IntroductionThis is a brief introduction to the basic concepts of running ORP.
ORP is built using the tools and techniques of Operations Research. ORP uses an industrial strength linear programming optimizer running on an Internet server.
Linear Programming - a mathematical technique for finding the maximum of a function of many variables subject to a set of constraints. To put it another way; optimization is the selecting of a small set of activities, from a very large universe of possible activities, that makes the most money without breaking the rules. ORP's optimizer computes the maximum amount of money available for spending over the entire time span of retirement.
To Use ORP
|Set your facts (Age, IRA balance, Soc. Sec. Benefits, etc.)|
|Make your choices (When to retire, start Soc. Sec., etc.)|
|Review the guidance (results).|
|Modify your choices and run again (sensitivity analysis).|
|Perform Monte Carlo risk assessment.|
- Each input form parameter has a help document associated with it. Click the parameters label (to the left) to see the parameter's help.
- Where appropriate ORP provides for separate accounts for husband and wife. The accounts appear in two columns, labeled Retiree and Spouse.
- Retiree's Current Age is required and must be filled in.
- One or more dollar amounts must be filled in, otherwise there is no plan.
- Except for Retiree's Current Age, all form entries are optional and may be left blank. ORP supplies a default value for blank fields on the form.
- Single retirees do not fill in the Spouse column.
- A married retiree with a stay-at-home spouse should still fill in Spouse's age even though all other values in the Spouse column will remain blank. Spouse's age is used to compute Social Security spousal benefits and income taxes.
- All dollar amounts are in thousands of dollars. For example $16,000 of annual Social Security benefits is entered as 16.
- A percentage is entered as an interger and fraction. For example 32.5% is entered as 32.5 and not .325.
- Ages are entered as integers.
ORP computes a cash flow schedule that maximizes retirement income. To make the model computationally feasible certain assumptions and simplifications are made. They are presented here:
- The United States Income Tax code will not change: Given Congress's predelection for tinkering with the Federal tax code, this is the most dubious assumption of them all. Our assumption is that changes to the tax rates will be to increase rates in the higher brackets and leave the lower brackets alone. Part of ORP's job is to keep you in the lower brackets. (ORP is promptly updated when the President signs new tax legislation that affects retirement issues.)
- Income tax computation: When computing both Federal and state personal income taxes ORP assumes that the standard deduction is taken and no itemization occurs. This implies that state taxes are not taken as an itemized deduction. Income taxes may be overstated under this assumption because the retiree may have mortgage interest payments and state tax payments that exceed the standard deduction.
- After-Tax Account tax rates: Computational simplification is achieved by treating the After-Tax Account separately for tax computation. (ORP computes personal income taxes for distributions from the Tax-Deferred Account using the Federal income tax tables for personal income.) We argue that most After-Tax Accounts are invested in common stocks and are taxed at the capital gains rate, computed separately from the personal income taxes that apply to tax-deferred distributions. Therefore, loss of accuracy caused by this generalization is minimal.
- Taxing Social Security Benefits: 85% of Social Security benefits are taxable as personal income if a married couples income exceeds $44,000 ($34,000 for a single person). A complex computation applies to income of lesser amounts. ORP assumes that the retiree will have a provisional income in excess of $44,000 and that 85% of Social Security benefits are taxed.
- Medicare Taxes: ORP does not account for post retirement Medicare taxes on earned income.
- Timing of events:
- Disbursments are made from all accounts at the beginning of the year.
- Returns are realized for all accounts at the end of the year.
Last Update: March 12, 2016