New FIRE - Withdrawal strategy advice desired!

[CardsFan]

We retired early this year, and have been living off of cash on hand. We are both 61 and plan to take SS at FRA (66.2). We plan to start pulling from investments soon, and want some advice on the pro's and con's of the different ways this can be done. In round numbers, we have 60 % in Tax deferred, 30 % in after tax investments and 10 % in cash. Roth IRA's have minimal amounts, as they have just been set up. Spend rate is about 3%.

A couple of options, at least until FRA:

1. Maximize Roth conversions to 15 % bracket. Fed and state Taxes would be about 10k. Spend from cash and/or after tax account.

2. Lower taxes by living off of cash plus after tax dividends and gains, selling a little to make up the difference. taxes would be minimal, according to TurboTax.

3. Live off of dividend, gains and tax deferred accounts. let the after tax account ride.

We originally planned to do #1, but the idea of paying almost no taxes is extremely appealing.

Any thoughts?

[walkinwood]

Try a calculator like iOrp. I think it will give you something to think about.

Maximizing ROTH transfers to 15% is good only if you are quite sure you'll be in a higher bracket later on. Will you be eligible for health insurance subsidies?

I've found it useful to make a few assumptions, use last year's tax returns as a base to model various futures using a tax program. It is just too complex to do it any other way.

[CardsFan]

Thanks for the quick response. I have use iOrp, but it is looking at maximizing dollars to the end. I guess my thought now is, if We are in the 25% bracket, or more, when I hit RMD then I guess we have won the game. By reducing taxes now, we are maximizing dollars invested.


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[Sunset]

My thinking is reduce your IRA type accounts as much as you can prior to RMD time so you don't pay extra tax.
For that reason I'm planning on delaying SS until 70 so have more years to draw down the IRA's (either cash to spend, or convert to ROTH if too much).

[Likes_to_Lurk]

Quote:

Originally Posted by Sunset My thinking is reduce your IRA type accounts as much as you can prior to RMD time so you don't pay extra tax. For that reason I'm planning on delaying SS until 70 so have more years to draw down the IRA's (either cash to spend, or convert to ROTH if too much).

This is what I am doing. 2/3 of my portfolio is in my IRA and I am drawing that down now to reduce RMD's later. I have been withdrawing up to the top of the 15% tax bracket. That and the dividends from my taxable accounts are covering my expenses and taxes. I am planning to re-evaluate this each year. I can convert some to a Roth if I don't need the cash or I can do more withdrawals from my IRA or tap my taxable account if I need more spending money.

While it's nice to pay only a small amount of tax in any given year as in your #2,you have to take into account what happens in the long run. Large RMD's can make some of your SS taxable.

[pb4uski]

We are in a similar situation to you... we are 60 with 27% taxable (~3-6% in cash), 57% tax-deferred and 14% tax-free and WR of ~3%, 15% tax rate with 25%+ once SS and pension start.

What we do is live off of cash and taxable account dividends, sell enough taxable investments to bring the cash back up to 6% when we rebalance and do Roth conversion to the top of the 15% bracket. If we overconvert, we recharacterize down to the top of the 15% bracket when we do our return (~$500/year).

Taxes with no Roth conversions would be zero and the effective tax rate on our roth conversions is about 10% because of deductions, exemptions, 10% bracket and 15% bracket. I would much rather pay 10% now than 25% or more later.

[CardsFan]

Quote:

Originally Posted by pb4uski We are in a similar situation to you... we are 60 with 27% taxable (~3-6% in cash), 57% tax-deferred and 14% tax-free and WR of ~3%, 15% tax rate with 25%+ once SS and pension start. What we do is live off of cash and taxable account dividends, sell enough taxable investments to bring the cash back up to 6% when we rebalance and do Roth conversion to the top of the 15% bracket. If we overconvert, we recharacterize down to the top of the 15% bracket when we do our return (~$500/year). Taxes with no Roth conversions would be zero and the effective tax rate on our roth conversions is about 10% because of deductions, exemptions, 10% bracket and 15% bracket. I would much rather pay 10% now than 25% or more later.

This was our original plan (#1 above) and probably the way we will proceed. However, I don't see a way to avoid being in the 25% bracket, and having 85% of SS taxed when we hit RMD's, unless we convert into the 25% bracket now. I might play out a few scenarios in iOrp.

Of course, who knows what the tax code will look like in 10 years. Or, for that matter, what the market will do!

[Cobra9777]

Quote:

Originally Posted by CardsFan This was our original plan (#1 above) and probably the way we will proceed. However, I don't see a way to avoid being in the 25% bracket, and having 85% of SS taxed when we hit RMD's, unless we convert into the 25% bracket now. I might play out a few scenarios in iOrp. Of course, who knows what the tax code will look like in 10 years. Or, for that matter, what the market will do!

We're in the same boat. Converting to the top of the 15% bracket will not eliminate 25% tax on RMDs. It does reduce the amount taxed at 25% (possibly higher), depending on market return assumptions. But I refuse to convert into the 25% bracket. Seems to me, the worst case scenario is to pay 25% now, have a bad decade, and end up owing 15% (or a mix of 15% and 25%).

If the markets are kind, I'll happily deal with the tax consequences. I still gained on tax deferral at 28%-33% when working. If the markets are unkind, I'll be happy I didn't prepay tax at 25%. Either way, I'm happy. So for us, there are too many unknowns at this point to convert beyond the 15% bracket.

IMHO, i-ORP is way too aggressive about converting huge amounts early on. I see only a small upside potential but plenty of ways it could go horribly wrong. I've already won the game; don't need to take risks like that.

