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Old 11-11-2014, 12:00 PM   #41
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Since I have no pensions my strategy pre RMD has been to derive my living expenses from my taxable funds invested primarily in bond funds and high dividend balanced funds. My IRA's are in stock funds I also started SS at 62 so as to limit total income when RMD's start and in anticipation of taxing SS at 100%.

As RMD's start in 6 years I plan to convert all my taxable holdings to an index stock fund (S&P 500 or total stock Market Fund) the year before so as to limit dividend and CG distributions. Conversely, mi IRA's will be switched to Bond and balanced funds. Most of my income then will come from RMD's and I expect that if present tax rates hold my top fed tax rate will be 15% unless my IRA stock funds go up in value tremendously ( which would be a nice problem to have).

I will not be converting to Roth's for a couple of reasons:

With my psychological make up whatever I convert to Roth will never be coming out because I'd rather cut living expenses. So effectively I'd be paying taxes on money I will not use.

I just do not know what curves future tax laws will throw at Roth's either directly or in tangential ways.

My strategy of converting all my taxable funds to Index stock funds will result in a stepped up value upon my demise for my heirs since I intend not to touch Taxable funds once RMD's start.

I realize this strategy is exactly the opposite of what is generally recommended...
For SS its only a maximum of 85% of your SS can be taxable, even with 1 million dollar income, 15% of your SS will be tax free.

Why would you not take out from 401K/IRA's when 62 and let your SS build to full value at approx 65 ?
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Old 11-11-2014, 12:09 PM   #42
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As I'm under 59.5, My plan had been to capture Capital gains in taxable accounts by selling the stocks, and immediately buying them back, as up to 94,xxx income means dividends/capital gains are tax free. This will reduce our income later when we have to cover a big expense when doing RMD's.
However, due to this discussion, I'm thinking once I hit 59.5, I should take out from IRA's to max the 15% so there will be less RMD's later.
Personally I'm fine with putting the $$ into something like BRK as it has no taxable effect until sold.
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Old 11-11-2014, 01:37 PM   #43
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I'm in the "it gives me a headache" camp like jim.

Basically, I've concluded that we benefited in our high-earning years (two good jobs plus decent bonuses) by being able to defer enough income to keep in a lower tax bracket, and the result is we pay taxes later. As much as it is annoying when it comes time to write the check, I'm convinced we are still better off.
I'm in the "I want my cake and eat it too" camp. Just haven't figured out how yet.

I've spent quite a bit of time messing around with i-orp since this thread started. It's definitely a black box, which irritates me. I like to see calculations, assumptions, explanations, etc that I can then comprehend, recreate, and customize in my own spreadsheets. Maybe that's not possible with i-orp. It is fairly well documented, which is where I've spent most of the time.

In any case, like others here, I have pensions/rentals that fill out much of the 15% bracket. So my own spreadsheet analysis says Roth conversions are a bad idea, except as a possible legacy play. I-orp seems to agree, but interestingly, it wants me to make HUGE 6-figure withdrawals from tIRAs starting immediately (72t I guess, as I'm only 53). At first I just laughed. But then I manually plugged the WD profile into my own spreadsheet. It seems to max out the 25% bracket for 5-6 years and then backs off in smaller amounts necessary to eliminate RMDs altogether, while loading up the taxable account. The end result at RIP is a slightly higher overall portfolio value than my baseline scenario. Roth conversions always give me a lower ending value.

It's not a huge difference (about 3%). I definitely need to study this more. I'm curious why this works for my situation and Roth doesn't. I would have thought they are essentially equivalent strategies. And I had long-ago concluded that converting into the 25% bracket is a bad idea.

Maybe I'll join the "it gives me a headache" camp after all.
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Old 11-11-2014, 02:19 PM   #44
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For the record, I am fairly certain that I will never adhere to I-ORP's aggressive strategy of voluntarily putting oneself into a higher tax bracket simply for the sake of doing early Roth conversions to allow tax free growth for the rest of retirement. I am willing to believe that there are reasonable assumptions that might make I-ORP's strategy optimal, but the problem I have with it is that there are equally reasonable assumptions that make it one of the worst possible ways to withdraw money from a 401k or traditional IRA. A typical example would be large unreimbursed medical expenses late in retirement that make most or all of an RMD tax deductible. If there's a realistic chance that an RMD is going to be essentially tax free, it makes no sense to pay 25% now just to avoid a 0% RMD later.

