Optimizing Retirement Income...

[daylatedollarshort]

Midpack, The Fidelity retirement planner appears to account for taxes and RMDs. They have year by year cash flow detail so you can see the taxes paid each year.

I make my own spreadsheet than validate the numbers against the RIP to make sure I am in the right ball park. The Fidelity RIP assumes higher returns and higher taxes than I do in our master plan, but the end results aren't too far off from each other.

 

[kaneohe]

The additional dilemma that I have is whether I should prioritize 0% capital gains over Roth conversions. I have ~2-3 year of living expenses in unrealized capital gain in taxable accounts and am finding those 0% capital gains hard to pass up but I'm not totally sure that is the best play and whether in the long run I might be better off prioritizing Roth conversions over 0% capital gains.

Have you considered the role of state taxes here? We typically focus on the 0% fed CG rate and neglect the state. Try modeling the state tax as using up a taxable side fund if you do the CG harvest but leaving it if you don't. I think you will find that if the subsequent holding period has "small" gains, the CG harvest comes out ahead. However if the the subsequent gains are large, the no CG harvest comes out ahead. The specific results obviously depend on what assumptions you make but the limited examples I did had 2x for the "small" gain and 10x as the large gain.

Another consideration is that if you never use these appreciated assets,the heirs get a stepup in basis and the CG tax never gets paid. Both of these results might give a slight edge for the Roth conversion but I suspect unless there are dramatic changes in tax rates or huge appreciations , the practical differences will be small.

A boglehead thread also points out that you can push a Roth conversion to the max because you can always recharacterize any undersired overage but you can't do that with CG gain harvesting.

 

[Animorph]

Is this the spreadsheet posted by BigFoot48? He supposedly has created a spreadsheet modelling taxes considering the impact of RMD's and SS. I've not looked at it yet because it won't be a question for me until 2015. I too am delaying SS until 70 which will impact tax levels. I do have a ROTH and 2/3 of PF is after tax, but I'm still going to look at the conversion to maximize my overall tax situation.

Keep in mind that efficient Roth conversion involves converting at the beginning of the year (when equities and bonds are at their lowest valuations on average), and estimating and paying estimated taxes in four equal installments starting in April. Then you can follow that up with additional conversions if your equities decline in value, and recharacterize the excess after you calculate your taxes the following year. So you have about a year to prep.

 

[pb4uski]

Midpack, I'm not sure whether to thank you or curse you.

This thread prompted me to recreate my model from the ground up to look at tax optimization - principally the mix of 0% CG harvesting or Roth conversions and including both federal and state income taxes. It took me most of the day. The results may cause me to change course a bit.

I was planning to prioritize 0% CG over Roth conversions but the model suggests that prioritizing Roth conversions is slightly better for me. My nestegg at age 100 is 7% higher prioritizing Roth conversions than prioritizing 0% CG harvesting. While I still end up in the 25% bracket after age 70, it is less so than with the other strategy.

The only thing now bothering me is "is it true"? There are a lot of moving parts. Also, if I prioritize CG harvesting now and there is a downturn, I may then be able to harvest bigger losses because of the step-up in basis and do bigger Roth conversions. I can't easily model such a scenario, but I suspect I am just rationalizing because 0% CGs are so tantalizing.

 

[pb4uski]

Have you considered the role of state taxes here? ....

Yes, I am considering state taxes. In my state, taxes are a bit of a push because Roth conversions and CG are both taxed at ordinary rates. The first $5k of CG each year isn't taxed, so there is a imperceptively slight preference to CG vs Roth conversions.

 

[Midpack]

Midpack, I'm not sure whether to thank you or curse you.

This thread prompted me to recreate my model from the ground up to look at tax optimization - principally the mix of 0% CG harvesting or Roth conversions and including both federal and state income taxes. It took me most of the day. The results may cause me to change course a bit.

I was planning to prioritize 0% CG over Roth conversions but the model suggests that prioritizing Roth conversions is slightly better for me. My nestegg at age 100 is 7% higher prioritizing Roth conversions than prioritizing 0% CG harvesting. While I still end up in the 25% bracket after age 70, it is less so than with the other strategy.

The only thing now bothering me is "is it true"? There are a lot of moving parts. Also, if I prioritize CG harvesting now and there is a downturn, I may then be able to harvest bigger losses because of the step-up in basis and do bigger Roth conversions. I can't easily model such a scenario, but I suspect I am just rationalizing because 0% CGs are so tantalizing.

Like I said earlier it's really mind-boggling if you try to factor in every variable (to me at least)...curse me if it helps in any way.

I will look at Fido RIP tomorrow (as suggested above) and if that doesn't work I'll probably build some crude spreadsheets that fit no ones circumstances but my own to see if I can develop several scenarios and thereby the best answers for us. My first effort was intended to allow other users to input their info and provide results (to share here) but that makes it several orders of magnitude more complex...and I gave up on that several weeks ago.

