A different take on tapping IRA

[BOBOT]

Our CFA, whose advice we're generally ok with, recently recommended that after DW FIRES in 6 months (joining me, 5+ yrs in) we fund that part of our basic living expenses not covered by our fairly small pensions with withdrawals from my IRA, using our taxable accounts to pay for the "extras" we're planning. This would enable me to defer SS until 70 (64 now).

She referred to this article, which is interesting but I'm not fully on board with the idea. It's always been my belief that first you tapped the taxable, then the IRA/401k, last the Roth.

I don't recall any other discussion of this approach; any knowledge/opinions?

 

[mickeyd]

Thanks for the article Bobot.

I have read similar articles in the past and on the surface it looks like this may work for some folks rather then the "use your taxable $ and SS first" gang. My inclination would be the get out the old stubby pencil and see if your situation could benefit from delaying SS and eating your IRA first.

Both SS and IRAs have a certain amount of flexibility built in and it's probably worth it to see where you and yours fit in.

 

[Cut-Throat]

I think the article assumes that you don't have any money in taxable and that you have to choose between the IRA and SS.

I still think it's better to consume the taxable first. In my situation, I'll have little income from 62-70 and will be living on taxable only. I can then move some money up to my deduction limit from my IRA to a Roth and not pay taxes at all. I'll do this for 8 years and it will definitely lower my RMD by the time I'm 71.

There are so many good reasons for delaying SS to age 70 now, that it becoming almost a no-brainer. Because I won't have much of an income before reaching Medicare, The new Obamacares Health Plan offers Insurance Subsidies based entirely on Income. Not Net Worth. According to this calculator Health Reform Subsidy Calculator - Kaiser Health Reform - The Savings are tremendous and makes planning for Health Care Insurance in retirement a Piece of Cake now. They took away my Veterans benefits in 2001, so I have no problems at all accepting these Subsidies!

 

[Animorph]

Not just consume the taxable, but do Roth conversions as well, up to a lower tax bracket. In your case this would look sort of like taking expenses from the IRA but putting some of your taxable money into a Roth. No problem spending from a Roth as needed since it has no tax consequences, though be careful not to run afoul of the 5-year rule. Even better than saving your taxable money. Of course, your tax situation may vary.

 

[BOBOT]

I think the article assumes that you don't have any money in taxable and that you have to choose between the IRA and SS.

I still think it's better to consume the taxable first. In my situation, I'll have little income from 62-70 and will be living on taxable only. I can then move some money up to my deduction limit from my IRA to a Roth and not pay taxes at all. I'll do this for 8 years and it will definitely lower my RMD by the time I'm 71.

There are so many good reasons for delaying SS to age 70 now, that it becoming almost a no-brainer. Because I won't have much of an income before reaching Medicare, The new Obamacares Health Plan offers Insurance Subsidies based entirely on Income. Not Net Worth. According to this calculator Health Reform Subsidy Calculator - Kaiser Health Reform - The Savings are tremendous and makes planning for Health Care Insurance in retirement a Piece of Cake now. They took away my Veterans benefits in 2001, so I have no problems at all accepting these Subsidies!

Not just consume the taxable, but do Roth conversions as well, up to a lower tax bracket. In your case this would look sort of like taking expenses from the IRA but putting some of your taxable money into a Roth. No problem spending from a Roth as needed since it has no tax consequences, though be careful not to run afoul of the 5-year rule. Even better than saving your taxable money. Of course, your tax situation may vary.

C-T thanks for the link (haven't seen posts from you in a long time?) I get Medicare next year, and the time to decide about supplemental plans is fast approaching. I can imagine that whole landscape will be shifting too in the months ahead. Who knows...

Things do get complicated even when your situation is basically simple. It's my understanding that I can contribute to Roth next year because DW will have a few month's income before she retires. Conversions after that have not been addressed yet by the FA, so I'll raise the question.
I believe taxes on SS will be less if we do the IRA w'drawals she recommends, and RMDs will be less for sure. But I'd like a more granular analysis before I sign up.

 

[LOL!]

I don't understand why a lot of people think you have a tap a certain kind of account "first". If you look at calculators such as the one found at www.i-orp.com the answer seems to be: tap all accounts simultaneously with the amounts set up to give you the lowest possible taxes.

So the question is never "Which to tap first?"; instead the question is "How much of each account type to tap including how much to convert from IRA to Roth IRA?"