So as far as I'm concerned, the I-ORP strategy fails what I would call a "robustness test". To me a 401k withdrawal strategy should not only perform optimally under certain assumptions about the future, but it should also perform reasonably well using other assumptions. Since I-ORP's strategy doesn't, I have no intention of using it.
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Old 11-11-2014, 03:14 PM   #45
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A typical example would be large unreimbursed medical expenses late in retirement that make most or all of an RMD tax deductible. If there's a realistic chance that an RMD is going to be essentially tax free, it makes no sense to pay 25% now just to avoid a 0% RMD later.
In some cases, it is worth considering the reverse situation (a higher % of income becoming taxable, or a higher than expected tax rate applied to the same income), and if applicable this could argue for the Roth conversions in early retirement even if it pushes the person into a higher tax bracket. The most common example might be a MFJ couple and the ramifications of one partner passing away. The drastically reduced standard deduction and exemptions (= higher taxable income on virtually the same RMD) and the reduced tax brackets (=higher tax rates on that taxable income) can be a real eye opener. Converting a big chunk of money to a Roth while both partners are still alive might prove to be a really smart move. But, a single surviving spouse in most cases would be expected to have lower expenses than 2 people, so it would be an unusual case in which these tax issues would significantly hurt. Still, worth considering for some people.


In addition to the case you cite (higher medical expenses), retirees could also find themselves in low tax brackets if their investments do poorly over the coming decades. It could clearly happen to most of us, and it would reduce the absolute value of RMDs and also of any cap gains from taxable accounts. I'd sure feel dumb if I went crazy and converted a lot of funds, paid tax at the 25% rate, and then our investments hit the skids and I found I'd be in the 15% bracket for a long, long time. That extra money paid in taxes earlier might come in handy.


I plan to do Roth conversions to the top of my "regular" expected bracket in early retirement (before I start taking SS). After that, I'll leave things alone and risk paying higher taxes well down the line --hopefully when it is apparent I've "won the game" and my nest egg is really going to outlast me.
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Old 11-11-2014, 05:30 PM   #46
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I was going under the assumption that I-Orp models filing status, tax brackets, standard deduction, personal exemptions and social security taxation.

Do you think that this is a stretch on my part, or are there other tax rules that you would like for them to implement?

-gauss
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Old 11-11-2014, 06:26 PM   #47
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In some cases, it is worth considering the reverse situation (a higher % of income becoming taxable, or a higher than expected tax rate applied to the same income), and if applicable this could argue for the Roth conversions in early retirement even if it pushes the person into a higher tax bracket.
It doesn't really make any difference at all what assumptions one makes about the future. In order to be "robust" in the sense I was using the word, a 401k withdrawal plan needs to perform reasonably well under most, and preferably all, likely future assumptions. Your scenario of getting hit with a massive tax bill in the future is certainly plausible, and incidentally shows that doing nothing at all until RMDs begin at age 70 1/2 is not a "robust" strategy. Doing nothing will be optimal under the scenario of large deductible medical expenses I outlined earlier, but will be a disaster in your scenario. Doing nothing is optimal under one set of future assumptions and is awful under another set, hence it's not a "robust" strategy, even though I suspect it's also the most common approach to 401k withdrawals.



