New to E-R: Need help with RMD and 15% tax bracket calcuations

[Happily Retired]

A financial planner versed (she says) in Drawdown Strategies suggested that my DW and I consider seriously converting a good portion of our taxable IRAs to roth IRAs. I understand the WHY, but think I may be okay NOT doing this. I need some help though.

Fastforwarding to RMD time at 70 1/2 Here's the math. We trying to stay in the 15% tax bracket. The spreadsheet show $417k of taxable IRA then.

$13,110 non-COLA pension for the both of us
+ $58,228 Social security for the both of us
+ $15,427 RMD year 1 ( $417k * 3.7% = $15,427)
------------
$86,765

$86,843 I'm projecting the 15% tax bracket top to be this for 2026

PROBLEM: We're WITHIN the 15% tax bracket, but barely.


QUESTION: Since only 85% of our Soc Sec is taxable, MAYBE we have much more cushion. CORRECT? Current cushion = $78.

$13,110 non-COLA pension for the both of us
+ $49,493 Soc Sec both (85% of $58,228 = $49,493)
+ $15,427 RMD year 1 ( $417k * 3.7% = $15,427)
------------
$78,030

$86,843 I'm projecting the 15% tax bracket top to be this for 2026

We now have $8,813 of cushion, using 85% of Soc Sec.

Thanks for your input.

Gary

[kaneohe]

try inputting here https://turbotax.intuit.com/tax-tool...ors/taxcaster/

you may be surprised....pleasantly.
1) don't forget deductions/exemptions may remove some 20K from AGI to get taxable income
2) UP TO 85% of SS may be taxed but it could be less.........in your case, much less.....so your cushion may be much much greater
like 50-60K?

[samclem]

Things to consider:

1) Unless you are just a few months from being 70.5 YO, that $417K balance in your IRAs is a squishy number. Assuming it's invested at least partially in stocks and bonds, it could do better or worse than that. If it does better, your RMDs will be higher and this will reduce any cushion. A good problem to have, but . .

2) Getting lower into the 15% bracket might give you flexibility if you need it. For example, if you need a chunk of change for an expense sometime, you'd probably want to sell some appreciated assets in your after tax accounts. You only get the 0% CG tax rate until the amount reaches the top of the 15% bracket, after that you'll pay 10%.

3) It may be worth crunching the numbers for a situation where you or your wife passes away. The tax brackets go way down for a single filer, and the standard deduction is also cut. It's a very big difference, many people are surprised by the tax hit. Getting money into a Roth might save the survivor a lot of tax payments.

Sorry, I don't know the answer to the SS question.

[pb4uski]

Need more info, like how old you are now and how many years you have before you start SS. As kanohe says, you need to reduce your income by deductions and exemptions - $20,600 in 2015 if you are MFJ and itemize.

If you have some years between when you retire and start SS it would probably be beneficial since you will be in a lower tax rate compared to when SS starts. I have done Roth conversions the last two years and paid 7% in tax on my Roth conversion in 2014 because some of it was tax-free as it was sheltered by deductions and exemptions, some was at 10% and some was at 15%.

Besides, after conversion the Roth will grow tax-free.

[RunningBum]

Don't forget to include dividends and cap gains in that number. They are only at 0% tax to the extent that they don't fill the 15% bucket. Any part that overflows that bucket is taxed at 15%. If you've reached that point, every $1 you convert from tIRA to Roth is not only taxed at 15%, but it pushes $1 of divs/CGs to be taxed at 15%, effectively making it a 30% tax on the last dollars you convert, unless all divs/CGs are taxed. Use the turbotax link posted above to see this.

Also, I don't get the math you are using to get 8813. The 15% line for marrieds is 74900. Subtract out the pension and 85% SS and you get 12,297. As others have pointed out, you'll have deductions and exemptions. And are you collecting SS and a pension now? You are talking about 2026 numbers but your planner is telling you to start converting now. If 2026 is when you have to take RMDs you aren't even eligible for SS now. What is your income now? I would bet you have a lot more cushion for a few years to convert, unless you have a lot of dividend/cap gain income.

