Modeling Taxes

Taxes are tricky :)

OnTrajectory provides a variety of mechanisms and techniques for modeling the effects of taxes over your financial life. However, it's important to always consult a professional when dealing which such complicated and technical subjects, and you should not depend solely on this tool for accurate projections of tax-handling and the effects of taxes when making long-term financial decisions.

The following topics will be covered in this Guide:

  1. Taxes on Accounts & Income
  2. Tax Types
  3. Gains Tax Rate
  4. Dividend Yield
  5. Automatically Calculate Tax Rates
  6. Non-Centralized Tax Rates

1. Taxes on Accounts & Income

Investment Tax

Your 'Default Account' contains your Effective Tax Rate and is used to tax both income and gains (unless you specify a separate Gains Rate, as discussed in the section Additional Tax Options below).

Your Effective Tax Rate is the actual amount you pay in taxes for a given year and is not truly known until you have calculated taxes/refunds for that year, although you can get a good idea of your typical Effective Tax Rate by looking at past returns.

For example, if you make $40,000 per year, and your employer withholds 25% — but you subsequently receive a $2,000 refund, here is your Effective Rate:

10,000 (withholding) minus 2,000 (refund) equals 8,000
divide that by 40,000 (salary) and your rate equals 20%

In addition, when you designate contributions that typically occur "pre-tax" (such as those to a 401K or Traditional IRA), OnTrajectory automatically excludes those contributions from taxable Income — meaning you needn't adjust your tax-rate to see the tax benefit of making those contributions.

Cost Basis — In some situations, you may want to set the "cost basis" for the Starting Balance of an account. Cost Basis is used to determine the amount of untaxed contributions in an account when it's first defined in OnTrajectory. Typically, this is only significant if you have a large account with sizable prior growth, such as a mutual fund account that's been growing for some time, and for which you have not paid taxes on the growth. This option is only available for accounts with Tax Type "Tax-Annual" and "Tax-Deferred (gains only)". For more information on Tax Types, see the section below.

Again, it is your 'Default Account' where you centrally define Tax Rates universally for any given year, as shown below:

Central Tax Rates

2. Tax Types

The tax Type dropdown contains the following options:

NOTE: Early withdrawals to Roth IRAs are taxed on 'gains-only' since contributions are made post-tax.

3. Gains Tax Rate

Gains Tax Rate

If entered, this rate is used to calculate taxes on gains when withdrawing funds from an account that is Tax-Defered (gains-only) or Tax-Deferred (contributions-only). If no value is entered, then the Effective Tax Rate is used to tax the gains.

4. Dividend Yield

Dividend Yield

If entered, this rate determines the portion of gains that are taxed annually at the Effective (Income) Tax Rate. For example, if an account’s growth rate is set at 5% and Dividend Yield is set at 2%, then 2% will be taxed each year. The remaining 3% (the remaining gains) will only be taxed when funds are pulled from the account.

If this value is left blank, ALL annual gains are taxed at the Effective (Income) Tax Rate. In other words, if there is no dividend yield set, all gains are treated as dividends (i.e. zero capital gains) and taxed at the income tax rate every year. If you wish ALL growth to be taxed as gains (upon withdrawal), select the tax type "Tax-Deferred (gains-only)."

Note: Dividend Yield is only available on accounts with the Tax Type "Tax-Annual". If no value is entered, ALL gains in the account are taxed each year.

5. Automatically Calculate Tax Rates

Automatically Calculate Tax Rates

To access the tax rate options, click the Settings gear on your default account, then click the Taxes tab. Select Automatically Calculate to have OnTrajectory estimate a hypothetical federal tax rate for future years. This estimate is based on an estimate of Total Taxable Income for each year, including:

If Total Taxable Income is greater than Expenses for the year, we subtract the standard deduction (either single or married) and determine the tax rate based on U.S. Federal Marginal Rates and any Tax Adjustment you may have defined.

If Expenses are higher, we determine if the source needed to fund those expenses is taxable — if so, we add that amount to the "Total Taxable", and proceed as described above.

NOTE: OnTrajectory is NOT Tax-Advising or Tax-Accounting software. This estimation is for informational and educational purposes only. Our calculations are based on limited information gleaned from the Income, Expense, and Account items you have entered for future years. Your actual situation may be significantly different based on your unique tax situation.

HELPFUL HINT: Always compare OnTrajectory's simulated results (from the Output Data window) to YOUR ACTUAL TAX RETURNS to ensure estimates are in the proper range.

Tax Adjustment Options Tax Adjustment Options

If the caluculations are significantly higher lower than your actual effective rate, use the "adjustment" fields (discussed below in Additional Options) to correct the difference.

Adjusting the Automatic Tax Calculation

Further configuration of your tax-treatment is available from the Additional Options section as shown below:

Tax Adjustment Options

Income and Gains Tax Adjustments — These can be either positive or negative values and are applied to your Automatically Calculated Rate(s). Most often, this is used to represent additional State or Local taxes OR to lessen your tax burden as a result of itemizing your taxes. Again, everyone's taxes are unique and OnTrajectory is not able to provide tax planning advice.

5. Non-Centralized Tax Rates

Centralized versus Non-Centralized Tax Rates — By default, OnTrajectory maintains "centralized tax rates" meaning; any given year, the same tax-rates are applied to every Income and Account item. Should you wish to set different rates for different items, you may do so from Menu / Calculation Options / Tax Settings (although this is NOT typically used).

NOTE: If Non-Centralized Tax Rates is selected you will have to separately set taxes for EVERY income and account item, otherwise no taxes will be taken on those items.