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I plan to do Roth conversions to the top of my "regular" expected bracket in early retirement (before I start taking SS). After that, I'll leave things alone and risk paying higher taxes well down the line --hopefully when it is apparent I've "won the game" and my nest egg is really going to outlast me.
I would defintely consider doing Roth conversions up to the top of one's current tax bracket to be a more robust strategy than either doing nothing or making massive Roth conversions regardless of tax bracket. That's because it avoids the worst case scenarios outlined above. Probably the retirees who use this strategy don't articulate their choice in terms of "robustness", but I suspect that their thinking is roughly that's it's a decent choice that's likely to save them some money in most cases and is unlikely to cost them very much in any case, i.e. "robust" in my sense of the word.
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Old 11-11-2014, 06:58 PM   #48
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There's no telling based on what you've written, but in your working definition of "robustness" I'd recommend you consider the concept of marginal utility of the returns under various scenarios (rather than strictly using a definition of "robustness" that only includes maximizing returns under various future conditions). To most retirees (maybe you), the first $50K of annual retirement income is likely to have much greater utility than the second $50K. That's an argument for delaying taxes and risking paying higher rates as a result, if it helps assure the first $50K gets paid in those later years.
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Old 11-11-2014, 07:28 PM   #49
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For the record, I am fairly certain that I will never adhere to I-ORP's aggressive strategy of voluntarily putting oneself into a higher tax bracket simply for the sake of doing early Roth conversions to allow tax free growth for the rest of retirement. I am willing to believe that there are reasonable assumptions that might make I-ORP's strategy optimal, but the problem I have with it is that there are equally reasonable assumptions that make it one of the worst possible ways to withdraw money from a 401k or traditional IRA. A typical example would be large unreimbursed medical expenses late in retirement that make most or all of an RMD tax deductible. If there's a realistic chance that an RMD is going to be essentially tax free, it makes no sense to pay 25% now just to avoid a 0% RMD later.

..............................
With Medicare and a good medigap supplement, I am hoping that out-of-pocket expenses will be near 0 (except for insurance premiums).
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Old 11-11-2014, 08:55 PM   #50
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For SS its only a maximum of 85% of your SS can be taxable, even with 1 million dollar income, 15% of your SS will be tax free.

Why would you not take out from 401K/IRA's when 62 and let your SS build to full value at approx 65 ?
I know that current law sets a maximum of 85% OF SS benefits as taxable. It seems likely to me that the law will be changed to 100% taxable in the medium term future as current benefits being paid are higher than current taxes collected. When the current surplus is spent ( maybe 15-20 years at max) then either benefits will be reduced or taxes will have to go up substantially.

As to why take at 62 instead of letting it build up and collect more later. Many many threads on that subject at this forum. Suffice it to say that for a minority of posters at this board (including moi) controlling our own resources (401K/IRA) to the extent possible instead of relying on government payouts (SS) in the future adhering to current law for the foreseeable future is preferable given certain views of the political/socio economic world we live in.
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Old 11-11-2014, 09:18 PM   #51
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In some cases, it is worth considering the reverse situation (a higher % of income becoming taxable, or a higher than expected tax rate applied to the same income), and if applicable this could argue for the Roth conversions in early retirement even if it pushes the person into a higher tax bracket. The most common example might be a MFJ couple and the ramifications of one partner passing away. The drastically reduced standard deduction and exemptions (= higher taxable income on virtually the same RMD) and the reduced tax brackets (=higher tax rates on that taxable income) can be a real eye opener. Converting a big chunk of money to a Roth while both partners are still alive might prove to be a really smart move. But, a single surviving spouse in most cases would be expected to have lower expenses than 2 people, so it would be an unusual case in which these tax issues would significantly hurt. Still, worth considering for some people.


In addition to the case you cite (higher medical expenses), retirees could also find themselves in low tax brackets if their investments do poorly over the coming decades. It could clearly happen to most of us, and it would reduce the absolute value of RMDs and also of any cap gains from taxable accounts. I'd sure feel dumb if I went crazy and converted a lot of funds, paid tax at the 25% rate, and then our investments hit the skids and I found I'd be in the 15% bracket for a long, long time. That extra money paid in taxes earlier might come in handy.


