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401k's, IRA's and RMD's - tax consequences
Old 11-04-2014, 11:18 AM   #1
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401k's, IRA's and RMD's - tax consequences

Im starting to rough calculate tax scenarios for 401k and IRA withdrawals down the road in retirement. Originally I thought I would live on taxable investments as long as possible before taking 401k/IRA withdrawals. But now I'm not so sure if this is the best solution tax wise.

I'm playing with an RMD calculator and it looks like the RMD for my 401k will be more than I will need when I'm 70-1/2. And I read online that 401k distributions are taxed as ordinary income. This would create a huge tax burden in the future.

Some people are converting all or part of their 401k's to Roth IRA's to minimize the future tax bite, but it seems that the biggest benefit of the Roth conversion goes to the heirs of the investor. We have no kids, so I'm not sure if this would work for us.

I'm going to dig deeper, research, read some books, etc. Can anyone recommend books, etc that address the tax consequences of withdrawals, and share what you and others have done to minimize the tax burden?
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Old 11-04-2014, 11:50 AM   #2
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I sure hope you get some good answers. I've seen this question asked several times here and elsewhere, and never seen a substantive answer, so I'd be thrilled. After trying to develop spreadsheets to answer for myself (there are an amazing number of moving parts if you get everything), I may have to resort to a pro for answers - and finding one who can answer definitely and accurately may not be easy.

And don't forget to add the impact of Soc Sec as well, another potentially significant variable in tax optimization.
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Old 11-04-2014, 12:29 PM   #3
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My goal is to convert as much 401k to Roth in my pre age 70 years while staying below the 15% tax bracket for married couple. During that time, all big ticket (ie: cars, vacations, toys, food) will be purchased with after tax savings. What ever is left over in 401k at 70 will be subject to rmd, but, at least i will have done do diligence to keep tax man's pockets empty.

As far as the heirs benefitting the most, I don't see that as even an issue? We don't have kids, and no goal to leave any behind. I see the Roth conversion to be strictly a tax smart way to go.

The plan to take SS is for DW to start drawing at 62 and I start at 70. I know DW's SS will reduce the amount we convert to Roth, but we want to also optimize SS benefit.

I'm interested to see the replies to this thread and learn other ideas to run in my calculations.
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Old 11-04-2014, 12:44 PM   #4
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For many people, the answer is Roth conversions. I'm still studying this, but my initial conclusion is a no-go. Reason: we have pensions and rentals that consume much of the 15% bracket. The amount we could convert is too small to make a meaningful dent in RMDs. Even after max conversions, the RMDs from our tIRAs would still be more than we need to cover expenses. So the Roth would never get tapped and any tax rate benefit would pass to our heirs. In our lifetime, the upfront tax from Roth conversions (plus the associated growth hit) would be more than any tax savings due to lower RMDs and taxable dividends.

If there is some other mechanism to reduce the inevitable tax disaster at age 70.5, I'm all ears.
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Old 11-04-2014, 01:50 PM   #5
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For many people, the answer is Roth conversions. I'm still studying this, but my initial conclusion is a no-go. Reason: we have pensions and rentals that consume much of the 15% bracket. The amount we could convert is too small to make a meaningful dent in RMDs. Even after max conversions, the RMDs from our tIRAs would still be more than we need to cover expenses. So the Roth would never get tapped and any tax rate benefit would pass to our heirs. In our lifetime, the upfront tax from Roth conversions (plus the associated growth hit) would be more than any tax savings due to lower RMDs and taxable dividends.

If there is some other mechanism to reduce the inevitable tax disaster at age 70.5, I'm all ears.
I'm with you on the approach and also not convinced it is going to make a big difference. We have a rental that will be paid off when I'm 70, and that along with pension and SS (DW 67, I'll draw spousal at 67, then convert to mine at 70) will take care of all our needs when RMDs kick in. 80% of our savings is IRA/401K so we will have to pay taxes like we have a JOB.
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Old 11-04-2014, 01:55 PM   #6
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For those that don't have heirs to leave their wealth too.... I'd like to step forward and solve that problem. I'm willing to be your heir.
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Old 11-04-2014, 02:10 PM   #7
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DW and I are only 41, but since 75% of our assets are in IRAs and 401ks, this is on my radar as well. At the moment, we are likely to make the problem worse since we are still earning money and will get nudged into the kind of tax bracket that makes it worth it to stash what we can, but this is a looming issue. The plan is to use Roth conversions to fill out the 15% bracket when we have lower income years. Since we have 20 years to fool with and the tax code is ever-changing (and ACA subsidies complicate things even worse), that is about as far as I can get. I expect to kick the can on starting my cash balance pension payout until we have gotten a bunch of conversions done.
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Old 11-04-2014, 02:10 PM   #8
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I am going through this analysis also.

