How can I compare 'How much can I spend?' to 'How can I spend $X net of tax?' plans?

Two 'Primary Plan Questions' and How They Differ

There are two different 'Primary Questions' you can ask when creating an Income Lab plan:

1. How much can I spend?
2. How can I spend $X, net of tax?

For the first question, the software looks at all of the resources available to the household for funding income, pairs those resources with goals like plan length, other/variable expenses (specific, important spending goals), income path (e.g., the age-based/'retirement smile' path or a flat, inflation-adjusted path), and portfolio legacy goal, and finds a gross-of-tax spending level that fits the targeted levels of overspending/underspending risk.

For the second question, the software 'grosses up' the targeted net-of-tax spending level to account for estimated taxes and finds the level of overspending/underspending risk that the household would have to take in order to achieve the targeted net-of-tax spending level.

Both of these 'primary questions' are useful in financial planning. The first question is especially useful in finding a range of income levels that could be 'affordable' for a household. In other words, in a world where we should all spend 'within our means', this first primary question helps us find 'our means' at times of life when it's not always so clear how much we can safely spend. The second question is great for honing the plan once the household's spending range is known. If you are targeting a reasonable net-of-tax spending level, this second question will produce a plan that accounts for lumpiness in taxes, such as when a plan includes Roth conversions or lumpy income sources (e.g., the sale of a business or other large income in certain year(s), or lumpy expenses such as a large outlay that will require large taxable withdrawals in a certain year).

Comparing Plans that have Different Primary Questions

Since a plan can have one of two primary questions, it may be tempting to compare two plans that differ 'only' on this dimension. For example, someone might create a plan asking 'How much can I spend?' and find that a household's resources can reasonably produce $15,500/month, which is estimated to net $12,400/month after taxes. If you create a 'How can I spend $12,400 net of tax?' plan, it will initially produce $15,500/month in gross-of-tax income, as long as both plans have the same tax distribution plan (e.g., taxable, tax-deferred, tax-free; or the same Roth conversion strategy). However, though these plans begin with the same gross-of-tax spending level, they don't necessarily continue that way for the whole plan. That's because the 'How much can I spend?' plan will target a gross-of-tax income level, and the 'How can I spend $12,400, net of tax?' plan will gross up that target net-of-tax income in each year.

The specifics of how these plans differ will depend on the make-up of the plan's income, mix of account types (taxable, IRA, etc.), and ordering of withdrawals. You can see the differences between these plans in the Cash Flows > Income Sourcing graph, in Life Hub, and in the Retirement Stress Test's comparison view. The Retirement Stress Test's comparison view can be particularly helpful because it allows you to see two plans at once, in one graph. (The Income Sourcing graph and Life Hub show only one plan at a time.)

Sometimes the differences between plans can be fairly small, as in this example of a single 65-year-old male with a $3 million IRA, $3,000 in Social Security, and a $1,000/month pension, following an age-based income path (the 'retirement smile') and not doing Roth conversions.

If, on the other hand, this plan contains Roth conversions (to the 24% bracket), the two plans differ by much more. In the example below, the Roth conversions drop off later in the plan, leading to much lower gross-of-tax income needs.

Comparing 'Test Plan' Results

The differences in the examples above are meaningful, but some 'How much can I spend?'/'How can I spend $X, net of tax?' plan pairs can have much larger differences. This means that comparing 'Test Plan' results between a plan that's asking 'How much can I spend?' and one asking 'How can I spend $X, net of tax?' can be very difficult. This isn't really an "apples-to-apples" comparison because the gross-of-tax income in the two plans can be radically different.

If you are attempting such a 'Test Plan' comparison, it is a good idea to first look at how these plans differ in their gross of tax targeted income. Even if plans look the same early on, they may be very different later in the plan. For example, Roth conversions may lead to a drop in gross-of-tax income (and therefore portfolio withdrawals and taxes) later in the plan. Or a low targeted spending level may lead to higher RMDs (and therefore higher taxes) later in a plan. These sorts of differences can make comparing 'Test Plan' results less useful than we might have otherwise expected.