Questions about the Optimal Retirement Decision

[veremchuka]

I experimented with the Optimal Retirement Decision Support website Optimal Retirement Calculator and Retirement Decision Support System that I saw in a thread about RMD's on Friday and I am somewhat confused by the results. I think all the various reports are excellent and cover a lot of ground but what is the purpose of this exercise?


Just to see how this works I made up pseudo parameters as follows. I would retire at 62 and collect my pension and Social Security at 62. I gave it a portfolio of $570,000 plus my house valued at $250,000, 15% federal bracket and 3% state. Inflation I set to 5%, returns on tax deferred and Roth at 5%. I told it I wanted to leave an estate of $350,000.


The OPR Withdrawal Report has me shaking my head. In the 1st year, age 62, it has me taking a tax deferred distribution of $201,000, doing a Roth conversion of $148,000 and paying taxes of $56,000! This is where I'm confused. Why would anyone in the 1st year of retirement at 62 pull $201,000 from tax deferred just to pay taxes on it and put it into the Roth? Sure it's tax free then but the taxes, I jump from the 15% to 28% bracket! And where does the money come from to pay the taxes? Maybe from the distribution but they always say not to use the distribution money to pay the taxes on a Roth conversion use taxable (after tax money). I told it I have only $8,000 in cash. My Social Security was $18,000 and pension was $21,000 so where exactly does the tax money come from! And why would I want to cough up $56,000 for taxes in the 1st year of retirement?

In the 1st 3 years of retirement it has me taking distributions of $364,000 from tax deferred, doing $255,000 in Roth conversions and paying $101,000 in taxes! By year 4 my taxes would be $7k, $8k or $9k per year for 7 years and then in the 11th year my taxes are $4k for ever. My spending would be $50,000 to $90,000 from year 3 thru 17 and then $100,000 to $180,000 to age 92! Where's all this money coming from? I don't get it.


Has anyone followed the withdrawal suggestion/results of the ORDS report? Maybe the report is just to show "what if" scenarios and not "do this" scenarios? I sure wouldn't do what it is showing! I thought would be a good tool but now I doubt the results.

 

[meierlde]

One thing a lot of the calculators ignore is the fact that 401ks and IRAs are bankruptcy safe as well. Even with an umbrella policy one could get hit with a lawsuit, so the bankruptcy protection is a worthwhile item.

 

[Nords]

In the 1st 3 years of retirement it has me taking distributions of $364,000 from tax deferred, doing $255,000 in Roth conversions and paying $101,000 in taxes! By year 4 my taxes would be $7k, $8k or $9k per year for 7 years and then in the 11th year my taxes are $4k for ever. My spending would be $50,000 to $90,000 from year 3 thru 17 and then $100,000 to $180,000 to age 92! Where's all this money coming from? I don't get it.

I think it's trying to minimize your lifetime taxes by paying them up front when they're "cheaper". How much tax would you pay over the rest of your life if you did not do the conversions? How much of your Social Security would be subject to taxation, and how onerously high would your conventional IRA's RMDs climb in your late 70s and early 80s?

The taxes would be paid for out of the distributions. You'd be over 59.5 so you could spend some of it instead of having to convert all of it.

The program is ignorant of political risk, but it's hard to see future taxes being being the same as today's taxes-- let alone lower.

I don't know how it treats your estimated medical expenses, but it seems to think you're going to be spending a lot on that category in your 90s...

 

[plex]

Vere, are you adding 0's to your numbers, you shouldn't have several zeros since the input values are by default already in the thousands.

I input my parents numbers and it spit out 20-25k each year in roth conversions for three years after the first one retires, and then not to do them anymore after that, which is exactly what I was expecting.

The amount they recommend spending is over 4% though, and results in running out of money at the 30 year mark, which I don't like. It also recommends draining the after-tax retirement accounts ASAP after both retire and their income drops, which I also find extremely odd, because it is the opposite of what they should do, which is to use tax deferred in low years, and then in the particularly high years tap the after-tax.