I plan to do Roth conversions to the top of my "regular" expected bracket in early retirement (before I start taking SS). After that, I'll leave things alone and risk paying higher taxes well down the line --hopefully when it is apparent I've "won the game" and my nest egg is really going to outlast me.
Bogle along with several other well regarded investment "Gurus" have repeatedly made the point that investment returns for the typical diversified portfolio are likely to be considerably lower going forward for both stocks (given current valuations) and bonds (given current yields) and that this situation may well extend for a decade +. I am skeptical of an approach that predicates payment of large taxes now in anticipation of significant future growth of a tax free portfolio. Also, for those of us in high income tax rate states such as Oregon or California the Fed 15% rate is really more like a 25%+ when the state income tax is taken into account.
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Old 11-11-2014, 09:20 PM   #52
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For the record, I am fairly certain that I will never adhere to I-ORP's aggressive strategy of voluntarily putting oneself into a higher tax bracket simply for the sake of doing early Roth conversions to allow tax free growth for the rest of retirement. I am willing to believe that there are reasonable assumptions that might make I-ORP's strategy optimal, but the problem I have with it is that there are equally reasonable assumptions that make it one of the worst possible ways to withdraw money from a 401k or traditional IRA. A typical example would be large unreimbursed medical expenses late in retirement that make most or all of an RMD tax deductible. If there's a realistic chance that an RMD is going to be essentially tax free, it makes no sense to pay 25% now just to avoid a 0% RMD later.

So as far as I'm concerned, the I-ORP strategy fails what I would call a "robustness test". To me a 401k withdrawal strategy should not only perform optimally under certain assumptions about the future, but it should also perform reasonably well using other assumptions. Since I-ORP's strategy doesn't, I have no intention of using it.
If it's just a one time medical event then you get to take your RMD out at 0%, and maybe some extra as well. That's a good thing. But most likely you'll be back to 25% the next year. Unless you reduced your 401k/IRA balance with Roth conversions before RMD's.

I'm not converting everything into Roth accounts. Just enough to stay pretty much in a lower tax bracket when RMD's hit. I'll still be able to take advantage of a huge deduction opportunity if it comes along.
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Old 11-12-2014, 11:10 AM   #53
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Every Roth thread eventually gets into all these esoteric tax scenario details. While it's certainly useful and I'm learning a lot from these "robustness" discussions, in my own modeling of this dilemma, it boils down to: long-term tax savings vs foregone growth in the portfolio by paying taxes early. I don't see this discussed a lot, just the gory details on the tax side of the equation.

I'm 53, and I use a modest portfolio growth assumption of 4.4%. Yet that growth trumps everything else... even jumping high into the 25% bracket in my 70s. I've done some very detailed modeling of conversions to the top of the 15% bracket, and the result is a smaller portfolio at RIP. I've analyzed every aspect of the portfolio change, and the driving factor behind my tentative do-nothing plan is the portfolio growth enabled by continuing to defer taxes as long as possible.

Age is part of that conclusion. Plus the fact that my pension/rental income leaves precious little room for conversions. So I started modeling conversions into the 25% bracket, at various depth and timing combos. Result is usually worse; best case about the same. The one exception is some bizarre, front-end loaded withdrawal profile suggested by i-orp. Not Roth conversions, just straight withdrawals. I doubt I would ever do anything that drastic no matter what the numbers say. Layer on top of all this some healthy skepticism about tax law continuity over the next 3-4 decades, and you'll start to understand my hesitancy.

In any case, I can only assume that those early retirees without pensions (and possibly older) are able to convert larger amounts, cut deeper into RMDs, and thus offset the foregone growth with higher tax savings. Still, I have to believe there's something better than my do-nothing plan.
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Old 11-12-2014, 11:29 AM   #54
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I'm 53, and I use a modest portfolio growth assumption of 4.4%. Yet that growth trumps everything else... even jumping high into the 25% bracket in my 70s.
Just checking: Your modelling also included indexing of the tax brackets and standard deduction for inflation, right?