[Which Roger]

In your projections, did you adjust SS upward to since it's indexed for inflation?
Given that you're planning for over a decade from now, there are a lot of variables that can and will affect the accuracy of your projections (IRA balance, top of 15% tax bracket, changes to SS and tax law, your health, etc). That's why I always discount the future - a dollar saved today is worth a lot more than a dollar that might be saved a decade or more from now. Another factor is what will happen to your estate when both you and your spouse pass. There are additional benefits of Roths if your estate will be going to heirs, but these don't matter if your estate will go to charity.

[karluk]

Quote:

Originally Posted by ThisIsHowWeRoll $13,110 non-COLA pension for the both of us + $58,228 Social security for the both of us + $15,427 RMD year 1 ( $417k * 3.7% = $15,427) ------------ $86,765 $86,843 I'm projecting the 15% tax bracket top to be this for 2026 PROBLEM: We're WITHIN the 15% tax bracket, but barely. QUESTION: Since only 85% of our Soc Sec is taxable, MAYBE we have much more cushion. CORRECT? Current cushion = $78. $13,110 non-COLA pension for the both of us + $49,493 Soc Sec both (85% of $58,228 = $49,493) + $15,427 RMD year 1 ( $417k * 3.7% = $15,427) ------------ $78,030 $86,843 I'm projecting the 15% tax bracket top to be this for 2026 We now have $8,813 of cushion, using 85% of Soc Sec. Thanks for your input. Gary

It appears to me that there are several mistakes in your calculations, which (fortunately for you) all tend to put you closer to the top of the 15% tax bracket than you really are.

First of all, the $86,765 in combined pension, SS and RMD income would have already been comfortably under the top of the 15% tax bracket in 2014. Since tax brackets are indexed annually for inflation, by 2026 you would be even further below the top of the 15% bracket. You are right that only 85% of your SS is taxable, so your AGI would be about $78,030. But you need to compare this amount to taxable income, not AGI. Taxable income is derived from AGI after subtracting out deductions and exemptions. In 2014, the standard deduction for a married couple both over age 65 was $14,800 and two personal exemptions were worth 2 * $3,950 = $7,900. Add these to the $73,800 of taxable income that was in the 15% bracket, and your AGI in 2014 could have been as high as $73,800 + $14,800 + $7,900 = $96,500 and you would have still been in the 15% bracket.

So, according to this rough estimate, your projected income in 2026 would have left you $18,470 under the top of the 15% bracket in 2014. You wouldn't have been close in 2014 and, barring signficant changes in the tax law, you won't be close in 2026.

The trouble is that "signficant changes in the tax law" are almost inevitable in the next decade. That's a good argument for hedging your bets and making some Roth conversions now, if you know for a fact that you're in the 15% bracket (or lower). But you appear to be right that your projected income after RMDs begin won't push you into a higher tax bracket.

[RunningBum]

Quote:

Originally Posted by RunningBum Don't forget to include dividends and cap gains in that number. They are only at 0% tax to the extent that they don't fill the 15% bucket. Any part that overflows that bucket is taxed at 15%. If you've reached that point, every $1 you convert from tIRA to Roth is not only taxed at 15%, but it pushes $1 of divs/CGs to be taxed at 15%, effectively making it a 30% tax on the last dollars you convert, unless all divs/CGs are taxed. Use the turbotax link posted above to see this. Also, I don't get the math you are using to get 8813. The 15% line for marrieds is 74900. Subtract out the pension and 85% SS and you get 12,297. As others have pointed out, you'll have deductions and exemptions. And are you collecting SS and a pension now? You are talking about 2026 numbers but your planner is telling you to start converting now. If 2026 is when you have to take RMDs you aren't even eligible for SS now. What is your income now? I would bet you have a lot more cushion for a few years to convert, unless you have a lot of dividend/cap gain income.