I have about 2/3 of my portfolio in IRA/401K's and next year will only have some dividend income. I plan on drawing down the IRA up to the 15% marginal bracket. This will help reduce RMD's that will begin in about 10 years. I am thinking that converting to a ROTH rather than a straight withdrawal might be the way to go. I would only convertup to the 15% marginal bracket. If I do the conversion, I will tap into my taxable portfolio for living expenses. This will generate capital gains. No plans to leave a legacy.

As Midpack noted above, this has a lot of moving parts, some of which are a bit down the road for me.

I just ordered two books from Amazon on ROTH's. I see some spreadsheets in my future.
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Old 11-04-2014, 02:40 PM   #9
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I do not have the answer but would think you would want spread your taxable income over as many years as possible.

So basically start the RMD the year you retire instead of at age 70. If you do not need the money than convert it to a Roth.


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Old 11-04-2014, 02:43 PM   #10
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I'll be interested in watching this thread since I'm in a similar situation. About 8 more years until RMD's kick-in for me and I'll be forced to withdraw more than needed (and pay the associated higher taxes). I did some calculations last year and based on that I started withdrawing enough to take me to the top of the 15% tax bracket limit each year and planned to continue to do so until RMD's start. That will help reduced the RMD's (and taxes) a little but not really that much so I'll be interested in any ideas/magic you folks come up with.
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Old 11-04-2014, 03:22 PM   #11
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Add to the "moving part" list the tradeoffs of 0 tax bracket for div/Cap Gain and staying in the 15% fed tax bracket. Adding IRA to Roth conversion to current income can cost a chunk more than the just the ordinary tax on the withdrawal.
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Old 11-04-2014, 03:40 PM   #12
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So just out of curiosity does anybody know the rough dollar amount saved in a tax deferred 401k/IRA that pushes people into this RMD withdrawal tax issue.

I have a pension also and a pension really presents a problem for RMD and keeping tax bracket low.

I am starting to think that I am saving too much in my tax deferred 401k.

Is there an actual ballpark dollar amount that could be considered a stop point in a tax deferred 401k/IRA. say 1 million. 3 million.
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Old 11-04-2014, 04:29 PM   #13
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Originally Posted by purplesky View Post
So just out of curiosity does anybody know the rough dollar amount saved in a tax deferred 401k/IRA that pushes people into this RMD withdrawal tax issue.

I have a pension also and a pension really presents a problem for RMD and keeping tax bracket low.

I am starting to think that I am saving too much in my tax deferred 401k.

Is there an actual ballpark dollar amount that could be considered a stop point in a tax deferred 401k/IRA. say 1 million. 3 million.
Take a look at IRS PUB 590. For me, I will be using Table III, so at age 70 1/2, the first RMD, the factor is 27.4. Just take the reciprocal of that, which is 3.65%. So take 3.65% of your IRA amount (as of Dec 31 of the proceeding year), and that will give you the first RMD amount in $. The second year's RMD is 3.78%, and they go up each year of age. Then, with that $ amount added to everything else, take a look at the taxes due for you.

Just a quick example, a 1 million IRA would have a first RMD of $36,500. The effect can be quite large!
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Old 11-04-2014, 05:04 PM   #14
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I always heard that one should have their bonds in tax advantaged accounts and have equities in taxable accounts. I never drilled down to get the reasoning of this. But given that some of the gains in the taxable accounts are taxed as capital gains, and all distributions from IRA's/401k's are taxed as ordinary income - it makes sense to put all bonds in 401k/ira and equities in taxable accounts.

Here's a few answers from experts on nerd wallet.com. 2 interesting ways to postpone RMD's are marrying a much younger spouse, or keep working past 70.5.