Thanks to rebalancing on top of DW's income and normal dividends and STCG, we're already up into the 25% bracket so the urgency on Roth conversions this year aren't as great as it will be when DW finally retires among other milestones.

 

[pb4uski]

Like I said earlier it's really mind-boggling if you try to factor in every variable...curse me if it helps in any way.

I will look at Fido RIP tomorrow (as suggested above) and if that doesn't work I'll probably build some crude spreadsheets that fit no ones circumstances but my own to see if I can develop answers. My first effort was intended to allow other users to input their info and provide results (to share here) but that makes it several orders of magnitude more complex...

+1 when I started the reconstruction I was hopeful to share something, but I wouldn't dare since it is so specific to me - I wouldn't want to share something that might be dangerous or misleading for someone else.

 

[Lsbcal]

One point I thought of, beyond age 80 is it really so important to optimize the tax issues? My feeling is optimization should be primarily for my active spending years. Only secondarily for my heirs.

Past 80 I don't want to have a really bad tax picture, but I won't worry too much about optimization for estate purposes.

 

[ducky911]

sorry no help here from me. I have give in this a lot of thought over the years and concluded that any benefit would not out weigh the pain of opening another account. I am trying to simplify things not only for me but for DW if she has to take it over one day.

I am happy , even knowing that I may not have taken the perfect path.

I do think that you could use ezplaner as a base to work around and get your answer.

 

[Midpack]

One point I thought of, beyond age 80 is it really so important to optimize the tax issues? My feeling is optimization should be primarily for my active spending years. Only secondarily for my heirs.

I agree but I'd hate to find out at 80 that we actually would have been better off taking income (Roth conversions among others) earlier and finding we're paying much higher taxes due to RMD and less net Soc Sec from 80 on. Yes, I agree having enough now is what's most important,, but that's no reason to unwittingly pay lots of taxes later/overall than need be.

 

[samclem]

This thread prompted me to recreate my model from the ground up to look at tax optimization - principally the mix of 0% CG harvesting or Roth conversions and including both federal and state income taxes. It took me most of the day. The results may cause me to change course a bit.
. . .
I can't easily model such a scenario, but I suspect I am just rationalizing because 0% CGs are so tantalizing.

Other factors (sorry!):
- Which opportunity is more fleeting/subject to changes in tax law, the Roth Conversion or the 0% CG? If you think one or the other might evaporate, it might make sense to use it now, use the other later.
- Survivor/Filing Single Taxes (sorry pb4uski, I don't recall if this applies to you): Assuming you are in the upper portion of the 15% bracket when MFJ, a surviving spouse would probably have marginal rates well into the 25% range. Under the above conditions:
-- Cap Gains harvesting: Every dollar of basis that is reset higher now saves the survivor 15 cents (for others following along, that's the cap gains tax rate for those in the 25% income tax bracket)
-- Roth Conversion: Every dollar converted to Roth now costs 15 cents in present taxes, but saves the surviving spouse from paying 25 cents in taxes. Net benefit: 10 cents.

So, looked at from this angle (minimizing taxes to a surviving spouse), the CG loss harvesting has a 5% edge (or, "provides 50% greater benefit!"). Plus, it keeps more money in your account (because you didn't pay those 15% taxes this year), and that's "pad" against uncertainties of the future. Market returns might stink for 20 years: in that case you'll be glad you kept this money in hand AND you'll avoid high taxes after all

And, it matches what your "gut" is telling you.

Caution: I have no idea how this impacts any other issues: PPACA subsidies, SS taxes, etc.

 

[Lsbcal]

I agree but I'd hate to find out at 80 that we actually would have been better off taking income (Roth conversions among others) earlier and finding we're paying much higher taxes due to RMD and less net Soc Sec from 80 on. Yes, I agree having enough now is what's most important,, but that's no reason to unwittingly pay lots of taxes later/overall than need be.

We all have different numbers but here is a peek at my projections. Right now we're spending from our retirement accounts maybe 60% from our Roth's to get the low taxes. When RMD's kick in that will drop to less then 50% from Roth's and we'll be forced into much higher marginal rates.

By age 80 my projections are that Roth's will only make up 20% of spending because RMD's will be forcing us to take so much from IRA's. So there is plenty of time for our heirs to get the Roth's bumped up by my sterling investment results from ages maybe 70 to 100.

Hopefully something I've mentioned here helps someone.

 

[Lsbcal]

...
-- Roth Conversion: Every dollar converted to Roth now costs 15 cents in present taxes, but saves the surviving spouse from paying 25 cents in taxes. Net benefit: 10 cents.
...

I'm not convinced that Roth conversions should stop at 15% marginal tax rates. It depends on what the marginal Fed + State are now and what they might be deep into RMD's or other age cases too. If we didn't have Roth money now, we'd be paying taxes at the combined marginal rates above 26%. Hard to generalize on this.

