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IRA Withdraw or Other Funds First?
Old 09-23-2011, 02:01 PM   #1
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IRA Withdraw or Other Funds First?

Forgive me if this has been covered before...

I have 30% of my portfolio in after tax funds (i.e. not sheltered in an IRA) and the balance in my IRA. I will have enough to live on via my dividends between the two sources. ‘After tax’ funds deliver about 5.7% in dividends. 25% tax bracket.

As I near my 59 withdrawal age, I’m torn: should I withdraw from the IRA dividends and pay the taxes or should I sell shares of my ‘after tax’ funds and not pay taxes? (taxes on those share sales would be minimal due to my basis)

My after tax funds would last me about 6-7 years before needing to tap my IRA but I’m terrified of ‘touching the principal’. To me once you sell a share, it’s gone for good.

In 6 years, my after tax piece would be gone but, having not paid taxes for those years might put me in a better place.

The original plan was to live on the dividends, pay the taxes and draw minimally from the after tax fund as inflation and other costs creep up over a longer period of time.

Any insights?
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Old 09-23-2011, 02:55 PM   #2
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People game the withdrawals for tax reasons. The plan is to withdraw enough from the IRA (taxed at ordinary income tax rates) to fill up one of the 15% tax bracket (or a higher bracket if you are a high roller tax bracket-wise). Then the rest comes from after-tax investments (taxed as capital gains).

There is a nifty online website calculator that tells you how to do a tax-optimal withdrawal scheme. They also may suggest some level of ROTH-IRA conversions as a tax-minimixzation strategy. Take a look at the link below:

http://www.i-orp.com/
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Old 09-23-2011, 03:11 PM   #3
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That's the ticket, live off your after-tax investments but withdraw from the IRA up to the 15% or lower tax bracket and place that whole amount into a Roth account as a Roth conversion. Pay the taxes with your after-tax investments. When those funds are exhausted, continue the IRA withdrawals up to the tax bracket and fill in Roth withdrawals as needed. All this keeps your taxes lower overall.
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Old 09-23-2011, 03:27 PM   #4
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but dont WD from your IRA if you will have to pay the 10% early WD penalty!
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Old 09-24-2011, 09:30 PM   #5
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but dont WD from your IRA if you will have to pay the 10% early WD penalty!
There's no 10% penalty if you convert IRA money to a ROTH or do a 72t.
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Old 09-24-2011, 11:37 PM   #6
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There is also no penalty if you are 59.5 years of age.

Another consideration for the folks with a large roll-over IRA from a 401k is if you delay taking withdraws to the point where your accumulated balance is very large you will take an even greater tax hit when you are forced to take minimum withdraws on the balance at age 72. For some that can be a pretty big chunk of change in taxes. It is far better to bleed off some of the balance before age 72 so your overall tax rates are not pumped up to the astronomical levels.

That said, using an after tax account first allows one to receive the most income with the lowest taxes...depending on other circumstances.

My plan is do do a combination of withdraws to keep my taxes close to what they are now or even lower as my other sources of income stop or start. Everyone is a bit different in their financial makeup so their plan will also vary. Generalities are just that...general comments and not specific advice. Chose what works best for your situation.
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Old 09-25-2011, 12:38 AM   #7
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There's no 10% penalty if you convert IRA money to a ROTH or do a 72t.
yes, i know but MB wrote of withdrawing from your IRA to just fill up the 15% tax bracket. that doesnt sound like a 72t as it would probably require a variable WD. and then later in that post MB said there were also suggestions of roth conversions which implied that the earlier discussion wasnt involving such a conversion. hence my warning. glad you already know of the pitfalls.
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Old 09-25-2011, 12:40 AM   #8
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There is also no penalty if you are 59.5 years of age.

Another consideration for the folks with a large roll-over IRA from a 401k is if you delay taking withdraws to the point where your accumulated balance is very large you will take an even greater tax hit when you are forced to take minimum withdraws on the balance at age 72. For some that can be a pretty big chunk of change in taxes. It is far better to bleed off some of the balance before age 72 so your overall tax rates are not pumped up to the astronomical levels.

That said, using an after tax account first allows one to receive the most income with the lowest taxes...depending on other circumstances.

My plan is do do a combination of withdraws to keep my taxes close to what they are now or even lower as my other sources of income stop or start. Everyone is a bit different in their financial makeup so their plan will also vary. Generalities are just that...general comments and not specific advice. Chose what works best for your situation.
my understanding is that RMDs start in the year the TIRA owner turns 70.5 y.o. not 72. but you are right that tax planing for that income change is important to do well before you are required to start taking RMDs. another good reason to do roth conversions as roths dont have a RMD.
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Old 09-25-2011, 07:39 AM   #9
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Thanks to everyone for your insights! The http://www.i-orp.com/ calculator was very helpful and let me see things more clearly.
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Old 09-25-2011, 08:00 AM   #10
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Originally Posted by MasterBlaster View Post
People game the withdrawals for tax reasons. The plan is to withdraw enough from the IRA (taxed at ordinary income tax rates) to fill up one of the 15% tax bracket (or a higher bracket if you are a high roller tax bracket-wise). Then the rest comes from after-tax investments (taxed as capital gains).