The answer is "One size does not fit all." For example, I may have a taxable account and you may not. I may have large carryover losses that somebody else may not have. Etc.

Folks we have to THINK about this carefully and understand why we have THINK about this carefully. Indeed, anything suggested by www.i-orp.com has to be double-checked with tax software such as TurboTax.

In particular, it may make sense to tap the Roth a little bit to stay below certain limits of income where taxes go way up. That is not an intuitive result.

 

[M Paquette]

This matches our plan. We are treating SS as longevity insurance, and want to maximize the monthly payments by delaying m SS until age 70. We plan to start IRA withdrawals as soon as possible, and use that plus capital gains and dividends from taxable accounts to cover us up to age 70. (Note that this model works well for OUR revenue streams. Yours may be different.)

As the article describes, this has two advantages. First, we make IRA withdrawals while in a very low tax bracket. Second, our eventual Required Minimum Withdrawal while we are taking SS will be lower as we will have drawn down the IRA, so the tax impact on SS won't be as severe. Under current law, this multiplier effect of making more of SS taxable, in addition to the tax on the IRA withdrawals, would be significant.

As with all such plans, the ability of changes to the tax code to de-optimize a tax strategy should not be underestimated. The portfolio tests out as survivable for any reasonable tax policy, from SS means tested cutoff of all benefits, to everything taxed as ordinary income.

 

[jebmke]

I don't understand why a lot of people think you have a tap a certain kind of account "first". If you look at calculators such as the one found at www.i-orp.com the answer seems to be: tap all accounts simultaneously with the amounts set up to give you the lowest possible taxes.

So the question is never "Which to tap first?"; instead the question is "How much of each account type to tap including how much to convert from IRA to Roth IRA?"

The answer is "One size does not fit all." For example, I may have a taxable account and you may not. I may have large carryover losses that somebody else may not have. Etc.

Folks we have to THINK about this carefully and understand why we have THINK about this carefully. Indeed, anything suggested by www.i-orp.com has to be double-checked with tax software such as TurboTax.

In particular, it may make sense to tap the Roth a little bit to stay below certain limits of income where taxes go way up. That is not an intuitive result.

This.

The chance that the OPs situation matches anyone else's is purely chance.

 

[growing_older]

I think it's a complicated balancing act. It also depends a great deal on how much you have in taxable and IRA accounts. Deferring taxes until later is good, unless it causes your eventual RMD to push you into a higher bracket. You can mitigate this somewhat by living off taxable and converting traditional IRA to Roth up to the edge of the next bracket. To balance optimally means knowing future investment returns and future tax rates, which you can never know exactly. Which means you will end up taking a best guess so no sense worrying over unknowable details.

I think your CFA is thinking to spread out income and reduce future RMD, but it may be worth running the numbers to see what combinations are most efficient with your current assumptions.

 

[Khufu]

What gives me the best long term level of disposable income when I run simulations using Esplanner is: spend taxable, convert IRAs, and defer SS. It's hard to know what is the optimum level of converting the IRAs, so I am going to convert up to the top of my tax bracket, which should convert almost all of it before SS begins at age 70.

 

[pb4uski]

What gives me the best long term level of disposable income when I run simulations using Esplanner is: spend taxable, convert IRAs, and defer SS. It's hard to know what is the optimum level of converting the IRAs, so I am going to convert up to the top of my tax bracket, which should convert almost all of it before SS begins at age 70.

I agree and that is consistent with my plan, however there are two other important considerations in my case that may apply to you and others as well.

First, I live in a high property tax state that offers significant property tax relief based on "income". While I didn't qualify for these programs while I was working, now that I am ERd and living on taxable savings I do qualify but IRA withdrawals/Roth conversions are counted as income. The property tax relief formula has a significant cliff at ~$47k of income. If I design my IRA>Roth conversions to stay below that amount of income then I am fine. After that, if I do another $100 of Roth conversion my taxes and reduction of property tax relief is almost $1,700 or if I do an additional $10,000 the net cost is almost $2,900 (29% tax cost - too much!!). So if you live in a state with property tax relief based on income rather than a homestead exemption then that should be considered.

Second, since I am now paying for my own health insurance in a high deductible plan I am cognizant of the implications of additional IRA withdrawals or Roth conversions on ObamaCare health insurance subsidies beginning in 2014 which may be at least tentatively based on 2012 tax return information.

