Asset drawdown in "Retirement"

[jarts98]

Q: When beginning to live off one’s investments, what is your preference (and why) among these to choices for drawing down assets: (1) Use taxable accounts first, letting IRA’s continue to grow; or (2) begin withdrawing some from IRA’s annually and use less of the taxable accounts to supplement the IRA distribution?

Basic background (trying to keep it simple to focus on the real issue): I’m considering giving up the day to day work grind and work on some areas of interest that may or may not produce income. Let’s assume no income is produced, so I’ll need to live off investments. Further, assume one has a significant amount in taxable accounts and a larger amount in IRA’s.

Scenario 1 Detail: First draw down the taxable accounts, leaving the IRA’s to grow tax deferred. As my taxable income would be low, I’d plan on converting (but not withdrawing) some traditional IRA balances to Roth IRA’s annually to take advantage of the low tax brackets. Eventually, when the taxed accounts are drawn down (but still leaving a nice sized “emergency” cash balance), begin to tap the IRA’s (Roth’s first, then traditional IRA’s).

Scenario 2 Detail: Begin in year 1 to take a distribution from the traditional IRA each year (using a 72T as I’m still in my 40’s) and take a much smaller amount from the taxable accounts to supplement my spending needs. Obviously the taxable account would last much longer with this scenario, but I’d start tapping the IRA’s earlier.

Do you see an advantage (or disadvantage) to one of the scenario’s?

Thanks for your thoughts.

jarts98

[MichaelB]

Hi jarts98. There are lots of past discussions on this. Here are a few

http://www.early-retirement.org/foru...ent-63934.html
http://www.early-retirement.org/foru...ney-63823.html
http://www.early-retirement.org/foru...ice-63125.html

This from the forum FAQ section Early Retirement FAQs - Early Retirement & Financial Independence Community

If you do a search you will find many more.

[fritz]

Quote:

Originally Posted by jarts98 Q: When beginning to live off one’s investments, what is your preference (and why) among these to choices for drawing down assets: (1) Use taxable accounts first, letting IRA’s continue to grow; or (2) begin withdrawing some from IRA’s annually and use less of the taxable accounts to supplement the IRA distribution? Basic background (trying to keep it simple to focus on the real issue): I’m considering giving up the day to day work grind and work on some areas of interest that may or may not produce income. Let’s assume no income is produced, so I’ll need to live off investments. Further, assume one has a significant amount in taxable accounts and a larger amount in IRA’s. Scenario 2 Detail: Begin in year 1 to take a distribution from the traditional IRA each year (using a 72T as I’m still in my 40’s) and take a much smaller amount from the taxable accounts to supplement my spending needs. Obviously the taxable account would last much longer with this scenario, but I’d start tapping the IRA’s earlier. Do you see an advantage (or disadvantage) to one of the scenario’s? Thanks for your thoughts. jarts98

I believe everyone's retirement scenario is as unique as their fingerprints. That being said - this is ours:

We fit into your given background and Scenario 2 detail - but we retired at 59/57 and are living off a separate cash savings account that was put aside for use until I reach 62 and start drawing SS (6 mos from now). Drawing SS @ 62 to minimize depletion of our own savings - allowing savings to continue to grow in our pocket. View SS as an annuity going away when we do. It is not crucial to our retirement income - but it sure helps, and should allow us to leave a larger nest egg to our children. I do work part-time as a consultant for a start up company, but no plans to go back to work at this point.....

We are starting to draw down on all our savings accounts equally - IRAs and taxable, to replenish the local cash savings accounts. Look to have at least (1) year local retirement income savings on hand. Our scenario is that we will have adequate living expenses with just dividends and my SS.

I've always felt that in our scenario - drawing down accounts equally would allow us to always have significant taxable accounts for any spending scenario (emergency or planned) with the objective of avoiding going into a higher tax bracket that year - possible scenario if we only had IRA funds available (sort of like juggling the books).