The growth assumption is critical to this, and so it's useful to briefly look at what happens if things turn out differently than we anticipate:
1) If growth is lower in real terms than you estimated, you might be in trouble overall. You'll need to cut back on some things. But at least you aren't getting hit with a higher tax rate, and because you didn't pre-pay a bunch of taxes up front, you have a few more dollars to see you through this rough patch.
2) If growth is higher in real terms than you'd anticipated, you are in great shape overall. Your investments are outpacing inflation by more than you thought they would when you retired, and you've got more available money to spend. In this case, is paying a higher tax especially objectionable? I don't think so.
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Old 11-12-2014, 11:35 AM   #55
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Just checking: Your modelling also included indexing of the tax brackets and standard deduction for inflation, right?
Yes. Personal exemptions also.
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Old 11-12-2014, 02:02 PM   #56
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I look at the tax rate paid for any given $ and think about it that way. In our case, we plan to delay SS to 70. We have modest pensions. Once the pension and SS are coming in, most of the 15% bracket is used up, particularly if we still have other income (dividend and LTCG). In the years prior to hitting 70, I'm planning to convert to the top of the 10% bracket (some is at 0% as mentioned thanks to standard deduction and exemption), then take LTCG/dividends to the top of the "15%" bracket, which is effectively 0%. If I use up my LTCG then I'll do more conversion. I have more money than can be converted in the time remaining in the 15% bracket, and depending on the market I may/may not have enough LTCG. If I can pay 0% and 10% rate on money at the Federal rate to convert while living off already taxed money, I'll do that all day long.

Once I hit 70, I won't have the flexibility. But if I have enough net worth and income to put me above the 15% bracket, that'll be a good problem to have.
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Old 11-13-2014, 11:14 AM   #57
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I'm 53, and I use a modest portfolio growth assumption of 4.4%. Yet that growth trumps everything else... even jumping high into the 25% bracket in my 70s. I've done some very detailed modeling of conversions to the top of the 15% bracket, and the result is a smaller portfolio at RIP.
Cobra, your post motivated me to make some calculations based on my own finances, and I have come to a completely different conclusion. I'm not sure if it's because of our different financial situations, differing assumptions, or perhaps a mistake in my spreadsheet, since I haven't had time to analyze it carefully. Based on the Roth conversions @15% that I expect to make before RMDs begin, and assuming 4.4% growth, my spreadsheet indicates that the do nothing option will start out ahead at age 70 because of the upfront taxes I would have to pay on the Roth conversions. But the early Roth conversion option gradually catches up because of the ever increasing RMDs that get taxed at 25%. The switch-over point occurs at age 80, when the Roth conversion option pulls slightly ahead of the do nothing option. By age 90, the Roth conversion option wins by about 5x the amount of upfront taxes I had to pay in order to do the Roths. If I'm lucky enough to live to 100, the Roth conversion option would win by 15x the upfront taxes on the Roths.

Although I can't rule out a mistake in my calculations, my results make a lot of sense. The whole point of the tax laws requiring RMDs is to deplete the entire balance of one's 401k or traditional IRA over the course of one's life expectancy. You can't shelter the higher balance in the 401k forever, and once it is withdrawn you have the "pleasure" of paying Uncle Sam 25%, instead of the 15% you could have paid earlier.

My calculations also give a little more insight into how darned complicated this whole matter really is. Tax rates, life expectancy, and future investment returns all play a huge role in determining the best 401k withdrawal strategy. And none of this can be known with any certainty at all. I could get hit by a bus on my 70th birthday and lose with early Roth conversions, or live until 100 and emerge a big winner.
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Old 11-13-2014, 03:22 PM   #58
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...my spreadsheet indicates that the do nothing option will start out ahead at age 70 because of the upfront taxes I would have to pay on the Roth conversions. But the early Roth conversion option gradually catches up because of the ever increasing RMDs that get taxed at 25%. The switch-over point occurs at age 80, when the Roth conversion option pulls slightly ahead of the do nothing option. By age 90, the Roth conversion option wins by about 5x the amount of upfront taxes I had to pay in order to do the Roths.
Karluk, thank you. I was hoping this thread would continue. In my case, the negative result from converting gets larger with age. There is no crossover point. The growth impact from paying taxes early compounds faster than the tax savings from lower RMDs and lower taxable dividends. Like you, I can't rule out an error in my spreadsheet or modeling logic. But I just spent several hours checking and rechecking everything after reading your post. The different conclusions are likely due to some combination of differences in assumptions and financial situations. However, let me ask you something... in the quote above you never actually mentioned the growth impact of the prepaid taxes. Are you only comparing RMD tax savings with the raw upfront tax dollars? Or are you looking at ending portfolio differences?