[Happyras]

Quote:

Originally Posted by CardsFan A couple of options, at least until FRA: 1. Maximize Roth conversions to 15 % bracket. Fed and state Taxes would be about 10k. Spend from cash and/or after tax account.

We are in a similar boat, and I-orp says to aggressively convert IRA to Roth. My wife says to take SS at 62, despite the math, it is just better to get the bird in hand cause the bush may burn. Beyond age 82 the higher SS checks would be just noise in the cash flow with RMD's, and a huge capital gain if we sell our business at that time.

I even started my first pension at 55, and now at 62 I am taking one more of my 3 plans early. Our cash flow is fairly predictable with rental income pretty high, and a business we own on steroids making us nervous about our tax bills going forward.

Since I retired this year, our marginal tax rate will be still in the 20's%, but I fear our RMD's at age 70.5 will be at the max rate with marginal >30%. With the coming elections a whole new economics may develop, and I fear we will revert back to tax rates much higher than 39.6% for a long time. If this were not the case, I may not consider the aggressive Roth conversions at a marginal rate >20%.

Has anyone else considered this probability of tax rate hikes in the near future? Or is it more likely that rates will be the same, but with less deductions?

[CardsFan]

Quote:

IMHO, i-ORP is way too aggressive about converting huge amounts early on. I see only a small upside potential but plenty of ways it could go horribly wrong.

From playing with iOrp in the past, this has been my experience.

Quote:

I've already won the game; don't need to take risks like that.

Agreed. We've got to be careful about trying to tweak the system for the last $, when we don't even know what the rules will be in 10 years.

[pb4uski]

Quote:

Originally Posted by CardsFan This was our original plan (#1 above) and probably the way we will proceed. However, I don't see a way to avoid being in the 25% bracket, and having 85% of SS taxed when we hit RMD's, unless we convert into the 25% bracket now. I might play out a few scenarios in iOrp. Of course, who knows what the tax code will look like in 10 years. Or, for that matter, what the market will do!

For us, based on my projections, if we convert to the top of the 15% tax bracket for 10 years (60-70), we'll be in the 15% tax bracket for the rest of our lives. OTOH, if we do not convert now, we'll be in the 25% tax bracket for about 10 years and then back into the 15% tax bracket. The savings in tax from 60-70 if we do not convert get sucked back in about 4 years once we get into the 25% tax bracket.

[Options]

Quote:

Originally Posted by Cobra9777 We're in the same boat. Converting to the top of the 15% bracket will not eliminate 25% tax on RMDs. It does reduce the amount taxed at 25% (possibly higher), depending on market return assumptions. But I refuse to convert into the 25% bracket. Seems to me, the worst case scenario is to pay 25% now, have a bad decade, and end up owing 15% (or a mix of 15% and 25%). If the markets are kind, I'll happily deal with the tax consequences. I still gained on tax deferral at 28%-33% when working. If the markets are unkind, I'll be happy I didn't prepay tax at 25%. Either way, I'm happy. So for us, there are too many unknowns at this point to convert beyond the 15% bracket. IMHO, i-ORP is way too aggressive about converting huge amounts early on. I see only a small upside potential but plenty of ways it could go horribly wrong. I've already won the game; don't need to take risks like that.

This completely sums up my thinking and current plan of action. Living off taxable (while tax gain harvesting), delaying SS until 70 and doing roth conversions up to the top of the 15% bracket. I do not like i-orp at all as I don't like deterministic calculators and agree there are too many ways things could go horribly wrong following its calculations.

I use tax software to figure tax liabilities as the tax code stands today. I must use today's tax code and deal with tax code changes as they occur as this is all we have. I view tax, medicare, and social security reform forecasting to be a waste of time (but do include a 20% PF buffer in later years given my age and PF life to cover potential changes).

As with all my investment planning, I'm purposely using an Occam's razor approach and engaging in "satisficing"(aiming to achieve only satisfactory results because the satisfactory position is familiar, hassle-free, and secure, whereas aiming for the best-achievable result would call for costs, effort, and incurring of risks). The more I read of behavioral finance, the more I keep seeing over and over that investing mistakes are psychological and emotional in nature. Self-knowledge, taking the opposite view, and a dogged adherence to simplicity in all things are the antidote.

[Animorph]

I'm doing #1, but essentially into the 25% bracket. If I don't do it now I'll be in the 25% bracket when RMD's hit. This way I shelter some currently taxable funds in a Roth account a little longer. Hopefully I'll be in the 15% bracket or very close after age 70 if all goes well.

Definitely try to minimize taxes by filling a low bracket with tIRA/401k withdrawals now. Estimate your taxes after RMD's start to determine which bracket. If you can get a lower tax rate now (10% versus 15% or 15% versus 25%) then do it. If you can get the same rate now (15% now or 15% later) it is generally beneficial to Roth convert, but the gains are fairly minimal.

That said, also watch for ACA subsidies or other tax breaks that you might lose if your income is too high. It can take a lot of Roth conversion gains to make up for losing a substantial tax credit.

[sengsational]

Yep, The PTC is why my Roth conversions now are minimal.

i-orp says doing those few mega conversions early (starting at age 65) will give me 2% more per year than limiting to 15%. I'll cross that bridge when I come to it.

[Packman]

I have a similar situation, except that I have $500k of L/T gains in the after tax account. So I am tax-gain harvesting to fill the 15% tax bracket each year at a zero tax rate until they are gone. Then I will convert tax deferred dollars into the Roth. Also planning to delay SS until 70.

One of my thoughts is that Congress is much more likely to begin taxing L/T gains on lower incomes than they are to significantly raise tax brackets. I know that RMD's at 70 will be higher and therefore taxes will be higher, but by then we will have SS income. Today we have no pensions, so no income except dividends and gains.