 

[kaneohe]

OP.......interesting question. I only played w/ that calculator a little bit a yr
or so ago and also was struck by the emphasis on conversions. Don't have an answer for you but also am interested in other's thoughts. Re: Nord's comments about minimizing tax impact.........the home page phrases it somewhat differently......to maximize after-tax amounts available for lifetime spending.....they might not be quite the same.

 

[golfnut]

I have been playing with this retirement calculator. How does one produce the OPR Withdrawal Report??

Thanks,
Golfnut

 

[Rustward]

From the home page click on the blue box that says Run ORP!
That takes you to the data entry page, where you enter your numbers.
As someone pointed out, dollar amounts are in thousands.
After entering the data, click the red Run ORP box at the bottom of the data entry page.
The results page appears in a new window or a new tab.
ORP produces a standard set of reports, and the ORP Withdrawal report is one of them -- the second or third report, depending on how you count the reports.

 

[omni550]

I have been playing with this retirement calculator. How does one produce the OPR Withdrawal Report??

Thanks,
Golfnut

It's the 2nd page of the ORP results...immediately after the "Asset Balance" section.


omni

 

[veremchuka]

Thanks. As to how much I'd pay in taxes if I did not do the conversions up front, I don't know but it seems at the 15% federal rate it would be less than pushing myself into the 28% federal rate, maybe it'd break even. It seems crazy to take a $200+k distribution when presently I don't take any as I live off my pension and bank about 1/2 of it because I LBYM.

I don't see anyone saying they followed the OPR recommendation. It seems risky to do so cuz once a distribution is taken you can't undo it much less years later should you find that you wish you hadn't done it.

I guess taxes are the price we pay for saving so well and enjoying the tax deferred benefit for 30 years.

 

[Kibitzer1]

Optimal Retirement Calc.

Taxes are likely going to go up in the future. This must be reckoned with and planned for.
Soc. security income is taxed today at $25K for single filer; 32K income for married filers. ORP founder is opposed to overpaying taxes, so the model attempts to minimize tax.
I think the ORP is a good calculator and a fine tool - their web pages describe the methodology and are worth reading.
Did you go back and re-enter your speculative data without extra zeros?

 

[chinaco]

I experimented with the Optimal Retirement Decision Support website...

You did not list the SS and Pension amounts. These are critical factors that are needed to understand why you had some very large rollover events.

My opinion... that tool is not an expert system that outputs your best decision, rather it is a linear programming calculator that produces information about an optimum outcome given the information provided... you have to make the expert decisions!

Also, keep in mind that an optimum plan that saves you $1 in taxes may be optimum but may not be worth the effort to follow it.

You should consider doing another illustration and make sure you put in the correct data (no input mistakes), and make sure you understand the reports (no interpretation mistakes).

Those reports are useful... but can be a little difficult to interpret at first glance.


This is a math problem where variables, rules, and constraints are applied and variables are altered to systematically evaluate scenarios to find an optimum solution. Assuming there is not a bug in the software... or a bug in the operator (you)... it is trying to find a way to minimize the tax liability.


Keep in mind... that software should only be used to work through the math drudgery... you should do some careful analysis (plus cross check and verify the results). You should perform a number of what-if scenarios changing the variables that you can control to see how that it affects the outcome. For example the pension and/or SS payout assumptions (when you take them and the difference in payout) to see if you get a better outcome.

However, there is more to managing your income than optimizing the tax outcome... you could have other personal constraints or situations where the most optimum tax situation may not be a good idea because of other circumstances. This type of analysis should be done with the rest of your personal circumstances and other parts of your retirement financial planning in mind to create a holistic plan.

Take your time and create a complete financial plan and double check your work.

 

[gneeby]

Inflation I set to 5%, returns on tax deferred and Roth at 5%. I told it I wanted to leave an estate of $350,000.

The interesting thing about your scenario is that assets returns = inflation, i.e. the economy goes into stagflation big time.

A second point is that the estate value is expressed in todays $ so that 25 years down the pike, at 5% inflation rate, it grows into quite a large sum.

I wouldn't use ORP as an accounting program. Support is the operative word in its title, not decesion. It doesn't make decisions, just supports decision making through lots of scenarios for a variety of choices.