You've stated that you are still in your 40's, but I would think that you will face the same scenario as we do as you age. The 72T has its pitfalls, but depending on your own scenario - might be worth investigating to keep a level investment playing field throughout your retirement

[pb4uski]

I'm more Scenario 1. Retired at 56 - will live off taxable accounts first and convert IRA money to Roth as I can and stay in 15% tax bracket. I plan to take SS at 70 but will do it earlier if needed. Roths will be the last drawn. So in a nutshell - taxable, tax-deferred and tax-free in that order.

[growing_older]

I'm expecting to draw down like pb4uski described, but with a little look ahead to try to keep from having so much remaining in tax deferred that I am forced to take RMD into a higher tax bracket than I want. I don't have a good way to measure this, but plan to use my best guess anyway.

[Tyro]

Quote:

Originally Posted by fritz I believe everyone's retirement scenario is as unique as their fingerprints.

+1. While general wisdom is to drain taxable assets first, there are situations where a mix of taxable and deferred/tax free assets can actually stretch a nest egg out further.

Tax-Efficient Retirement Withdrawal Planning Using a Linear Programming Model

It's probably mentioned somewhere in the threads MichaelB referenced, but some of the online retirement calculators take this into account, and suggest such mixes where appropriate. I don't recall off the top of my head which calculators do this; others here may be more familiar with those specifics.

[Focus]

Quote:

Originally Posted by Tyro some of the online retirement calculators take this into account, and suggest such mixes where appropriate. I don't recall off the top of my head which calculators do this; others here may be more familiar with those specifics.

Like this one? ORP Retirement Calculator

[mathjak107]

i will draw down ira's first up to the limit of the bracket im in . i want to reduce the rmd's down early on.

[scrabbler1]

I am solely in Scenario 1. And even within Scenario 1 I am still running a surplus of overall dividends over expenses. This means I do not have to touch any principal while reinvesting said surplus into the mutual funds which generate the dividends, a mild inflation guard.

So my first backup plan is to use some of the dividends now being reinvested to cover my expenses should they grow more quickly than the dividends do. Only if the expenses exceed all the dividends will I have to tap into principal, and it does not appear that will happen for at least 8 years, if it happens at all. Therefore, I can maintain a wall between my TIRA and my taxable accounts until I have unfettered access to the TIRA which will be able to grow over the next 10+ years (when I turn 59.5). The TIRA is the first of my "reinforcements" I will have access to at that time or slightly later, the others being SS and my frozen company pension.

[jarts98]

scrabbler1,

Are you converting any from a TIRA to a Roth annually to take advantage of the lower tax brackets? Perhaps your dividends already use up the lower brackets......just curious how others plan for distributions years down the road by taking advantage of relatively low taxable income years.

Thanks.

jarts98

[Tyro]

Quote:

Originally Posted by wishin&hopin Like this one? ORP Retirement Calculator

Yeah, like that one!

This one does it too. The Flexible Retirement Planner | A free online retirement calculator based on Monte Carlo Simulation
There may be more; I like to try a lot of them -- helps me easier.

Tyro

[scrabbler1]

Quote:

Originally Posted by jarts98 scrabbler1, Are you converting any from a TIRA to a Roth annually to take advantage of the lower tax brackets? Perhaps your dividends already use up the lower brackets......just curious how others plan for distributions years down the road by taking advantage of relatively low taxable income years. Thanks. jarts98

I have looked at this over the 4 years I have been ERed. I have been very close to the top end of the 15% bracket (sometimes slightly exceeding it), so converting a little bit to a Roth would benefit me little if at all.

[Alan]

Quote:

Originally Posted by pb4uski I'm more Scenario 1. Retired at 56 - will live off taxable accounts first and convert IRA money to Roth as I can and stay in 15% tax bracket. I plan to take SS at 70 but will do it earlier if needed. Roths will be the last drawn. So in a nutshell - taxable, tax-deferred and tax-free in that order.

