Best practices to balance withdrawals from taxable accounts and IRAs

[davidfin]

I have several investment buckets: taxable joint investment account, two IRAs and a Roth. Clearly if the Roth is held for a minimum of 5 years, there are no tax consequences. My question therefore, pertains to balancing withdrawals from the IRA and the taxable accounts. The advantage of tax deferred growth in the IRA is a strong incentive to “let it ride” and fund living expenses from the taxable investment account with lower tax rates for LTCG until depleted. Possibly by then, my social security benefits will have kicked in and the draw down on retirement accounts will be reduced. Oregon does not tax SS benefits but distributions from taxable (non-LTCG) and IRA accounts ranges from 5% to 9.9% rates. Once the taxable account is depleted, I am left with SS benefits and IRAs taxed as ordinary income. I know you have to pay the piper, but I'd like to keep more of my money.
The goal is to reduce federal and state taxes to extent possible. Are there best practices that can be employed to balance withdrawals from taxable accounts with lower tax rate LTCGs and IRAs taxed at the marginal rate expected to be higher than the LTCG tax rate?

 

[SecondCor521]

I don't have specific recommendations about your situation. In general:

1. Do tax planning in the fall each year. At least sit down and do a proforma tax return for the current year, and evaluate if it makes sense to harvest capital gains, harvest capital losses, do a Roth conversion, etc.

2. Try to project out multiple years in broad strokes. Several people here, for example, think that it is a good idea to do Roth conversions so that RMDs plus SS don't put you into a super high bracket at age 70 or so.

3. Using modeling programs such as i-orp can give you multiple year planning insights. (I always found i-orp hard to understand myself, but I can be dense understanding other people's models. Maybe it will work for you.)

4. You can ask here about specific trade-offs and often times people here will at least give you things to think about.

5. I think it's pretty hard to get more than a general sense of what to do, as taxes are quite complicated. Also, the laws change often enough that at some point you do as much as you can, pay your tax bill, and move on.

Finally, I'd just point out that holding a Roth for 5 years is necessary but not sufficient to have "no tax consequences". You also need to be over 59.5. That may indeed be the case in your situation, but it is not generally speaking completely accurate.

Good luck!

 

[FI_RElater]

it really depends on how much you have in the tax-deferred accounts and what impact that will have on your tax rates once RMD’s hit. Age plays a part in what you can access and how long you have to potentially convert IRA to Roth. If you retire really early then you might be able to convert a significant amount over a long period.

you probably just need to titrate your withdrawals from IRA’s to stay in the lower bracket and use your taxable to supplement. That way you slowly deplete the IRA but try to minimize taxes. (Roth never gets touched). If you have room...you can also convert some small part of the IRA into Roth (in addition to that which you take for ongoing needs), staying under the higher rates, in order to give additional flexibility.
Remember to also consider the effects of single versus MFJ if one predeceases... hence the push for conversions to give tax exempt for the surviving spouse


If you’re like us, I haven’t started taking any IRA nor SS yet (will wait until at least FRA plus) so will be doing some Roth conversions to top of lower rates__but I’m early sixties, not as typical of this forum vs BH, so don’t have as long to convert. Taxable will supplement pension and IRA will be titrated to slowly take it out (we will probably never be able to fully convert all the IRA’s). Once we claim SS, exempt in OR, we will be taking out more in IRA until 70 1/2 then do minimum distributions unless more is really needed... unlikely with our levels of taxable accounts and CD ladder.

 

[DrRoy]

Still pre-RMD, so all taxable for now. I am recharacterizing reg IRA to Roth up to the limit of the 10% bracket.

 

[MrLoco]

I think it depends. There are a lot of moving parts and obviously everyone's situation is different.


One thing I would not do is deplete any of the investment "buckets" but keep a taxable account; a tax-deferred account (Trad IRA); and a tax free (Roth IRA) for the rest of your life. Because your expenses will change year to year and having all three type of accounts allows one to efficiently withdraw money year to year.
An example would be if someone is pre 65 and is currently receiving an ACA subsidy. As a family of two, estimated MAGI will come in right round $60,000.....just under the cliff where the subsidy would be lost. The couple wishes to buy a new car for $30,000 but doesn't have this amount in cash and would have to withdraw from taxable generating gains or from a Trad IRA and this would cause them to go over the ACA cliff and lose the subsidy. What to do? Withdraw the $30,000 from the ROTH IRA ( as long as the 5 year rule has been satisfied) ; no taxes due or changes to MAGI; and able to buy that new car.


