Forward Tax Planning Strategy

[frayne]

Just curious as to what your forward looking tax strategy is to ensure you pay the lowest legal allowable tax as possible.

I've always been under the impression to draw from tax deferred accounts first, after tax accounts second. When facing RMDs in a few years would it make more sense to increase the take from the tax deferred accounts now and pay versus possibly paying a higher rate three years down the road. A major variable is growth of funds in the tax deferred account between now and then.

Hope this makes sense and again just curious how people approach this problem. Appreciate any and all comments on this convoluted issue in advance.

Just some ballpark hypothetical numbers

Both spouse and I 66 years of age.

Annual expenses $60K

Take $30K from IRA and receive $33K in SS

Currant IRA balance $750K

After tax accounts $250K

50-50 AA split.

 

[gauss]

I-Orp always has me drawing from after tax accounts prior to tax-deferred. I am younger than some around here, so perhaps the early withdrawal penalty is a factor.

-gauss

 

[pb4uski]

I would take the $30k from taxable instead and do Roth conversions to the top of the 10% or 12% tax bracket.... you'll move more money out of tIRAs that are subject to RMDs and reduce RMDs dramatically.

If you do smaller Roth conversions your taxes will be lower... I'm coming up with ~11% tax on $50k of conversion or 12% tax on $75k of conversion but you'll need to do some sensitivity testing to see where the sweet spot is for you. If you use TT, the What-If worksheet is a good tool to use.

 

[Jerry1]

I-Orp always has me drawing from after tax accounts prior to tax-deferred. I am younger than some around here, so perhaps the early withdrawal penalty is a factor.

-gauss

I-Orp has me pulling from my tax deferred accounts first. I’m not sure how good it is, but it seemed pretty comprehensive. I imagine it’s as good as the data you enter into it. For me, it was an interesting data point and the result has caused me to give much more thought to RMD’s.

Good to know it doesn’t spit out a one size fits all answer. Good suggestion for the OP to go to I-Orp and spend some time. It will help.

 

[VanWinkle]

Current tax law shows a 7 year window for low tax rate conversions from TIRA to Roth IRA. That could change, but all planning should be based on current law. I will draw from taxable and continue conversions until RMDS to the top of the 12% brkt. That way on Dec 31 2025 when the rates revert to the old rates, I will have saved at least 3% in taxes on the converted amounts.

You have the flexibility to draw from the most tax efficient accounts. Well done.

VW

 

[GravitySucks]

I've been taking from 401k up to the 15% point then taking any other needs from after tax.
Now with the temporary 23% rate I will be taking everything from the 401k and IRA until I get to the next increase point. ( not likely, but with a new roof and fence this year....)
My after tax is only 6% of my total savings but it's enough for smoothing.

 

[Freedom56]

It makes more sense to let your tax deferred accounts continue to grow until you are forced to draw from it. We are still too young to draw from our tax deferred accounts (unless we use it for healthcare) without the 10% penalty. We have no plans to withdraw from our IRAs until 70 1/2, when we are forced to do so. Our income is from taxable accounts and a company pension. We plan to start collecting SS when I am 62. I am in my 3rd year of retirement and so far our taxable income far exceeds our expenses and therefore are continuing to save.

 

[oldphd]

I would take the $30k from taxable instead and do Roth conversions to the top of the 10% or 12% tax bracket.... you'll move more money out of tIRAs that are subject to RMDs and reduce RMDs dramatically.

If you do smaller Roth conversions your taxes will be lower... I'm coming up with ~11% tax on $50k of conversion or 12% tax on $75k of conversion but you'll need to do some sensitivity testing to see where the sweet spot is for you. If you use TT, the What-If worksheet is a good tool to use.

+1

Converting to the top of your "lowest ever" tax bracket is a no brainer.

 

[CRLLS]

Our needs and wants are less than what all the calculators say we can survive on. We are fortunate on that point. DW is currently collecting SS, I will file for spousal in Nov. I am waiting for age 70 to claim the Max SS. Until then, we will take whatever excess we need to fill our nut from our IRA's. Then in Dec, determine what can be Roth converted up to the top of the 12% tax bracket. In general, this will reduce our RMD's some of which would be in the next tax bracket bit.

 

[24601NoMore]

If you pull from tax deferred, the entire amount is taxable income.

If you pull from taxable, only your gain is taxable income.

For that reason, we've sat on a good cushion of cash and will pull from that in ER. I've already paid taxes (whoo boy, have I paid taxes) on our after-tax investments, so can live off my after-tax piggy bank for some time..

Seems the "pull from tax deferred first" is backwards - at least for us.

 

[meierlde]

If you pull from tax deferred, the entire amount is taxable income.

If you pull from taxable, only your gain is taxable income.

For that reason, we've sat on a good cushion of cash and will pull from that in ER. I've already paid taxes (whoo boy, have I paid taxes) on our after-tax investments, so can live off my after-tax piggy bank for some time..

Seems the "pull from tax deferred first" is backwards - at least for us.

It some what depends on your tax bracket if in 24 or below its not a big difference, but if you can use tax deferred withdrawals to reduce the amount after rmds that is in the 32% bracket it can make a difference. (In particular if you file as single)

 

[Rustward]

If you pull from tax deferred, the entire amount is taxable income.

This is generally true but there are exceptions in which you may make after-tax contributions to a 401K or IRA, although few do this. I had some some after-tax money in two 401K's and one IRA. The other half also has some in her IRA.

 

[LOL!]

I've been doing Roth conversions. I no longer have any money left in a traditional IRA. Now I am working on converting my wife's traditional IRA.

 

[pb4uski]

Reverse here... we did DW's first because we could convert the total quickly and have one less account to deal with... now working on mine.

 

[Gotadimple]

Leaving the tax-deferred (i.e., Traditional IRA or 401K) til last may leave you with a tax torpedo at age 70.5. You will need to pencil this out, but consider:

* lowest tax bracket you want to achieve after Medicare starts
* Medicare IRMAA - a part B premium increase if your MAGI exceeds $85K/$170K for a single/couple (IRMAA applies in the year you turn 63 - as Medicare looks back two years from the current year to determine if the surchage is applicable.)

So when Ed Slott talked about a tax torpedo he was only referencing the sizeable amount of RMD withdrawels. Medicare takes it's part as well.

https://www.medicare.gov/your-medicare-costs/part-b-costs/part-b-costs.html

 

[Cobra9777]

Currently, we're living off 2 pensions, some rental income, and the taxable account... mainly dividends. Sales of shares are infrequent. We're both 57, so SS is still at least 5 years off and we will likely defer one or both to FRA or later.

We are Roth-converting tax-deferred to the top of the 15%/12% bracket. But this is a very slow process due to ordinary pension and rental income. With lower rates in 2018, we might consider converting into the 22% bracket. Otherwise, we will only convert about 35-40% of the tax-deferred balance by 70.

So our tax minimization strategy has been to stay within the 15%/12% bracket, convert as much as we can, defer SS, and end up at 70 with a balanced, tax-diverse portfolio of taxable, tax-deferred, and tax free (Roth and HSA). With SS and RMDs, we'll likely be well into the 22%/25% bracket at that time. I'll be testing the waters in the 22% bracket, but I'm unlikely to go all-in with that conversion strategy. Too many unknowns.