income
nor estate taxes.
Lump-Sum distribution with 10-year forward averaging
I am eligible for 10-year forward averaging on part of my retirement savings, and I am considering doing the 10-year thing as a guard against my beneficiary having to pay a huge income tax bill if one of the HORRIBLE drivers on the Utah roads gets me any time soon. Does your program handle this, and if so, how?
Since few people qualify for 10 year forward averaging of a lump-sum distribution it is not formally included in the ORP model.An immediate lump sum distribution moves the Tax-deferred Account balance to the After-tax Account, after taxes have been paid. This will be reflected in ORP's initial account balances. 10 year forward averaging spreads the personal income taxes of the lump, which is reflected in ORP's tax rate.
The after-tax returns on the after-tax lump are inferior to tax-deferred returns (see Appendix A of the ORP paper) and hence the lump sum distribution is sub optimal. This can be shown by comparing an ORP run with a lump-sum distribution against an ORP run in which the Tax-Deferred Account is drawn down normally.
All of this ignores the issue of estate planning; but that is not ORP's function. ORP is intended to devise a plan for minimizing estate taxes through well planned spending that leaves a minimal estate.
Production Version of ORP
I noted that you have a production model of this program and was consequently interested in the possibility of its commercial use in my business.
We are in touch with one broker
and retirement counselor who uses ORP to persuade her clients
to invest in her tax-deferred accounts.
The philosophical purpose
of ORP is to put into perspective the deluge of articles appearing
in the popular press that are both alarmist and fluff. The practical
purpose of ORP is to assist in long term financial planning.
ORP is a useful financial planning tool,
but it might require the assistance of a professional financial advisor.
Many clients are not versed in the subtleties of the tax issues of
tax-deferred savings and need help in interpreting the ORP results.
Some don't comprehend the wonder of compounding that makes it
to their advantage to exploit the tax-deferred saving opportunities
available to them.The professional version is
in the development phase. It will include graphics presentations,
cross case comparisons, and formulation refinements.
Could you provide some graphs of the output?
We are working on it for the
production version of the program.
Privacy
I am concerned regarding the security of putting personal information of a Web-based tool such as ORP.
Privacy is an issue, for sure.
That is why we do not ask users for any identification and use
a randomly generated id for internal operations. You may note
that each run has a separate id, so there is no memory from run
to run. We purposely have no way of associating run data with
individual users.
Availability of ORP
Is there a version of ORP that can be downloaded to my computer?
We are not at this time set
up to download the software. Its size, at 20 megs, is a problem.
Much of the software that powers ORP is commercial and the
license fees would be prohibitive to the average user. Finally,
by having a single ORP on a web site you are assured of running
latest version with the latest modifications to the tax code.
Inconsistent Parameters
What does it mean when ORP reports that my estate requirement exceeds my accumulation of funds?
This message usually indicates
an error in your input parameters.This error is issued by ORP
if the initial account balances, plus compounding over the designated
time frame is insufficient to fund the estate requirement or
if are insufficient funds to withdraw $1,000 per year over the
time frame designated.
Thousands of Dollars
Why is all of ORP's input and output in thousands of dollars instead of dollars?
There are two reasons for
using thousands of dollars instead of dollars:
- Shorter numbers are easier to read and type accurately, as long as the user mentally applies the 1,000-scale factor.
- Model computations over a 30 to 60 year time horizon have no significance at the dollar level. Thousands of dollars are sufficient. To print results in dollars implies accuracy that just isn't there.
Taxes on After-Tax Account Returns
ORP assumes that returns are
taxed in the year that they are realized, which is the case for
interest and mutual funds. That is not the case for other asset
types that are taxed at the capital gains rate when the asset
is sold. Intuitively, it would seem economically advantageous
to invest after-tax dollars in equities so that no taxes are
paid until sale.
It appears
that the After-tax Account is being burdened with tax on the
total amount earned rather than just what is withdrawn (spending
+ tax on total withdrawn). This practice would seem to assume
all the "earnings" are currently taxable (as if the
account were all interest bearing instruments); in many cases,
a significant amount might be in equities where the appreciation
wouldn't be taxed until actually withdrawn.
Deferred Capital Gains
ORP does not reflect the potential for deferring capital gains tax and the lower rate on capital gains. ORP promptly pays 'income tax' rates on investment returns in the After-Tax Account.
On the other hand, assets
in a tax-deferred account can be managed without regard to taxes,
giving the investor the latitude to be more aggressive.A pure after-tax capital gains
account, meaning that assets appreciate without tax liability
until sale, seems hard to achieve with equities. Mutual funds
pay dividends and capital gains annually, while enjoying appreciation
that is realized only when they are sold. A stock account is
unlikely to pass from pre retirement to death without ever paying
a dividend or selling an asset. To have the model tax only
withdrawals means that compounding has taken place on untaxed
assets on which taxes should have been paid.
Non Liquid Assets
I have a home that is a significant portion of my After-tax Account balance. The optimizer may liquidate that asset and that is not realistic.
ORP is intended for the management
of liquid assets, cash, stocks, bonds, CDs, etc. Fixed assets,
such as your home, are not necessarily disposed of just to get
cash and their appreciation (or depreciation) rate will probably
be different from liquid assets. For the last few years the stock
market has done well while real estate values have been flat
to down. In the 1970's the situation was reversed. Assets that
you don't want to dispose of for reasons other than cash flow
should be omitted from the model. Remove their value from the
current After-tax Account and reduce your estate by their future,
appreciated, after-tax, value. If you have significant fixed
assets, just set your estate value to zero, and assume that they
can be liquidated at the end of the retirement term, as part to
processing the estate.
I own some commercial real estate. How should I include it in the ORP model?
One approach is to reduce
your estate by the value of the asset that will free up other,
liquid assets for spending. The revenues from the asset may be
included as inflated, pension income.
Another idea is to pick an
age to sell the non-liquid asset and run ORP from that point with
value of the asset added to the After-tax Account.Commercial real estate presents
two problems for the current version or ORP:
|
|
 |