Similar approach here.

[Midpack]

Quote:

Originally Posted by pb4uski I'm more Scenario 1. Retired at 56 - will live off taxable accounts first and convert IRA money to Roth as I can and stay in 15% tax bracket. I plan to take SS at 70 but will do it earlier if needed. Roths will be the last drawn. So in a nutshell - taxable, tax-deferred and tax-free in that order.

+1. Exactly what I'm doing, thanks for describing our plan for me.

[LOL!]

For those converting IRA to RothIRA up to the top of the 15% marginal income tax bracket I have a question:

Did any of those calculators tell you to convert up to the top of the 15% tax bracket?

I ask because those calculators tell me to convert up to the top of the 0% tax bracket, but there appears to be no reason to convert more.

[samclem]

Quote:

Originally Posted by LOL! For those converting IRA to RothIRA up to the top of the 15% marginal income tax bracket I have a question: Did any of those calculators tell you to convert up to the top of the 15% tax bracket? I ask because those calculators tell me to convert up to the top of the 0% tax bracket, but there appears to be no reason to convert more.

It would depend on what you expect your tax rate to be during your retirement. It often makes sense to convert to a Roth up to that rate, but nor beyond it.

[LOL!]

^Yes, I realize that.

I was mostly wondering if the calculators gave advice that folks decided not to follow. Or if folks just didn't use the calculators. Or if the calculators are just plain wrong. Or if the calculators recommended filling up the 15% tax bracket.

[imoldernu]

Am beginning to learn about SWR... which never crossed my mind, when we retired. It was just a matter dozens of spreadsheets, calculating different possibilities... trial and error...

Our retirement plan was, and is based on life expectancy and boils down to this.

Quote:

There are hundreds of financial planners on line where you put in your estimates of assets, and return and inflation, and come up with the amount you need to retire. In our case it doesn't work... All of the planners make the assumption that you will want to maintain your asset capital until you die... In our case, had we followed their plan, we NEVER would have retired. We just decided to die at age 85... dead broke. Made our planning much easier. Personal decision of course, but if you plan to spend down capital assets, it makes planning easier. Our plan is extremely simple... On the spending side, we have three different budgets that we can adjust as circumstances warrant. Best case... Nominal... and Austerity. On the Asset/Nest Egg side, We boil our assets down into three categories. 1. Fixed assets... house, auto, and other valuable non cash items... real property, jewelry, . We do not count household goods... (experience tells us that this is not realistic) 2. Non Income producing assets... bank accounts, cash, cash value life insurance policies. 3. Income producing assets... stocks, bonds, annuity. All of these items are kept on a spread sheet and periodically updated. It's easy to come up with a total value... and then to average the income from the total... To calculate where we stand in our retirement plan, we add a. Social security amount. b. Amount of interest earned on income producing assets. c. ... and add the Total Assets divided by the number of years between now and age 85. That establishes how much we can spend, which we then adjust to our best/nominal/austerity budget. Sounds funky, but it works,and it takes about 2 minutes to tell if we're on budget or not. The second part of this budgeting thing, is that we've been blessed by not having any debt. All of this makes for very simple accounting. One more thing... we don't try to calculate for inflation. In fact, it has not been a problem over the past 20 years. This may have to change.

Our current budget is built from the ground ... up, with Social Security $25K (for 2) as a base.

As to the taxes? Frankly, didn't even plan, but haven't had to pay taxes yet.
Looking back, left a very few bucks on the table. Now getting in to drawdown of tax deferred assets, but because living expenses are getting low, don't expect to have to pay much. Retired 1989 @age 53.

[jarts98]

Quote:

Originally Posted by LOL! For those converting IRA to RothIRA up to the top of the 15% marginal income tax bracket I have a question: Did any of those calculators tell you to convert up to the top of the 15% tax bracket? I ask because those calculators tell me to convert up to the top of the 0% tax bracket, but there appears to be no reason to convert more.