 

[Nords]

I don't see anyone saying they followed the OPR recommendation. It seems risky to do so cuz once a distribution is taken you can't undo it much less years later should you find that you wish you hadn't done it.

We've been converting our IRAs to Roths for nearly every one of the nine years I've been ER'd.

I'd rather pay a little tax now (and have a choice about withdrawals) than pay a lot of tax later.

 

[haha]

Another thing that complicates these decisions is that once you start drawing SS and/or enroll in Medicare, your adjusted AGI affects far more than your marginal tax rate.

I think it is definitely worth while to give real consideration to conversions before either of these events begin.

Ha

 

[veremchuka]

Thanks.

Yes I entered $100,000 as $100 (no $ sign).

I entered a pension and SS, I entered all data it wanted I just did not mention all of it here. I read every single word on the site on how to enter data and how the OPR works, multiple times, so I have no doubt I understood how to enter the the data and what it represented. I read what the reports meant several times. I ran different scenarios varying SS age and inflation rates.

It still boggles my mind taking a $200k distribution that I don't need. I haven't tapped any tax deferred or tax free except a tiny amount in tax deferred to help pay off my mortgage. At this rate I may not need to take any distributions before 70 1/2 which is why I was concerned about the taxes that'll incur. But like i said, sooner or later we have to pay taxes of these tax deferred dollars and I put 90% of my money into my 401k. I maxed the Roth since 2000 but those contributions were puny. All the taxable money was spent to pay off the mortgage so I really only have tax deferred and Roth. I'm banking $700 to $1000 a month from my pension that I don't spend to build up cash. This would be used to do any Roth conversions if I do any.

I gotta talk to a pro!

 

[chinaco]

....

It still boggles my mind taking a $200k distribution that I don't need. ...

This is a math problem that revolves around the tax bracket. The math is pretty simple.

If... for example one is in a higher tax bracket and there is no way to lower it in the future (because of a pension and SS).... one might as well max the amount rolled for that bracket and get it into the Roth. Especially if later, you might be shifted into a higher tax bracket (due to something out of your control).

You probably also should consider if income taxes might go up soon... because of new legislation related to the national debt and obligations.

You can model it in a spreadsheet. Do some what-if analysis in a spreadsheet and compare the numbers. Seeing the calculations will demystify it for you.


Plus... at Roth has special characteristics related to inheritance (compared to a traditional IRA). Ed Slott's books are pretty good resources on the inheritance topic.

 

[wolfbay]

We've been converting our IRAs to Roths for nearly every one of the nine years I've been ER'd.

I'd rather pay a little tax now (and have a choice about withdrawals) than pay a lot of tax later.

Isn't it also true that even if tax rates didn't change and you had a significant amount of your IRA left when you died your heirs would pay higher taxes? I don't like paying higher taxes even when I'm dead!

 

[Independent]

I've done traditional to Roth conversions in years when my marginal FIT rate was 15%. I converted enough to "fill up the 15% bracket".

I'm trying to understand the advantage in doing larger conversions right now. Any additional conversions would be taxed at 25%. I can imagine us being in a 25% marginal bracket after age 70 due to RMD's, but the 28% bracket starts at $167k taxable (maybe $200k gross) and I'm not seeing us getting that high. There's no age limit on conversions, if congress looks likely to raise tax rates, I should have some forewarning and be able to move to the Roth then.

I suppose the catch is that if I tried to move lots to the Roth over a short time frame I'd kick us into a 28% bracket in the year of the conversion.

The other side is the possibility that Congress follows the Simpson/Bowles plan and raises taxes by eliminating deductions while reducing rates.

I'm having trouble with the inheritance analysis. It seems that one way I might leave each of my kids $100k in a trad IRA, the other way I leave them $75k in a Roth. I don't see an big advantage in one or the other.

 

[kyounge1956]

Isn't it also true that even if tax rates didn't change and you had a significant amount of your IRA left when you died your heirs would pay higher taxes? I don't like paying higher taxes even when I'm dead!