Like many posters here, I'd take the current tax rates as the lower bound for future rates. Medicare will have to be fixed someday.

 

[Options]

Yep. He debugged it (13 iterations?) with feedback from the Boglehead community and it's probably great. But I need to pick it apart to understand what assumptions are made before I can have confidence in the results - so far I haven't had the patience.

Yes, the feedback is great, but I know I have no patience to pick apart the assumptions after 13 updates.

Good thought, and I bought ESPlanner+ in the mid 00's but I've let mine lapse out of date. I was going to resubscribe to see Roth conversion and Soc Sec tax impact. Unfortunately last time I looked a few months ago, ESPlanner does not really handle Roth conversions. They offered up a workaround in 2009, that's cumbersome and not accurate by their own admissions, and they've promised to add that functionality for several years now, but it hasn't been done yet that I know if.

Roth IRA Conversion - The effects of taxation on this decision. | ESPlanner Inc.

Bad news as I was hoping to use ESPlanner next year to assist with figuring out the conversions. I'd read about the workaround but was under the impression it would have been fixed by now. Looks like there are no easy answers.

Edit: Additionally, what the stock market does and the shape my PF is in (i.e., another 2008 meltdown) may impact/complicate any conversion decisions I make as well. Again, no easy answers.

 

[samclem]

. . . Hard to generalize on this.

Like many posters here, I'd take the current tax rates as the lower bound for future rates. Medicare will have to be fixed someday.

Yes, and the specifics matter a lot. I'd need to run my numbers and have a lot of faith in my assumptions before paying taxes now at the rate of 25% when I'll be safely inside the 15% zone when I retire (soon).

Those fixes to Medicare and other due bills: one idea bandied about is to continue to leave Roth withdrawals untaxed (officially "keeping the promise"), but add those withdrawals for purposes of computing the taxes on other income. So, the Roth withdrawals could force retirees to pay higher rates om the other income sources (tIRAs, taxable accounts, SS, etc). I'm not betting on that proposal, but it would sure sting if somebody had bet everything on the Roth IRA horse.

Nothing's certain but death and taxes--and it turns out nothing is certain about the "how" of either of those!

 

[Animorph]

Yes, and the specifics matter a lot. I'd need to run my numbers and have a lot of faith in my assumptions before paying taxes now at the rate of 25% when I'll be safely inside the 15% zone when I retire (soon).

Those fixes to Medicare and other due bills: one idea bandied about is to continue to leave Roth withdrawals untaxed (officially "keeping the promise"), but add those withdrawals for purposes of computing the taxes on other income. So, the Roth withdrawals could force retirees to pay higher rates om the other income sources (tIRAs, taxable accounts, SS, etc). I'm not betting on that proposal, but it would sure sting if somebody had bet everything on the Roth IRA horse.

Nothing's certain but death and taxes--and it turns out nothing is certain about the "how" of either of those!

Might be great if you had everything in the Roth and no other income. Not so good if you are only topping off income with the Roth to stay within a tax limitation.

 

[Lsbcal]

Yes, and the specifics matter a lot. I'd need to run my numbers and have a lot of faith in my assumptions before paying taxes now at the rate of 25% when I'll be safely inside the 15% zone when I retire (soon).
...

If you are safe within the 15% zone through SS and RMD's, then it's a no brainer. You don't need to do any Roth conversions.

I was referring to the case where someone knows they will likely have 2 income streams (SS + RMD's) that push them into higher brackets later in life.

 

[sengsational]

I've probably spent most of my retirement working on this problem. It's not easy if everything is in play.

If you can identify the federal tax bracket that you will be exceeding during RMD's you can then try to Roth convert whenever you get a chance to within that bracket. Until it looks like RMD's will come out within that bracket. This might be determined with a fairly rough calculation of your taxes at age 70. Then if you get the chance to take extra tIRA withdrawals/Roth conversions in a lower bracket before age 70, jump on it.

It's not a big deal if you don't get it exactly perfect. But if you are well into the 25% tax bracket with RMD's at age 70 and have no taxable income now, it can make a big difference.

Any time you need to make a taxable withdrawal from a tIRA and have an equivalent amount in your taxable account, make it a Roth conversion.

I was right with ya until the last sentence.

If you are safe within the 15% zone through SS and RMD's, then it's a no brainer. You don't need to do any Roth conversions.

I was referring to the case where someone knows they will likely have 2 income streams (SS + RMD's) that push them into higher brackets later in life.

I'm still in non-actionable territory, but next year I could take action. I'd even like to see a 'non-calculator' app that used rules like the above to direct people to the right general scheme, or if they fall into a place where there are more considerations. If the latter, the tool might be able to bracket the scope of the advantage. For instance, are we talking 0.5% or 5%? I recall in one of my spreadsheets messing up the state income tax and realized that I could save 10X more by moving 20 miles south than I could by optimizing conversions!