I assume my rate would be higher than 15% when I'm drawing out larger amounts from a TIRA account to cover my annual expenses. So I might as well take advantage of the 15% when I can.

[Animorph]

Quote:

Originally Posted by LOL! For those converting IRA to RothIRA up to the top of the 15% marginal income tax bracket I have a question: Did any of those calculators tell you to convert up to the top of the 15% tax bracket? I ask because those calculators tell me to convert up to the top of the 0% tax bracket, but there appears to be no reason to convert more.

I wrote my own software to do my retirement calculations. It includes taxes (inflation adjusted), but just uses simple investment growth and inflation. Surprisingly, to me, it is telling me to Roth convert now, even though DW is still working and this year's income is well past the 15% bracket already. I've been working on this for a couple of weeks now, with and without the Bush tax cuts in future years and with and without using additional individual savings and emergency funds to increase Roth conversions.

Here's why I think it's optimum for me to convert past the 15% bracket:

#1 When all my income sources come on line (mostly SS at 62 and 70) RMD's will push me into the current 25% bracket. Even if I Roth convert using taxable funds not allocated to retirement, RMDs eventually exceed the 15% bracket for me. Obviously this will be different for many, but I have some IRA withdrawals that will be taxed at 25% or higher.

#2 Earlier conversions have longer to grow tax-advantaged in the Roth accounts, and effectively reduce the last withdrawals out of the traditional IRA, not the first. These conversions are the last out of the Roth. So if the tax rates for conversion versus a much later hypothetical traditional IRA withdrawal are equal, or even even slightly higher (like 3%) now, the added after-tax value growth in the Roth over a long time is enough to overcome that disadvantage. In my case, the tax rates were 25%+ now and maybe 28%+ later, but I'm still better off converting now.

Later in retirement, my last Roth conversions are coming just before I'm going to start RMD's and withdrawing from the Roth to avoid higher taxes. I can either Roth convert and use Roth withdrawals the next year, or I can keep the taxable funds and use them instead of Roth withdrawals the next year. So that last Roth conversion, for me, is , I think, effectively in the Roth account for just a short time. Not enough time to make even an equal taxes in and out worth it.

#3 I have a limited amount of time between now and when we need to take RMDs, and when all other income sources are on line. I have to cram enough Roth conversion into that period so that the RMD's are significantly reduced. For me, it looks like I need to convert lots of it at roughly equal taxes in and out, not just up to the 15% bracket.

#4 My taxable accounts must pay not only the Roth conversion taxes, but also our living expenses. That limits the number of years I can Roth convert. I need to squeeze an optimum amount of Roth conversion into those years, before I exhaust my taxable accounts.

Those are my thoughts on why my optimum conversion strategy includes conversions over the 15% bracket. Too bad my simulation can't enumerate them explicitly!

Anyway, my optimum conversion strategy according to my simulation is this:

20012 & 2013: convert partially into the current 31% tax bracket!
2014 - 2018: convert to the top of the current 25% tax bracket (even if tax rates move to 28%)
2019 and beyond: convert if taxable funds available up to the 15% tax bracket, or withdraw traditional IRA funds up to the 15% tax bracket.
2030: RMD's start (I'll have emptied my traditional IRA accounts, but DW's will still have some no matter what.)

I've tried perturbing the conversion amounts a little bit each way and this looks like a pretty robust optimum.

All of that said, the fact that I'm Roth converting at all seems to gain me about $7k extra spending per year during retirement. The fact that it is now super-optimized seems to gain me less than $1k per year. The biggest gains were had with the big earliest conversions. I'm now sorry I didn't do this optimization earlier, since I probably should have been Roth converting for a few years now.

I also have to send in big estimated federal and state tax payments in January, and detail our quarterly earnings and taxes in TurboTax for this year. Big PITA. I'll be more prepared next year.