Or tax loss harvest in the taxable account to minimize taxes.


Or later in life you or your spouse requires assisted living or nursing home care. Withdraw the money from a Trad IRA and the taxes due would be offset by the medical deduction available on Schedule A of Form 1040.


These examples are why I feel it is important to have all 3 options available; taxable, tax deferred , and tax free in retirement as it gives you options on where to withdraw the money while minimizing taxes year to year.

 

[davidfin]

Thanks for your input. As it happens, I do use the ACA and through careful AGI management try to maximize the subsidy. So far I'm not willing to lose the $11K+ subsidy by converting a significant chunk of IRA to a Roth. Perhaps short sighted. The comment about purchasing a car rings true. Given I'm not too far from medicare, I'll probably take a loan and then pay it off once I'm done with the ACA. The interest payments would be much lower than the loss of ACA subsidy by paying all at once coupled with increased in income taxes. A single payer plan would certainly simplify tax planning. Too many hoops to jump through.

 

[Scuba]

I tried using online models such as I-Orp and in the end decided it was worth it to pay our CPA a few hundred bucks for tax projections and advice on strategy. As others have said, everyone’s situation is different. Generalized advice may or may not be the best for your specific situation. In our case a suboptimal decision could easily cost several thousand dollars per year. Paying our CPA to try to get this right is a good investment for us.

 

[TwoByFour]

The goal is to reduce federal and state taxes to extent possible. Are there best practices that can be employed to balance withdrawals from taxable accounts with lower tax rate LTCGs and IRAs taxed at the marginal rate expected to be higher than the LTCG tax rate?

We are going to get walloped when I turn 70/71 because at that point I will start SS and start RMD withdrawals. Our tax rate is low right now, about 10% effective tax. We mostly live off LTCG and a pension.

So I also am concerned about the tax hit. Bogleheads talks about this a lot and some people advocate taking RMD now but I am not sure that would buy us a whole lot, but I will look into it. As others have said, there won't be a one-size fits all answer, you have to run your exact numbers to see.

Part of me is resigned to just pay the tax. We will pay more tax because we are making more money which I am not complaining about.

 

[MrLoco]

We are going to get walloped when I turn 70/71 because at that point I will start SS and start RMD withdrawals. Our tax rate is low right now, about 10% effective tax. We mostly live off LTCG and a pension.

So I also am concerned about the tax hit. Bogleheads talks about this a lot and some people advocate taking RMD now but I am not sure that would buy us a whole lot, but I will look into it. As others have said, there won't be a one-size fits all answer, you have to run your exact numbers to see.

Part of me is resigned to just pay the tax. We will pay more tax because we are making more money which I am not complaining about.

I can appreciate your current low tax rate of 10%....but one solution depending on your current ages....might be to do Roth conversions up to the top of the 12% level.


The top of the 10% bracket for 2018 is $19,050. The 12% level tops out at $77,400 for a joint return. So for only an additional 2% in a tax rate; you could convert up to $58,000 from your trad IRA to a ROTH and minimize the taxes due from RMD's while enjoying future tax free growth in the Roth.

 

[TwoByFour]

I can appreciate your current low tax rate of 10%....

Thanks for the comment, but that 10% rate is not the bracket but the effective tax rate. In other words, the percentage of tax we paid relative to MAGI. Our bracket was 15%.

 

[HI Bill]

holding a Roth for 5 years is necessary but not sufficient to have "no tax consequences". You also need to be over 59.5.

Can't you withdraw the contributions tax-free prior to 59.5?

 

[HI Bill]

My general game plan is to defer taxes as long as possible, paying as little as possible up front. This has the advantage of allowing tax-deferred accounts to grow, and may also lessen the sequence of returns risk (I'll pay more in taxes once SS, and then RMDs kick in, but then there's a 'guaranteed' source of income from SS). In FIRECALC, etc., the risk of running out of resources at a ~4-5% withdrawal rate usually kicks in around 20 years.

So, I'm planning on paying little in Federal taxes (<$2K annually) for the first 7 years of my retirement, until I hit 62, mostly by hitting taxable accounts and Roth IRA contributions and cash first; then, after 62, I start hitting the IRAs, and add SS between 67-70. I haven't run calculators to see if this is the optimal plan, but it does leave my assets invested as long as possible. And, with the distribution of taxable accounts and cash, I have little choice before 59.5, without establishing a SEPP (72t), anyway.

I'd suggest setting up a spreadsheet from retirement age to end of life, then calculating potential taxes year by year (selecting income streams as appropriate).