Calculating my tax torpedo situation - did I do it right?

[SecondCor521]

I'll guess that the small difference in time frame is generating misleading differences in the numbers you want.

...

Thanks for the data, I really appreciate it.

I went back and looked, and I was using 3% for SS COLAs based on data from the SSA website. But looking at it again, it has COLAs from the 70's, which were obviously much higher on average.

I plugged in the 2.6% number and it does affect things somewhat, but from my spreadsheet it looks like the annual amount of Roth conversions overwhelms the SSA COLA effect.

 

[Luck_Club]

Torpedo:

I compare my 2039 AGI to the 2039 tax brackets and find that I fill some of the lower ones and part of one of the middle ones, which becomes my marginal rate. Like most who do this exercise, this marginal bracket in 2039 is a few brackets higher than what I pay today, so I should consider Roth converting more between now and then.

So my main question is, did I get the math fundamentally correct? That is, did I make any errors in the above logic which could materially affect the resulting conclusion?

Your logic is correct, many successful investors have a tax bomb waiting in their 401K's & IRA's. It beats the alternative of having no money in your 401k.
Strategies I'm (1967) exploring to minimize the impact:
Roth conversions
start to take and or spend 401K /IRA money @59.5
Take SS at 62
Tax free muni's for non IRA money

On the plus side. My Accountant always said having to pay taxes is a good problem to have, because it means you made money.

 

[marko]

In 2039, tax rates may be much higher, or lower. Or there may be a VAT. Or we may be a different country. Or an asteroid may hit.

I'm sure I'm missing something.

I can't imagine why I'd be trying to figure out my taxes 21 years in advance. I can't even consider worrying about my taxes for 2019 just yet.

Way, way, way too many variables.

 

[audreyh1]

I'm sure I'm missing something.

I can't imagine why I'd be trying to figure out my taxes 21 years in advance. I can't even consider worrying about my taxes for 2019 just yet.

Way, way, way too many variables.

Because you might decide to do some Roth conversions if it appears you’ll pay lower taxes now rather than later?

 

[marko]

Because you might decide to do some Roth conversions if it appears you’ll pay lower taxes now rather than later?

That's fine, but 21 years out?

Must be me, but I just see way too much change and life variables tax-wise in 21 years to try to build an actual action plan.

 

[audreyh1]

That's fine, but 21 years out?

Must be me, but I just see way too much change and life variables tax-wise in 21 years to try to build an actual action plan.

It might take 21 years to significantly reduce your IRAs without exceeding certain income limits. Usually the longer the better because the smaller the annual chunks the lower the tax rate.

 

[SecondCor521]

@marko and @audreyh1:

audreyh1 has it exactly correct. In my case, it appears that, since I have 21 years, I can do conversions anywhere between about $9K and $50K, and that can move me two or more brackets in my 70's. The savings is, well, take a look at the width of the middle tax brackets and multiply that by the differences between two of the middle brackets. It's serious coin that can go to my kids rather than the IRS.

Another thing is, for me anyway, I'd like my income to be low for the next few years while my kids are in college, so I am limiting my conversions for some of those 21 years. I was curious to know if I was getting myself into a high-tax situation from which I couldn't extricate myself.

But I see marko's point as well. I start looking at RMD's at 70, IRMAA, SS, kids' college, lifetime consumption smoothing, the probability of me even being alive to spend the money, the 4% rule, the market, asset allocations, the probability of Congress changing the tax laws again, and so sometimes I feel like I just want to take some very simple actions (like convert to the top of the X% bracket) and then go do something else because chances are I can't perfectly optimize everything all the time.

@Luck_Club, my grandfather, a tax accountant, had the same saying.

 

[Gotadimple]

Your logic is correct, many successful investors have a tax bomb waiting in their 401K's & IRA's. It beats the alternative of having no money in your 401k.
Strategies I'm (1967) exploring to minimize the impact:
Roth conversions
start to take and or spend 401K /IRA money @59.5
Take SS at 62
Tax free muni's for non IRA money

On the plus side. My Accountant always said having to pay taxes is a good problem to have, because it means you made money.

It all looks good, except for the social security part. By adding SS to Roth conversions (taxable) and 401k/IRA withdrawals (taxable) you are adding another taxable income stream.

If withdrawals and conversions are large enough you'll pay tax on the Social Security stream. Sure SS tax is capped at 85%, but it is still a tax burden to consider. Instead, consider delaying SS until age 70, and take larger withdrawals, or make a larger Roth conversion to deplete the 401K/IRA accounts sooner. It will significantly reduce the amount of RMDs, lowering the taxes due, but you'll have taxes to pay on SS - eventually.

Finally, when considering the entire income stream up to age 63*, be mindful of the income limit on Medicare Part B premiums (generally not discussed but it's a bomb too!). Currently, a single individual pays the quoted Medicare premium up to $85K of modified AGI. Above that number IIRMA kicks in and there is a surcharge to the quoted Part B premium, and it's not little.

* Age 63 because Medicare looks at Modified AGI two years before the current premium year to determine if IIRMA applies. To avoid it you need to reduce incomes to the maximum allowed before IIRMA. MAGI also includes tax-exempt interest.

Just a bunch of moving parts to include in your planning

-Rita

 

[Lawrencewendall]

This may of use to some:

To calculate how much of your SS is taxable

https://www.fool.com/retirement/2016/06/06/social-security-tax-calculator-are-your-retirement.aspx

My plan is to convert as much as I can from tax-deferred to Roth starting at 57 until 70. My yearly spending is only about 70k and the top of the 12% bracket is 101.4k (77.4k + 24k standard deduction) That leaves me around 20k after taxes to convert for 13 years. At 70, the RMD will equal the conversion so I will just stop converting.