How do I reduce my required minimum distributions (RMDs)?
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Old 11-04-2014, 05:15 PM   #15
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So just out of curiosity does anybody know the rough dollar amount saved in a tax deferred 401k/IRA that pushes people into this RMD withdrawal tax issue.

I have a pension also and a pension really presents a problem for RMD and keeping tax bracket low.

I am starting to think that I am saving too much in my tax deferred 401k.

Is there an actual ballpark dollar amount that could be considered a stop point in a tax deferred 401k/IRA. say 1 million. 3 million.
I am sure that there are way too many variables to give a specific dollar amount that would have much validity. But as a simple thought experiment, consider that a married couple in 2014 gets to take advantage of the 15% tax bracket on $73,800 of taxable income. Add to that the $12,400 standard deduction and two personal exemptions at $3,950 each and you get $94,100 that the couple can withdraw from a traditional IRA or 401k and remain in the 15% tax bracket. These amounts are indexed to inflation, so extrapolating out to a 30 year retirement starting at age 60, the couple can withdraw 30*$94,100 = $2,823,000 from their IRA, as measured in 2014 dollars.

Naturally this amount will be much lower if the couple has a lot of other taxable income that might push them into a higher tax bracket. It also ignores the fact that most investors are hoping for inflation beating investment returns over the course of a multi-decade retirement. But in general there tends to be enough wiggle room to have a million dollars, or even multiple millions, in a retirement account and still stay in the 15% tax bracket. The key is to start withdrawals early in retirement and whittle down the IRA balance before RMDs start mandating extremely large annual withdrawals.
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Old 11-04-2014, 05:18 PM   #16
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It's known as the IRA/401k Trap: decades of cap gains poised to be taxed as ordinary income. The partial solution many here employ is to use the years between ER and SS/RMDs to slowly convert from traditional to Roth, never pushing their marginal rate sky high in any one tax year.
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Old 11-04-2014, 08:47 PM   #17
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Here's a few answers from experts on nerd wallet.com. 2 interesting ways to postpone RMD's are marrying a much younger spouse, or keep working past 70.5.
Well, I like one of the ideas and I'm not going back to work.
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Old 11-04-2014, 09:05 PM   #18
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I believe that (I-Orp) Retirement Calculator - Parameter Form takes a shot at optimizing your Roth conversions to maximize your overall retirement spending plan.

-gauss
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Old 11-04-2014, 09:15 PM   #19
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I do not have the answer but would think you would want spread your taxable income over as many years as possible.

So basically start the RMD the year you retire instead of at age 70. If you do not need the money than convert it to a Roth.


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That is basically my strategy, however, I will need to convert more than just to fill the 15% tax bracket. With pensions, the amount to fill 15% would be fairly small (ie less than $10,000/year or so for the next 20 years until 70 1/2)

As such I believe that I will be resigned to being in the marginal 25% bracket for the rest of my life on average (or at least until tax rates change).

I would have the freedom, however, to manipulate the income by varying Roth conversions in any single year or so if that were to be to my advantage.

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Old 11-05-2014, 07:59 AM   #20
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Originally Posted by RetireAge50 View Post
I do not have the answer but would think you would want spread your taxable income over as many years as possible.

So basically start the RMD the year you retire instead of at age 70. If you do not need the money than convert it to a Roth.
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That is basically my strategy, however, I will need to convert more than just to fill the 15% tax bracket. With pensions, the amount to fill 15% would be fairly small (ie less than $10,000/year or so for the next 20 years until 70 1/2)

As such I believe that I will be resigned to being in the marginal 25% bracket for the rest of my life on average (or at least until tax rates change).

I would have the freedom, however, to manipulate the income by varying Roth conversions in any single year or so if that were to be to my advantage.
+1. Same conclusion I've come to, though I'd rather see the (theoretical) math at least. Filling out to 15% between now and age 70 won't be enough to minimize lifetime taxes as RMDs and Soc Sec alone will probably exceed our spending after age 70 for us (nice problem I know). So I plan to keep taxable as constant (inflation adjusted) as possible using dividends, passive and active cap gains, RMDs, Soc Sec and whatever other "income events" we expect. Still wish there was a calculator or even a pro who could do it (one of the few financial services I'd pay for).
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