I misread the OP, sorry about that, so my 2nd paragraph is kind of off the mark. I understand the math now, that you are projecting the tax brackets in 2016. I still think you are missing the deductions and exemptions, which give you more room, but also the cap gains and dividends in taxable accounts (if you have them), which will take some of the room away.

My thought is that the certainty of taking 15% now and tucking the money in a Roth that will never be taxed is better than 15% later which could possibly peak above 15%. For example your tIRA could grow faster than expected and push RMDs higher. A nice problem to have, but an even nicer way to handle it is to have moved it to a totally tax free Roth. Also, tax rates could go higher. They could also go lower, but I think higher is more likely.

Some may point out that tax rules could change and the IRS may find a way to tax Roth withdrawals again, and while that's possible, I think it's highly unlikely.

Also, you haven't given enough info about your current numbers now. Is it possible you can convert some of your tIRA at 10%? At a minimum I would do that.

[Rothman]

One thing you can consider is converting whatever amount you can to the top of the bracket each year. It causes tax earlier but you only expect tax rates higher in the future and the growth on that conversion is tax free forever. Roth money can be used to manage your taxable income in the future as well, and if you don't spend it makes the best inheritance for grandchildren.
Having a diversity of tax differed, tax free and taxable gives you more options both to manage how to withdraw but also for changes we don't anticipate today.

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[Elbata]

Seems to me OP is right in his thinking. Why pay the 15% tax now losing all potential income on that 15%? If all stays the same, he'll only be paying the 15% later.

Even so, it's just me, I like the idea of my money being tax free (Roth). And as the tax laws might change on the 15% rates, so might Roth rules.

[Animorph]

Also take a look at years after 70.5. The RMD percentage amount increases each year, as well as your portfolio. I've had a few retirement projections that were fine at 70.5 but jumped tax brackets within about five years. This may be a problem for you if you are just barely with the 15% bracket when RMD's start.

[hnzw_rui]

Quote:

Originally Posted by Animorph Also take a look at years after 70.5. The RMD percentage amount increases each year, as well as your portfolio. I've had a few retirement projections that were fine at 70.5 but jumped tax brackets within about five years. This may be a problem for you if you are just barely with the 15% bracket when RMD's start.

I think the problem might stem more from a simultaneous increase of 401k/tIRA balances. For the first 5 years, RMD increase is fairly small (0.12-0.17%). It's not really until your 90s that you have to withdraw 10% of the previous year's ending account balance.

[Rothman]

Animorph hit the nail on the head, the problem is expected case or best case scenario where trad IRA growth in out years far exceed money needed and you waste money paying tax to put excess funds in taxable where you can again pay taxes on its dividends and growth.


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[RunningBum]

Quote:

Originally Posted by Rothman Animorph hit the nail on the head, the problem is expected case or best case scenario where trad IRA growth in out years far exceed money needed and you waste money paying tax to put excess funds in taxable where you can again pay taxes on its dividends and growth.

That's a good point, it's not just about taxes during the conversion vs. RMD, but if you have to take RMDs and don't spend it all, that excess money will generate more taxes in the following years since it has to go to a taxable account. Unlike Roth money which can stay there, and growth is not taxed. Makes me feel better about being more aggressive in converting my Roth.

[Pilot2013]

I'm sorry, but I can't see any case where paying higher taxes now to do a Roth conversion makes sense when you are going to likely be below, or maybe just over the 15% bracket in the future? Of course, the OP did not say his current tax bracket, but I am assuming higher than 15%....

[pb4uski]

I don't think anyone is suggesting doing Roth conversions now if one's tax bracket will be lower in the future. Where did you get that idea?

In my case and many others, if I do not do Roth conversions between now and 70 then I'll be in the 25% tax bracket in my 70s and early 80s according to my projections, which are probably conservative since my investment earnings rate assumption is conservative so I am far ahead to pay 7% on my 2014 conversion now than 25% later.

