FMO wrote:Most SWR models assume that no taxation occurs until funds are withdrawn to fund living expenses. Consider further that the average dividend payout of the S&P 500 exceeds the rates of safe withdrawal commonly calculated for prospective early retirees. Consider further that few people hold 100% of their retirement portfolio in tax-deferred vehicles. This tells me that the SWR models fail to address the effects of taxation on the compounding of retirement funds. There have been many years when the dividend rate of the S&P 500 has exceeded 7%. Even if 4% is withdrawn from the portfolio, 3% of the dividends cannot avoid taxation, yet are assumed to compound tax-free for long periods. Few people want to talk about this and while I can't quantify the impact, the impact is real and will reduce SWRs. Perhaps the issue is too difficult to address. Does that mean it should be ignored?
I agree entirely with your statements, especially the one I emphasized in bold. My answer to your question is No, plans for retirement should not ignore taxation, even if SWR studies do not (yet?) include this issue. I have raised taxation as a factor in retirement planning in at least one recent post at NFB. It's an issue I am happy to talk about, not that I look forward to paying the taxes.
There are some ameliorating circumstances, however, in the taxation of dividends and realized capital gains. While few people have all the retirement stash in tax-deferred accounts, many of us have a significant part of our assets there. In my case, it is almost half. Further, with the new tax law, (most) dividends paid in taxable accounts are taxed at a maximum of 15%. (Under present law, the federal tax rate on dividends is zero for one year only, 2008 as I recall. As a citizen of Nevada, I happily ignore the state income tax problem, but other people may need to consider it. The tax-happy state of California, from which I only recently escaped, treats capital gains distributions from mutual funds as ordinary income, and therefore subject to a maximum tax rate of 9.3%.) Dividend and realized capital gains taxes are still a significant burden when compounded over years, as you said, but not so bad as formerly. Finally, the current dividend on the S&P 500 is only a little over 1%, so the problem of dividend taxation may not be urgent at the moment. Still, long range planning for taxation is important to me, difficult as it is. We cannot predict what the changes in tax law and regulations will be, just as we are not sure what inflation and stock market returns will be.
The problem that concerns me more than dividend taxation just now is this: I can see a doubling or tripling of my real income tax payments starting in about six years when I have to start making withdrawals from my IRA. Further, my analysis says that, for my purposes, I cannot reduce that tax problem by taking some optional IRA withdrawals before age 70 and a half when withdrawals become mandatory. That influences my assessment of a SWR since I don't plan on letting that predictable tax increase reduce my after-tax inflation-corrected standard of living in retirement.