In my spreadsheet, I can breakdown the ending portfolio difference (do-nothing vs converting) at any age, into 4 components:

1. upfront taxes paid at 15%
2. growth impact from upfront taxes paid (4.4% growth assumption)
3. tax savings from lower RMDs at 25%
4. tax savings from lower taxable dividends at 15%

The kicker is #2. The taxes themselves (#1) are relatively inconsequential. Like you, my RMD tax savings exceed the raw upfront tax dollars at age 79. But the RMD tax savings never grow fast enough to exceed the growth impact (#2). So, yes, lifetime taxes are lower with conversions. But the ending portfolio is worse. And that's my acid test.

Also, in order to compare our conclusions, may I ask a few questions about the assumptions in your analysis?:

1. At what age are you starting conversions?
2. What percentage of your tax-deferred balance is ultimately converted?
3. At what age do you take SS?
4. How much of the 15% bracket do you have available for conversions?
5. What inflation rate are you assuming for tax brackets, std deduction, and exemptions?
6. Do you make Roth withdrawals? Or do RMDs still cover expenses?
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Old 11-13-2014, 04:04 PM   #59
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.....However, due to this discussion, I'm thinking once I hit 59.5, I should take out from IRA's to max the 15% so there will be less RMD's later.
Personally I'm fine with putting the $$ into something like BRK as it has no taxable effect until sold.
Ok, I'm learning some fine points here.
My above idea is a little stupid about putting the $$ into a non-ROTH.
As I missed the idea that regardless of whats invested within the Roth, its all tax-free upon withdrawl vs paying even low long term Capital Gain outside a Roth.
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Old 11-14-2014, 10:03 AM   #60
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However, let me ask you something... in the quote above you never actually mentioned the growth impact of the prepaid taxes. Are you only comparing RMD tax savings with the raw upfront tax dollars? Or are you looking at ending portfolio differences?
The metric I used for comparing strategies was total portfolio value, not taxes paid. Saving on taxes may make one feel better, but it doesn't seem to have much relevance to evaluating strategies. The real proof is in the bottom line - is my net worth higher with early Roth conversions instead of doing nothing until RMDs begin? For me, doing nothing wins until age 80, at which point Roth conversions forge a few hundred dollars ahead. At age 90, I am ahead by mid-to-high five figures, and by at 100 the difference is well into six figures. Not bad for taking some simple steps right now, although I admit it's a little disconcerting to have to wait until so late in life to see a large difference. However, for me the benefit to my heirs is also a motivation, so it's a win in my view, even if I die early.


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1. At what age are you starting conversions?
2. What percentage of your tax-deferred balance is ultimately converted?
3. At what age do you take SS?
4. How much of the 15% bracket do you have available for conversions?
5. What inflation rate are you assuming for tax brackets, std deduction, and exemptions?
6. Do you make Roth withdrawals? Or do RMDs still cover expenses?
1. age of first Roth conversion = 61. I intend to make small conversions every years from age 61-69.
2. I intend to convert a total of between 16% and 17% of the current value of my tax deferred acccount to Roth, an average of around 1.5% per year. In addition, for the purposes of the spreadsheet, I have to make additional withdrawals in order to cover the taxes due on the conversions. To convert $10,000 to Roth, for example, it's necessary to withdraw an additional $1,765 to cover the 15% Federal tax that is due on the extra $11,765 in taxable income. The total - Roth conversions plus extra money to cover taxes - is between 19% and 20% of the starting value of the deferred account.
3. SS starts at age 70.
4. The amounts converted in the spreadsheet are what take me to the top of the 15% bracket, based on current finances. Since my calculations seem to indicate that Roth conversions are a terrific idea for me, I will be looking into ways to increase the amount I can convert and still stay at 15%.
5. I don't think the inflation rate is relevant for my situation. I have a COLAed pension and SS is also COLAed. They will put me right at the top of the 15% bracket at age 70, and with the COLAs I should stay there for the rest of my life. So I assumed 25% tax on all RMDs and that I could maneuver the taxable account created from the RMDs to produce qualified dividends taxed at 15%.
6. For the purposes of the spreadsheet, I never make withdrawals from any account, except to do the Roth conversions, take RMDs, and pay taxes due. I don't expect to need it, so any spending from these accounts will be strictly discretionary.
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