Lesson 3 of 4, 4 minutes
Tax: to spend 100 you take out more
Tax sits between your corpus and your spending, and it raises the FIRE number.
You need ₹80,000 a month to live. Your corpus can pay it. Between the corpus and your bank account stands the tax office, and it takes its share of what comes out. So what leaves the corpus each month has to be more than ₹80,000.
How much more
Say 20% of what you take out goes to tax. The common mistake is to add 20% to the spend and take out ₹96,000. After tax of 20%, that leaves ₹76,800, which is short.
The tax is charged on the larger amount, so you have to divide. To keep 100 after a tax of 20%, take out 100 divided by 0.8, which is 125.
| No tax | take out ₹80,000 |
|---|---|
| Tax of 10% | take out ₹88,889 |
| Tax of 20% | take out ₹1.00 L |
| Tax of 30% | take out ₹1.14 L |
What it does to the FIRE number
Every month of retirement costs more, so the corpus has to be larger by about the same share. The legacy and the emergency reserve are not withdrawals, so tax doesn't raise them.
| No tax | ₹5.03 Cr |
|---|---|
| Tax of 10% | ₹5.46 Cr |
| Tax of 20% | ₹5.97 Cr |
| Tax of 30% | ₹6.64 Cr |
What the one rate stands for
Real tax is not one rate. It depends on the country, the kind of investment, how long you held it, how much of a withdrawal is gain and how much is your own money coming back, and what else you earned that year. The calculator knows none of this. It asks for one figure: of everything you take out over a year, what share do you expect to lose to tax?
The share depends on the rules you live under. Where tax falls only on the gain, part of every withdrawal is your own money coming back untaxed, and the share is lower than the rate on the gain. Where the whole withdrawal counts as income, the share is the rate on that income. The Realistic setting uses 10% as a placeholder until you have your own figure. A tax adviser can give you one.
What the calculator leaves out
It applies the same rate to every withdrawal, in every year, at every size. It does not tax the returns inside the corpus while you are still investing. If your investments are taxed every year on what they earn, lower the return you enter by that amount.
Do this week
- Find out how withdrawals from your main investments are taxed where you live. Look for the rate on gains held for a long time.
- Estimate your share: the tax you would pay on one year of withdrawals, divided by those withdrawals. Put it in the calculator.
- If the rate depends on how long you hold an investment, note the date each holding crosses that line.