There is a nifty online website calculator that tells you how to do a tax-optimal withdrawal scheme. They also may suggest some level of ROTH-IRA conversions as a tax-minimixzation strategy. Take a look at the link below:

Optimal Retirement Calculator and Retirement Decision Support System

Thanks for sharing this link- I haven't come across this one yet. However, unless I'm missing something I didn't see any entry fields for itemized deductions (such as medical, charitable, property taxes and mortgage interest), which can have a big impact on determining the optimal withdrawal strategy. Is the program simply pushing you up to the top of the 15% so you can take the deductions at 25% (assuming the person is currently in the 15% bracket)?
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Old 09-25-2011, 08:06 AM   #11
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. Is the program simply pushing you up to the top of the 15% so you can take the deductions at 25% (assuming the person is currently in the 15% bracket)?
What does this mean? Won't the deductions be at 15% in this case?
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Old 09-25-2011, 08:39 AM   #12
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Thanks for sharing this link- I haven't come across this one yet. However, unless I'm missing something I didn't see any entry fields for itemized deductions (such as medical, charitable, property taxes and mortgage interest), which can have a big impact on determining the optimal withdrawal strategy. Is the program simply pushing you up to the top of the 15% so you can take the deductions at 25% (assuming the person is currently in the 15% bracket)?
I spent a little more time looking at the program and it seems like a flaw not being able to enter the deductions.

Kaneohe, the concept is a bit difficult to explain like this (I need pictures!!) but here's what I'm getting at:

Marginal income tax rates represent the rate at which your next dollar will be taxed. This rate is determined by Taxable Income (not Adjusted Gross Income). Taxable Income is calculated as AGI less deductions and exemptions... so I may have AGI of $89,000 but Taxable Income of only $69,000, meaning I was able to reduce amount of income that is taxed by $20,000 using my deductions and exemptions. For married jointly filers $69,000 is where my next (marginal) earned dollar is taxed at 25% so the $20,000 in deductions in this scenario got the benefit of the 25% rate... but under $69,000 I only had to pay taxes at 15% (although some dollars were taxes at 10%, the next lower bracket). It's playing the tax code like a violin!
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Old 09-25-2011, 09:00 AM   #13
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CFPMatt, the world (OK, those of us who inhabit the FIRE world) would welcome your "Drawdown Optimization Calculator" complete with IRS violin. When do you think you'll be ready to go live at Carnagie Hall with it?
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Old 09-25-2011, 10:27 AM   #14
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CFPMatt, the world (OK, those of us who inhabit the FIRE world) would welcome your "Drawdown Optimization Calculator" complete with IRS violin. When do you think you'll be ready to go live at Carnagie Hall with it?

- I think we'd all be waiting a really long time. Actually, I think the calculator is pretty slick to structure a general withdrawal plan, but IMHO some annual year-end tax planning would also be a good idea to refine the plan.
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Old 09-25-2011, 12:19 PM   #15
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The last few times I've run i-orp it has recommended spending our Roths down in the next 4-5 years putting us in the 10% bracket and then relying on IRA. We are now out of already taxed. Can't accept just spending the Roths, seem too valuable, but do plan to start taking their dividends next year while maintaining 15% taxable rate on IRA.
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Old 09-25-2011, 01:12 PM   #16
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i also wonder about spending down the Roth IRA before the regular IRA. Roth withdrawals are tax free, so I would think one would like to keep them earning $$'s as long as possible. After all, you get to keep 100% of each dollar your withdraw from a Roth.

Regular IRA's are taxed at normal rates. No chance to pay the lower capital gains rate. I would take that money out first unless somebody gave me a good reason not to do so.
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Old 09-25-2011, 02:54 PM   #17
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i also wonder about spending down the Roth IRA before the regular IRA. Roth withdrawals are tax free, so I would think one would like to keep them earning $$'s as long as possible. After all, you get to keep 100% of each dollar your withdraw from a Roth.

Regular IRA's are taxed at normal rates. No chance to pay the lower capital gains rate. I would take that money out first unless somebody gave me a good reason not to do so.
Well, we do plan on the dividends as I said. We are flirting with needing to withdraw enough from IRA to hit 25% bracket so that makes near term Roth of some withdrawal reasonable to me. Dividends only and not principal.
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