Ed_The_Gypsy
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With the Tax Torpedo in mind, I am looking for a conversion strategy. Using a relatively simple spreadsheet and on-line tax estimators to compare different cases, and after wringing out the obvious bugs, I have learned some things that may be helpful to others, even though it may not be possible to generalize from our situation. This close to 70.5, our options are limited.
Basis:
1) We are 66. There is a reasonable possibility that I will ‘retire’ in Jan ’14 at 67, hence this homework.
2) DW is taking SS now. I have filed-and-suspended at my FRA this year and plan to take my SS at 70-1/4, in Jan of 2018, the year I turn 70.5 and MRDs begin. We would have a 4-year window to convert while our total SS is solely at my wife’s lower amount. I considered taking my SS at 67, but it reduces the survivor’s benefits for my wife, so this is out of the question. We will get a sizable combined SS eventually.
3) Virtually all of our assets except the house are in a modest traditional IRA. We each will get a one-time exemption for capital gains when we sell the house (and the condo when we go to the Home), so that should have no negative impact on these calculations. We own no other real estate.
4) Projections were made for both of us to age 100, just for grins.
5) An after-tax income starting at 67 from all sources was assumed, based on FIREcalc portfolio survivability plus some. In the first year, this is equivalent to over 8% from the IRA (for taxes and spending money). This high drain will only be for the first 4 to 7 years and is unavoidable unless I want to take SS before 70. (It is only about 1/3 of what my normal income used to be in North America, by the way.)
6) SS and IRA distributions were assumed to be our only income. Taxes will be paid from the IRA distributions.
7) After-tax income grows uniformly at an assumed 3%, SS payments at 2%, ROI is assumed to be 6%.
Cases:
A) The minimum case. The IRA does not get emptied.
From 67 to 71, withdraw from the IRA only enough to give us the target after-tax income and pay the taxes.
The IRA will not be empty by 71, so take RMDs from 71 onwards.
I take SS at 70-1/4.
B) Again, the IRA does not get emptied.
From 67 to 71, withdraw from the IRA up to the top of the 15% marginal tax bracket. Pay the taxes out of that, give us the target after-tax income and convert what is left over to the Roth.
The IRA will not be empty by 71, so take RMDs from 71 onwards.
I take SS at 70-1/4.
C) Empty the IRA.
From 67 to 71, withdraw from the IRA up to the top of the 15% marginal tax bracket. Pay the taxes out of that, give us the target after-tax income and convert what is left over to the Roth.
I take SS at 70-1/4.
At 70.5, we will be in the 25% marginal bracket (the Tax Torpedo). Withdraw from the Ira to the top of the 25% bracket. Pay the taxes out of that, give us the target after-tax income and convert what is left over to the Roth. The IRA will be empty in 3 years.
D) Empty the IRA faster.
From 67 to 71, withdraw from the IRA up to the top of the 25% marginal tax bracket. Pay the taxes out of that, give us the target after-tax income and convert what is left over to the Roth.
The IRA will be empty after those four years, before the MRDs start at 70.5.
I take SS at 70-1/4.
Summary of each case:
A) 67-71: minimum conversion at 15%. IRA still lives.
B) 67-71: maximum conversion to top of 15%. IRA still lives.
C) 67-71: maximum conversion to top of 15%.
71-73: convert to top of 25% each year. Empty IRA by 74.
D) 67-71: maximum conversion to top of 25%. Empty IRA by 70.5.
At age 100, the same total after-tax income in all cases. Results at age 100 by case:
A) Total taxes paid = $128k. IRA still has $18k. Roth has $473k left. (Total = $491k.)
B) Total taxes paid = $77k. IRA still has $12k. Roth has $560k left. (Total = $572k.)
C) Total taxes paid = $114k. IRA zero at 74. Roth has $288k left.
D) Total taxes paid = $105k. IRA zero at 70.5. Roth has $253k left.
Lessons learned:
1) Before 70.5, anything you can convert at 15% is good.
2) Converting the max at 15% before 70.5 has the best overall outcome: least taxes and maximum residual assets.
