i-orp - early tIRA withdrawals?

[SecondCor521]

Hi all,

I did a simple i-orp run with my numbers the other day. I am 50, will take SS at 70, and have roughly 67% tIRA, 20% Roth, 13% taxable.

I understand (a little) about linear programming and constraint optimization. But I started taking a look at the plan it spit out and wish it could explain why it made certain choices.

The first hurdle for me is that the plan recommends I start taking over a year's worth of spendable income out of my t-IRA and pay the 10% early withdrawal penalty. It recommends doing this for the next five years or so, then dropping to about half of that amount for the next 4 years until I reach 59.5.

My current actual plan is to spend down some of my taxable until 59.5 and do Roth conversions up to a certain level to minimize the tax torpedo.

Any insight on why i-orp would recommend this? It seems like a pedestrian question and that I shouldn't bother the i-orp guy.

I'm uncomfortable sharing my plan results because it contains my actual numbers. If my question can't be answered without that info, I understand and apologize in advance.

As a secondary question, for those of you who trust or rely on i-orp, how do you know that he programmed it correctly? I was very good at math and actually took a linear programming class in college. I did well but I still made mistakes (got a B in the class IIRC). It seems like i-orp is a big black box with no reasonable way to ensure it's correct.

 

[SecondCor521]

I think I may have a potential answer. Doing those aggressive traditional IRA withdrawals reduces the size of my traditional IRA quite a bit. At RMD age, my plan projects an age 70 traditional IRA balance that is about 10 times the size of the i-orp plan, and thus RMDs that are 10 times larger.

I think the i-orp plan has determined that paying those 10% penalties for a few years up front actually saves on income taxes post-70. My plan has me in the 24% bracket at age 70; i-orp claims I'll be in the 10% bracket. Doing the aggressive withdrawals earlier probably is the most effective way to trim that excessive exponential growth.

Hmmm.

Still interested in anyone's answer to the second question.

 

[CardsFan]

My current actual plan is to spend down some of my taxable until 59.5 and do Roth conversions up to a certain level to minimize the tax torpedo.

Any insight on why i-orp would recommend this? It seems like a pedestrian question and that I shouldn't bother the i-orp guy.

Bold by me, and this is what I would do. I-ORP tries to maximize life time income, but since it is based on estimated returns, it is, at best, a guess.

My guess is that even with the 10% penalty, I-ORP thinks you will eek out a few percent more, long term. And that MIGHT be true. Or, it might not, depending on the market.

If you have the ability to 72t (when you are 55) from your pre-tax money (no penalty) then that might make some sense. And, of course, when you get to 59.5 you can start Roth conversions, as you propose, if that makes sense.

Just my 2 cents.

 

[RunningBum]

If you have taxable available, I would definitely spend from that, and to reduce the tIRA I would be doing conversions. It makes no sense at all to take the 10% penalty. It's stories like these that make me distrust i-Orp, and I agree that being a "black box" program you can't tell.

It's been awhile since I've looked at i-Orp. Is there any way to tweak the plans, so you could compare what I outline vs what they do, for example, and see the difference in what you wind up with and what taxes you pay with various options?

 

[SecondCor521]

@RB, I don't think there is a way to do what you describe, except manually compare the i-orp output (which is quite extensive) with my own Excel data.

@CardsFan, I wasn't clear. I'm 50 now and am currently spending down taxable and doing Roth conversions. But compared to i-orp, my Roth conversions are "timid" and still leave me in the 24% bracket at age 70 (as opposed to the 10% bracket at age 70). Since the plan in i-orp runs to 92, that's 22 years of 24% vs 10% times RMDs, which is a lot of spendable money.

But it depends on rate of return, as you note, and who knows if I'll enjoy spending money at 70 more or less than I do today.

I haven't thought about SEPPs in a while, but now that you mention it it might make sense for me to do a modest one from 55 to 60. That would bleed off my traditional IRA more and leave more of my taxable available. Given the tax torpedo I already face and the SECURE Act taking away the stretch IRA, that probably makes sense. Hmmm.

 

[CardsFan]

@RB, I don't think there is a way to do what you describe, except manually compare the i-orp output (which is quite extensive) with my own Excel data.

@CardsFan, I wasn't clear. I'm 50 now and am currently spending down taxable and doing Roth conversions. But compared to i-orp, my Roth conversions are "timid" and still leave me in the 24% bracket at age 70 (as opposed to the 10% bracket at age 70). Since the plan in i-orp runs to 92, that's 22 years of 24% vs 10% times RMDs, which is a lot of spendable money.

But it depends on rate of return, as you note, and who knows if I'll enjoy spending money at 70 more or less than I do today.

I haven't thought about SEPPs in a while, but now that you mention it it might make sense for me to do a modest one from 55 to 60. That would bleed off my traditional IRA more and leave more of my taxable available. Given the tax torpedo I already face and the SECURE Act taking away the stretch IRA, that probably makes sense. Hmmm.

If you read some of the info on i-ORP, even they say the gain for early conversions/withdrawals is fairly minimal (2-4%?). I find i-ORP to be very aggressive with conversions, and I just can't pull that tax trigger for a nominal, potential, gain.

Obviously, anything you can do now in the 12% bracket makes sense, after that, maybe a few percent better.

FYI, I am older (63), so I have fewer years to make a difference, so my thinking may not apply to you.

 

[SecondCor521]

Well, the other thing that i-orp doesn't handle is FAFSA. For me that is an additional 5% to 8% "tax" (in terms of reduced financial aid) on any income I take for the next few years.

But then I might just be the kind of person who will always find a way to want to avoid paying taxes now even if there is good sense in doing so. Sigh.