[RunningBum]

The OP never came back to this thread so we're all guessing what his tax bracket is now, or whether any of our comments and suggestions were even looked at.

[Happily Retired]

Quote:

Originally Posted by Pilot2013 I'm sorry, but I can't see any case where paying higher taxes now to do a Roth conversion makes sense when you are going to likely be below, or maybe just over the 15% bracket in the future? Of course, the OP did not say his current tax bracket, but I am assuming higher than 15%....

Hi, Thanks for the feedback.

Please take a look at my later post on the "IRA withdrawal tax strategy" thread.

The spreadsheet that I put together for my DW's and my financial forecasting minimizes taxes by keeping us in the 15% or under tax bracket. As mentioned in that thread we have 70% of our assets in tax deferred taxable IRAs. It's soon time to pay the tax man, but keeping things are tolerable as possible.

I need to supply more details to adequately explain what the financial planner was suggesting to us. We're both 59 years old and plan to FIRE our employers in 2 years, some time in 2017.

We want the ACA healthcare subsidies so need to keep taxable income right below the ACA 400 FPL threshholds. No problems there.

The spreadsheet shows that we get tax-hammered immediately at age 70. Soc Sec is taxed fully, Medicare premiums are high. It's miserable.

Solution: Over the next 2 years 2016 and 2017 we will take two taxable IRA distributions of $75k each. TurboTax projections for those years show Effective Tax Rates of 17.8% and 16.4%. It's IMPORTANT to do it BEFORE the ACA (affordable Care Act) years and before Medicare, Social Security, Pensions and RMDs enter the picture. It would get very messy then to have WAY too much deferred income. We've elinimated $150k total, or 16% of the burden. This is JUST enough at a little-higher-than 15% to work for us.

By doing this we'll have enough room to keep taxable income maxed out at 15% AND have IMPORTANT room to continue drawing down taxable IRAs.
TurboTax projecs show Effective Tax Rate of 9% to 10% for most of the draw down.

Also as mentioned in the "IRA withdrawal tax strategy" thread we're rescued by Social Security benefits reducing to 75 cents on the dollar in 2033 (or whatever other year they decide to do it). THIS helps us by allowing more $$$ room in the 75% tax bracket window for taxable IRA draw down.

Heck, by 2044 the taxable IRA balance is ZERO and we're left with 100% after-tax cash and Roth IRAs.

With NO MORE taxable IRAs left we're then in the 1% to 2% Effective Tax Rate range.

It's important to us to not saddle our son with taxable assets.

THIS proves to be the most tax-efficient IRA withdrawal strategy for us.

I'm thinking strongly this summer of running all of this by a local financial planning firm that specializes in tax-efficient withdrawal strategies. If they have any different ideas I'll post their ideas here for everyone's use.

There are surely a great many others about the same age who are in this same situation... 70% or more of assets tied up in tax deferred and very taxable IRAs. These folks suffer a tax torpedo at age 70 and older.

One article calls the strategy that we're using a reverse tax torpedo... aimed right back at the IRS.

Happy spreadsheeting... Without them one is just wondering and worrying.

[pb4uski]

SS is 85%, not 75% so you may have a glitch there in your calcs.

I decided that we were better off forgoing ~$4k a year of Obamacare subsidies if we restricted our income to 400% FPL in favor of higher Roth conversions from ER until we are 70. The incremental tax from 15% to 25% later on far exceeds the Obamacare benefits. Obviously, YMMV.

Luckily, we are both healthy and qualify for catastrophic coverage which is reasonably affordable because the lowest cost bronze plan exceeds 8% of our income.

[kramer]

If the income limits for the start of taxation for Social Security are not adjusted for inflation, these sorts of calculations will become less relevant over time for the sorts of people on this board. Because, at some point, most members will have full taxation (85% of benefits) of their Social Security.

Any idea on the prospects of inflation adjustment for these income limits on taxation of Social Security? My understanding is that they have not been adjusted for inflation for some time.