3) To empty the IRA, I pay more than the minimum taxes. This simplifies my future taxes because at some early point I will have no taxable income. I may not have to file quarterly estimates of income or file annually at all. This would be nice in my dotage—to be totally free of the Feds!
4) Interestingly, emptying it fast in 4 years at the 25% rate costs less tax than emptying slow (15% for 4 years, then at 25% for 3 years), because it gets emptied before I start my SS. However, I have less in the Roth all the way to the end, because I start drawing down the Roth 3 years earlier in Case D than Case C.
5) As a sub-case of Case C, I did consider postponing my taking SS until after the IRA was depleted at the 25% rate, but the impact of loss of income from SS for those few years was much larger than the taxes saved. The Roth would be drained by about age 85. A really bad idea. Good thing I checked this.
Twists:
Remember, these four cases are really base cases.
If I continue to work after 67, I pay higher taxes but I net more, so OK. Still convert until 70.5, pay the taxes with after-tax money. Also contribute straight to the Roth. If I work until 71, our options are limited to living with RMDs or going gangbusters and converting the IRA at the top of the 25% rate.
Of course, depending on life events in any particular year, I can always take a higher or lower income, take less (until MRDs start at 70.5) or more out of the IRA and convert more or less and/or take more or less out of the Roth in distribution mode. If we can live on less than I planned here (house-sitting in Guatemala?), more can go into the Roth in conversion phase.
Being free of MRDs at some point would solve the problem of higher taxes if one of us dies before 100 (highly probable, but can happen in any of these cases). The lowest-tax case, Case B, has that trap. I have not investigated this yet, but it could make it not the lowest-tax case anymore, meaning: wipe out the IRA at all costs.
Of course, returns will not be smooth. The average ROI may not be as high as 6%. We may be forced to live on less than I planned.
The Feds could change the rules again (for example, eliminate conversion, eliminate tax-protected accounts altogether, change the marginal rates, etc.).
SS may be cut back to 78% in 2037 (we will be 90 then, if we are lucky).
By the way, if you want to try it yourself, the tax estimator at the TurboTax web site is the easier to use and gives slightly different (lower) tax estimates than the estimator I used. It is only an estimate, remember.
Basis:
1) We are 66. There is a reasonable possibility that I will ‘retire’ in Jan ’14 at 67, hence this homework.
2) DW is taking SS now. I have filed-and-suspended at my FRA this year and plan to take my SS at 70-1/4, in Jan of 2018, the year I turn 70.5 and MRDs begin. We would have a 4-year window to convert while our total SS is solely at my wife’s lower amount. I considered taking my SS at 67, but it reduces the survivor’s benefits for my wife, so this is out of the question. We will get a sizable combined SS eventually.
3) Virtually all of our assets except the house are in a modest traditional IRA. We each will get a one-time exemption for capital gains when we sell the house (and the condo when we go to the Home), so that should have no negative impact on these calculations. We own no other real estate.
4) Projections were made for both of us to age 100, just for grins.
5) An after-tax income starting at 67 from all sources was assumed, based on FIREcalc portfolio survivability plus some. In the first year, this is equivalent to over 8% from the IRA (for taxes and spending money). This high drain will only be for the first 4 to 7 years and is unavoidable unless I want to take SS before 70. (It is only about 1/3 of what my normal income used to be in North America, by the way.)
6) SS and IRA distributions were assumed to be our only income. Taxes will be paid from the IRA distributions.
7) After-tax income grows uniformly at an assumed 3%, SS payments at 2%, ROI is assumed to be 6%.
Cases:
A) The minimum case. The IRA does not get emptied.
From 67 to 71, withdraw from the IRA only enough to give us the target after-tax income and pay the taxes.
The IRA will not be empty by 71, so take RMDs from 71 onwards.
I take SS at 70-1/4.
B) Again, the IRA does not get emptied.
From 67 to 71, withdraw from the IRA up to the top of the 15% marginal tax bracket. Pay the taxes out of that, give us the target after-tax income and convert what is left over to the Roth.