All my sources of income will COLA'ed and I have VA medical.

 

[Happily Retired]

The calculator link provided above by LawrenceWendall is a great one for checking to see if you’ll have the “Social Security Tax Torpedo” issue. The link is has unfortunately been shortened so can’t be copy and pasted. It can be found by searching for “Social Security Tax Calculator: Are Your Retirement Benefits Taxable?”.

We’ve got the Tax Torpedo problem (too high of a percentage of our retirement money in tax deferred IRAs). Our solution is nearly the same as Lawrence’s. Here’s our plan:

We FIREd our FT employers at age 59 ½. Between 59 ½ and age 70 ½ we’re busy with Roth conversions. A home-grown Excel spreadsheet helps us determine the annual Roth conversion amount. We’re being careful to spread our tax load across those 11 or so years keeping our Effective Tax rate as low as possible. We’re currently showing 12.7% average across that range of years.

All of our Roth conversions should be finished by ages 70 or 71. We should be paying near-zero income taxes from then on! That’s what our tax software (TurboTax) is showing. Yes, I know that tax laws change annually and that our TurboTax software’s tax laws are “frozen” in time, however, doing future taxes using our very best dollar figures is as accurate as it probably gets. I feel good about the results and re-do our future taxes annually.

Healthcare insurance needs, our solution. Neither DW nor I had employers that helped with healthcare costs during retirement. Wife and I are currently age 62, so don't yet qualify for Medicare. We’re getting our Healthcare by working seasonally 4 months of the year for the local IRS center. When in “non-work status”, or furloughed (laid off) we continue to enjoy government-provided healthcare, dental and vision. Yes, we pay our “small” part of the insurance costs. We would recommend this to others not-yet-65 and needing insurance.

Also while furloughed we can collect unemployment, until we get recalled for work in January. This is a nice “bonus” on top of the insurance.

This solution has been working well for us!


Call us "Happily semi-retired" for now then "Happily Retired" at age 65 with Medicare and supplemental insurance.

 

[Animorph]

If you're paying near zero income taxes after age 70 then you're Roth converting too much! Hang on to some of your tIRA and make use of some of those low post-70 tax rates.

 

[Helena]

I take my RMD plus my SS minus the standard deduction of $12K. (I think the standard deduction also increases by chained CPI but I chose to ignore that here.) The result is my taxable AGI in 2039.

The current standard deduction for a single person age 65 and older is $13,600. Yes, it will increase based on Chained CPI.

.

 

[Happily Retired]

If you're paying near zero income taxes after age 70 then you're Roth converting too much! Hang on to some of your tIRA and make use of some of those low post-70 tax rates.

Thanks for the reply.

I agree. To keep my reply brief I left that part out. We're already planning to do just that. Nice call.

 

[SecondCor521]

The current standard deduction for a single person age 65 and older is $13,600. Yes, it will increase based on Chained CPI.

.

Good point. I'm 49 now so didn't think about the increased standard deduction. Not sure it makes that much of a difference with the numbers I have, but it would be more accurate if I make the change. Thanks.

 

[Helena]

Good point. I'm 49 now so didn't think about the increased standard deduction. Not sure it makes that much of a difference with the numbers I have, but it would be more accurate if I make the change. Thanks.

That is really LONG range planning !

The tax laws will have changed several times by then. I recently read that another tax cut is now in the works.

.

 

[racy]

...In 2039, tax rates may be much higher, or lower. Or there may be a VAT. Or we may be a different country. Or an asteroid may hit.

For sure we'll have 10 sets of congressmen/women messing around between now and then.

 

[pb4uski]

If you're paying near zero income taxes after age 70 then you're Roth converting too much! Hang on to some of your tIRA and make use of some of those low post-70 tax rates.

What "low post-70 tax rates"? Tax rates are based on income and don't change with age... my tax rate will be higher when I am 70 than it is now at 62.

 

[Dtail]

What "low post-70 tax rates"? Tax rates are based on income and don't change with age... my tax rate will be higher when I am 70 than it is now at 62.

Perhaps the poster meant taking advantage of at least the standard deduction after 70 vs. all Roth conversions before 70?

 

[pb4uski]

Only thing that I could think of is the higher standard deduction, but that is a 65... not 70.

 

[RunningBum]

What "low post-70 tax rates"? Tax rates are based on income and don't change with age... my tax rate will be higher when I am 70 than it is now at 62.

Hard to know what Animorph is talking about, reviving a 3 month old thread with no quoting of who this applies to. I don't think the OP was paying nearly 0 taxes post-70, nor did I notice anyone else in the thread say that. Very odd to just throw out a meaningless tidbit like that in an old thread.

 

[audreyh1]

That is really LONG range planning !

The tax laws will have changed several times by then. I recently read that another tax cut is now in the works.

.

One thing is tax cuts now are temporary, so you have a multi year window to do Roth conversions before rates revert to the old ones.

Unfortunately, just as we are no longer subject to AMT which dropped our marginal rate significantly, IRMAA rears its head, and I have to look carefully at the trade offs.

 

[karen1972]

I used i-orp to do my analysis as I didn't trust my own numbers.

The RMD projections were a little staggering so I kicked up my ROTH conversions, especially since I am willing to bet 12% is going to be a great tax rate moving forward for me. I also was swayed to take the HSA exchange option even though I've had a few ER visits as that is a win/win, take taxable income which I pay zero in taxes since its LTCG to fund it, then use ROTH conversion income to take the tax break against, so $6900 becomes non-taxable with zero tax cost to me this year.

I'm at 37% tax free for my total portfolio including my cost basis in taxable, but given what I'm converting each year weighed against ACA credits, etc.. in an avg stock market I will just be converting gains and never touch the principle because that snowball gets very large quickly.