As discussed in our post of February 21, 2025, pre-eminent retirement researcher Dr. Wade Pfau has become an actuarial approach convert. You can hear Dr. Pfau and Alex Murguia discuss why they prefer using the Funded Ratio [Status] to Monte Carlo modeling for retirement planning in Episode 168 of their podcast series.
In his podcast, Dr. Pfau also refers to the potential issue associated with calculating the present value of future household taxes, which is an essential expense liability on the household balance sheet and therefore affects the Funded Status calculation. In this post, we will spend a few moments discussing this liability and how you can address it in the Actuarial Financial Planner.
As noted by Dr. Pfau, whenever a household receives additional taxable income, it’s tax liability may increase. So, for example, if you or your spouse decide to:
- Return to work,
- Start collecting a pension,
- Start collecting your Social Security benefits,
- Start taking distributions from taxable accounts (voluntarily or because of Required Minimum Distribution requirements),
- Sell certain assets,
The
new taxable income will generally increase your federal and/or state
tax liability in the U.S. Additionally, it is also possible (although it
seems unlikely to occur in the near term in the U.S.) that current tax
rates may be increased. To reflect expected increased tax liability in
your Funded Status calculations, you will need to estimate the amount
and timing of the additional tax requirements. This can be done by using
a higher rate of expected increase on current tax expenses or by
treating the future increases as non-recurring expenses. To estimate the
future increase (or increases), you can estimate how the specific
income increase would affect your current taxes and have the AFP
calculate the present value of such increases assuming a future starting
date (or dates). For additional guidance on how to calculate present
values of non-recurring expenses (including non-recurring expenses
expected to commence in the future), see Q1 of our FAQ post of February
8, 2025.