The IRA will not be empty by 71, so take RMDs from 71 onwards.
I take SS at 70-1/4.
C) Empty the IRA.
From 67 to 71, withdraw from the IRA up to the top of the 15% marginal tax bracket. Pay the taxes out of that, give us the target after-tax income and convert what is left over to the Roth.
I take SS at 70-1/4.
At 70.5, we will be in the 25% marginal bracket (the Tax Torpedo). Withdraw from the Ira to the top of the 25% bracket. Pay the taxes out of that, give us the target after-tax income and convert what is left over to the Roth. The IRA will be empty in 3 years.
D) Empty the IRA faster.
From 67 to 71, withdraw from the IRA up to the top of the 25% marginal tax bracket. Pay the taxes out of that, give us the target after-tax income and convert what is left over to the Roth.
The IRA will be empty after those four years, before the MRDs start at 70.5.
I take SS at 70-1/4.
Summary of each case:
A) 67-71: minimum conversion at 15%. IRA still lives.
B) 67-71: maximum conversion to top of 15%. IRA still lives.
C) 67-71: maximum conversion to top of 15%.
71-73: convert to top of 25% each year. Empty IRA by 74.
D) 67-71: maximum conversion to top of 25%. Empty IRA by 70.5.
At age 100, the same total after-tax income in all cases. Results at age 100 by case:
A) Total taxes paid = $128k. IRA still has $18k. Roth has $473k left. (Total = $491k.)
B) Total taxes paid = $77k. IRA still has $12k. Roth has $560k left. (Total = $572k.)
C) Total taxes paid = $114k. IRA zero at 74. Roth has $288k left.
D) Total taxes paid = $105k. IRA zero at 70.5. Roth has $253k left.
Lessons learned:
1) Before 70.5, anything you can convert at 15% is good.
2) Converting the max at 15% before 70.5 has the best overall outcome: least taxes and maximum residual assets.
3) To empty the IRA, I pay more than the minimum taxes. This simplifies my future taxes because at some early point I will have no taxable income. I may not have to file quarterly estimates of income or file annually at all. This would be nice in my dotage—to be totally free of the Feds!
4) Interestingly, emptying it fast in 4 years at the 25% rate costs less tax than emptying slow (15% for 4 years, then at 25% for 3 years), because it gets emptied before I start my SS. However, I have less in the Roth all the way to the end, because I start drawing down the Roth 3 years earlier in Case D than Case C.
5) As a sub-case of Case C, I did consider postponing my taking SS until after the IRA was depleted at the 25% rate, but the impact of loss of income from SS for those few years was much larger than the taxes saved. The Roth would be drained by about age 85. A really bad idea. Good thing I checked this.
Twists:
Remember, these four cases are really base cases.
If I continue to work after 67, I pay higher taxes but I net more, so OK. Still convert until 70.5, pay the taxes with after-tax money. Also contribute straight to the Roth. If I work until 71, our options are limited to living with RMDs or going gangbusters and converting the IRA at the top of the 25% rate.
Of course, depending on life events in any particular year, I can always take a higher or lower income, take less (until MRDs start at 70.5) or more out of the IRA and convert more or less and/or take more or less out of the Roth in distribution mode. If we can live on less than I planned here (house-sitting in Guatemala?), more can go into the Roth in conversion phase.
Being free of MRDs at some point would solve the problem of higher taxes if one of us dies before 100 (highly probable, but can happen in any of these cases). The lowest-tax case, Case B, has that trap. I have not investigated this yet, but it could make it not the lowest-tax case anymore, meaning: wipe out the IRA at all costs.
Of course, returns will not be smooth. The average ROI may not be as high as 6%. We may be forced to live on less than I planned.
The Feds could change the rules again (for example, eliminate conversion, eliminate tax-protected accounts altogether, change the marginal rates, etc.).
SS may be cut back to 78% in 2037 (we will be 90 then, if we are lucky).
By the way, if you want to try it yourself, the tax estimator at the TurboTax web site is the easier to use and gives slightly different (lower) tax estimates than the estimator I used. It is only an estimate, remember.
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