 

[Khufu]

I agree and that is consistent with my plan, however there are two other important considerations in my case that may apply to you and others as well.

First, I live in a high property tax state that offers significant property tax relief based on "income". While I didn't qualify for these programs while I was working, now that I am ERd and living on taxable savings I do qualify but IRA withdrawals/Roth conversions are counted as income. The property tax relief formula has a significant cliff at ~$47k of income. If I design my IRA>Roth conversions to stay below that amount of income then I am fine. After that, if I do another $100 of Roth conversion my taxes and reduction of property tax relief is almost $1,700 or if I do an additional $10,000 the net cost is almost $2,900 (29% tax cost - too much!!). So if you live in a state with property tax relief based on income rather than a homestead exemption then that should be considered.

Second, since I am now paying for my own health insurance in a high deductible plan I am cognizant of the implications of additional IRA withdrawals or Roth conversions on ObamaCare health insurance subsidies beginning in 2014 which may be at least tentatively based on 2012 tax return information.

Yikes. That's really complicated. You would want to optimize the RE taxes, but over the long term bearing in mind the effect that RMDs along with SS after 70.5 will have. It could conceivably be the case that it's better to go way over now with Roth conversions with the confidence that your RMDs will be low or zero and you won't be subject to the RE bump after 70. But that depends on your numbers.

 

[pb4uski]

I agree - it is really complicated and the effect on future RMDs is the dilemma. The rub is that the property tax relief benefits are real since they are there today and the RMDs are such a long ways off for me (14 years) it is harder for me to see the benefit as clearly and who knows what will happen between now and then.

But my thinking is that even if I went to the edge of the 15% federal tax bracket of $69k TI as many here do, the incremental tax rate on the additional Roth conversion would be about 20% (incremental federal and state income tax and lost property tax relief) and that ignores any Obamacare health insurance subsidies. Adding an estimated health insurance subsidy benefit that I would lose by taking more Roth conversions today would increase the 20% to 37% whereas I think the "cost" of RMDs when the time comes will be less.

At least that is my story and I am sticking to it.

 

[foxfirev5]

There's no one answer. Over the years I feel I went overboard on the 401k contributions and wish I had more of a taxable portfolio to draw from. At this point the Roth conversion is not a solution either. For now I'm going to contribute to the match, max out the Roth and try to scrape up the cash to get me from age 58- 59 1/2. My DW chuckles at that one since we have reserve accts upon reserve accts for various emergencies that may arise.
At that point I plan to fill up the 15% tax bracket with rollover IRA withdrawals and see if I can delay SS at 62. I still don't know which is the best route. I do know it's not a no brainer situation. Other factors come into play as well -health, estate situation and flexibility are three big ones that come to mind.

 

[BOBOT]

Wow, as I said, it can get complicated. Thanks for the thought-provoking replies.
I should have said in my op that soon after the CFA's plan I got the VG freebie. Although they won't specifically review someone else's plan the guy was adamant about deferring w'drawals from the ira's.
So I'm still kind of at sea on this.

 

[LOL!]

Wow, as I said, it can get complicated. Thanks for the thought-provoking replies.
....
So I'm still kind of at sea on this.

So did you put your assets into the calculator at www.i-orp.com ?

 

[Animorph]

So did you put your assets into the calculator at www.i-orp.com ?

+1.

That's probably your best bet at a simple second opinion.

 

[Katsmeow]

There are so many good reasons for delaying SS to age 70 now, that it becoming almost a no-brainer.

I don't agree. I do think that in many instances it can be a good idea to delay to 70 but I think that for many (even most perhaps) people it is far from a no-brainer for many reasons. You have to look at the whole picture on an individual basis.

 

[BOBOT]

So did you put your assets into the calculator at www.i-orp.com ?

Yes, but I don't know that I trust those results either. First, ORP shows big withdrawals, starting now, from both after-tax and the tax-deferred, with a lot of that rolling over to the Roth in each of the next 4 years (age 68), then withdrawing from the Roth (as well as the other accts) for the remainder of the plan.
Also gives a spending level nearly double of other planning tools (and CFA), about a 9.7 withdrawal rate!
Maybe I gave it bogus input, or am not interpreting the results correctly.

Our situation is not complicated or unusual in any way, so I don't get why this should be confusing or difficult.