 

[RunningBum]

See, I think of that tIRA as holding not only my money, but also a tax liability. I'm not going to get all of that tIRA just like I never got all of my salary. Uncle Sam got his cut on my wage income, and he's going to get it on the deferred income. And like a lot of people around here think about mortgages, I don't like to owe money. That tax liability is money I owe. So I'd like to get it off my back as quick as I can, as long as I can do it in a sensible way.

Just another way to look at it.

 

[copyright1997reloaded]

Well, the other thing that i-orp doesn't handle is FAFSA. For me that is an additional 5% to 8% "tax" (in terms of reduced financial aid) on any income I take for the next few years.

But then I might just be the kind of person who will always find a way to want to avoid paying taxes now even if there is good sense in doing so. Sigh.

If you have FASFA considerations, I would (as you seem to be) look at spending down non-retirement accounts first and deferring the tIRA withdraw as distributions are counted as income for FASFA purposes.

However a wrinkle is that tIRA distributions for educational spending are not subject to the 10% penalty.

There is also a FASFA exception for Roth Conversions: FinAid | Professional Judgment | Dear Colleague Letter GEN-99-10

Disclaimer: I haven't yet done a FASFA, so who knows if I am out to lunch with this...

 

[IrishMoss]

I would not subject myself to a 10% penalty on an early IRA/tIRA withdrawal if you don't need the money. And you do not.

What you could do is withdraw from your tIRA and immediately convert monies to Roth IRA and that can be done penalty-free before age 59.5. The money you withdraw from tIRA to convert would be counted as regular taxable income in the year of the withdrawal, but once converted to Roth it will grow tax free and not be counted as taxable income upon withdrawal years later (5+ yrs minimum hold period). Do this every year, keeping at or just under your desired income tax % level and you'll reduce your RMDs.

And then as others recommended, spend down taxable accounts first.

 

[SecondCor521]

@c1997r, good wrinkle, but at the moment I already have enough in 529/ESA accounts to cover expected college expenses. The Roth conversion exception is a professional judgment item, which means the university may or may not adjust the aid.

@IrishMoss, yes, I am already doing Roth conversions as you describe. I don't think I'll follow i-orp, but I will start to consider whether making more aggressive Roth conversions make sense.

 

[IrishMoss]

I think it's good to do a sanity check on the plan.

I've discovered issues with i-orp around roth conversions, specifically with use of the ACA field and if the taxable account total > Roth account total. The underlying assumption forced by the creator of the program is taxable accounts are, by default, considered 100% cash, which of course is incorrect for anyone who is getting divs or interest from their taxable accounts, which I think would be most people. For me it makes the tool nearly useless for the years I'll be on the ACA, as the tool has incorrectly calculated my IRA2Roth conversions and even total spend maximum.

 

[SecondCor521]

Somewhere in the help file I noticed a caveat that if your outside income is higher than the ACA cap, it would make the 100% cash assumption. The fact that it does this silently I find a little disconcerting. Oh well.

 

[SecondCor521]

Another thing I find distressing is that after carefully reading through the help file and using the extended version and entering more precise data, the resulting plan was pretty wildly different. I'm nervous trusting a black box that is also, for lack of a better term, skittish.

 

[IrishMoss]

I understand your skittishness. The program and models are often changed/morphed/nuanced (whatever word you'd like to use) and sometimes not necessarily for the better, as I discovered with this ACA/Roth IRA conversion snafu.

I've reported my findings, but I'm getting tired of running into problems that in my mind should be able to be overcome. I use the tool every few months or maybe a couple times a year and there's always something the model outputs that has me scratching my head in confusion and I have to go digging to figure out what's going on and why.

 

[big-papa]

If you're into spreadsheets, you might want to try out the retiree portfolio model over at bogleheads.

Warning: this isn't just "enter a few numbers in a few fields and out pops an answer" type of tool. It's pretty extensive which also means it takes some time to come up to speed on it. Then again, not every retiree has a simple situation, either. It'll also compare results from I-ORP, by the way.

https://www.bogleheads.org/wiki/Retiree_Portfolio_Model

 

[Whisper66]

... (1) The first hurdle for me is that the plan recommends I start taking over a year's worth of spendable income out of my t-IRA and pay the 10% early withdrawal penalty........
Any insight on why i-orp would recommend this?......... (2) It seems like a pedestrian question and that I shouldn't bother the i-orp guy......
(3) how do you know that he programmed it correctly?

(1) It recommends this to maximize your life time disposable income based on it's algorithms. You can change this to some extent. See I-ORP Guide ( https://i-orp.com/IRMAA/help/ORPHelp.html#earlyW ). You can set "Early Withdrawals (pay 10% Penalty) to "0" which disallows withdrawals triggering the 10% penalty.

(2) LOL - James (ORP author) answers most questions within a couple days, even from us "pedestrians". He also appreciates constructive comments or identification of errors. Last error I found in how SS was handled, we had a couple emails back and forth and he fixed the issue in a couple days once he understood it. He also sometimes participates in this board as "orplanner".

(3) I read that it was checked against the complicated spreadsheet provided in the Bogelheads forum and they were reported to be very similar. However, I honestly don't fully trust any program calculation I haven't comfirmed with my own calcs. I also don't put any confidence in long term projections. So I run ORP yearly to get a feel for how much Roth conversion it would recommend and what a reasonable maximum yearly budget would be. I also run Firecalc yearly to double check the max yearly budget limits. They give me similar results for max yearly budget limits. But I use these only as general guidance. If they doesn't make sense after studying the results, I don't follow them. In our situation, ORP recommends quite high Roth conversions. After thinking it through quite a bit, I have come to the conclusion that this is the right thing to do in our specific situation.