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Calculation Of Net Worth

Bozo
  |     |   1,375 posts since 2011

For the economic gurus out there in DA land, I have a question regarding calculation of net worth, specifically as regards to IRAs and 401Ks.

Background: As we all know, popularly-available net worth calculators always require you to subtract "debt" from "assets" to calculate net worth.

Query: Is a prospective tax liability on a tax-deferred account correctly noted as a "debt" when calculating net worth?

Analysis: The handy-dandy net worth calculator I use (at Alliant Credit Union's website) does not automatically characterize future tax liabilities as "debt". Indeed, after-tax assets and tax-deferred assets are all lumped together.

Problem: As any retiree will be quick to note, an after-tax asset is worth more, dollar-for-dollar, than a tax-deferred asset. Reason being: taxes (duh). Tax-deferred assets get nailed with ordinary income taxes (state and federal) on withdrawal. After-tax assets are subject only to capital gains tax. Ignore California for the moment.

What's the Point?: Quite simple. A dollar in a tax-deferred account (whether IRA or 401K) is, by definition, worth less when calculating "net worth" than a dollar in an after-tax account. Think of a future tax liability as a "debt".

Example: Joe and Jane have $1,000,000 in their combined IRA/401K accounts. They have little else to speak of in terms of assets. What is their net worth? See the issue?

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Answers
Kaight
  |     |   1,192 posts since 2011
First of all, Bozo, fair warning I ain't no guru, economic or otherwise. So I probably should leave this issue for them. But, for the sake of discussion, I won't.

Seems to me, if you wish right now to factor known future obligations, you must first express their dollar amounts in current dollars. Thus, for example, a known debt of $100 you must pay ten years from today does not deduct $100 from your present net worth. There is a word, a term, for this. But I'm having a senior moment and I cannot think of the term.

OK, maybe I'm thinking of what they call "present value" calculations. It has been a really long time since I've done any of that so I'm not really certain.  More than thirty years ago I actually wrote computer programs to calculate stuff like this.  It was when I was trying to determine whether or not my retirement would work out.  I don't think I have the juice any longer to be able to construct those sorts of programs.  Fortunately there is no longer a need.  
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alan1
  |     |   877 posts since 2015
Accountants treat deferred tax obligations as long-term liabilities. I do not know how they determine the value of those obligations, which I would think involve calculations of present values and of tax rates.

And there are other issues your example raises that may (or may not) affect computation of net worth. Take two other people in the same situation as Joe and Jane (including age, health, etc.). But the other two people have substantially higher Social Security and defined pension benefits. Do you calculate the present value of those benefits in determining net worth? I don't now the accounting answer, but as you wrote: "See the issue?"
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RJM
  |     |   499 posts since 2011
I have the same issue. I do not discount for future taxes for my IRA even though I know I will eventually owe them. And I have sizable gains in my IRA from 25+ years of overall good investing results.

My thinking is the ultimate tax bill will be relatively low because my income will be relatively low when Im forced to take distributions. If Im still alive then that is. And if not, its not my problem. (No wife, no kids)
But, its still a significant liability and one I do not include when calculating my net worth.

I guess I could estimate the taxes that will be owed and discount it based on the years until it will be owed.
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