You can designate IRA beneficiaries in such a way that they get to spread the distributions over their whole life expectancy. If you make grandchildren (or other young people) the beneficiaries of your IRA, their long life expectancy will spread the distributions over many years, so they will not suffer a single large tax hit as they would if they inherited a lump sum all at once via your will. Ed Slott's books, mentioned by chinaco, explain how to do this.

 

[rescueme]

Isn't it also true that even if tax rates didn't change and you had a significant amount of your IRA left when you died your heirs would pay higher taxes? I don't like paying higher taxes even when I'm dead!

Unless your "heir" is a registered non-profit charity. Then (under current tax laws) the entire amount would be given tax-free, and a way to also possibly reduce estate taxes (depending on current estate tax laws).

For most folks this may not be an option. However in some cases that one wants to avoid taxes to the fullest extent possible for a large residuial estate, it is a way around the tax burden, while allowing your named charities to continue their "good works" rather than have a good portion of the estate value going to the government.

 

[jdw_fire]

I'm trying to understand the advantage in doing larger conversions right now. Any additional conversions would be taxed at 25%. I can imagine us being in a 25% marginal bracket after age 70 due to RMD's, but the 28% bracket starts at $167k taxable (maybe $200k gross) and I'm not seeing us getting that high. There's no age limit on conversions, if congress looks likely to raise tax rates, I should have some forewarning and be able to move to the Roth then.

the problem with waiting till you have started RMDs to do conversions to your roth IRA is that you will have larger RMDs and they (the RMD amounts) cant be converted to your roth IRA. so if you start earlier you can convert more (up to the entire TIRA value) to your roth IRA.

 

[Nords]

Isn't it also true that even if tax rates didn't change and you had a significant amount of your IRA left when you died your heirs would pay higher taxes? I don't like paying higher taxes even when I'm dead!

We plan to avoid this issue by ensuring that there's not a significant amount of IRA left when we die.

 

[Alan]

I've done traditional to Roth conversions in years when my marginal FIT rate was 15%. I converted enough to "fill up the 15% bracket".

I'm trying to understand the advantage in doing larger conversions right now. Any additional conversions would be taxed at 25%. I can imagine us being in a 25% marginal bracket after age 70 due to RMD's, but the 28% bracket starts at $167k taxable (maybe $200k gross) and I'm not seeing us getting that high. There's no age limit on conversions, if congress looks likely to raise tax rates, I should have some forewarning and be able to move to the Roth then.

I suppose the catch is that if I tried to move lots to the Roth over a short time frame I'd kick us into a 28% bracket in the year of the conversion.

The other side is the possibility that Congress follows the Simpson/Bowles plan and raises taxes by eliminating deductions while reducing rates.

I'm having trouble with the inheritance analysis. It seems that one way I might leave each of my kids $100k in a trad IRA, the other way I leave them $75k in a Roth. I don't see an big advantage in one or the other.

We're in the 25% bracket now and ORP recommends converting 1/3 of our tIRA's to Roths now, at a rate of ~$40k/year, then stop in a few years time and not touch the rest of the tax deferred until age 70. Not sure why, and I can't seem to bring myself to choose to pay an extra $10k/year of taxes now, so I'm converting $25k/year.

 

[Independent]

the problem with waiting till you have started RMDs to do conversions to your roth IRA is that you will have larger RMDs and they (the RMD amounts) cant be converted to your roth IRA. so if you start earlier you can convert more (up to the entire TIRA value) to your roth IRA.

I'm going to restate this to see if I've got it.

If I've got more money coming out of the TIRA via RMDs than I want to spend, that money will have to be invested somewhere. There is no other option that's as attractive as a Roth IRA. But the money that came out due to the RMD isn't eligible for a Roth.

The key is to move it to the Roth before the RMD. I could wait and do that at age 69, but I might want to move so much in one year that I'd drive myself into a 28% bracket in that year. So it's better to do some math and see how soon I need to start to spread it out enough to avoid the 28% bracket.

But, that calc won't necessarily show that I need to be moving money at 60. Depending on my assets and other income, it might turn out that I can wait a number of years before I start.

 

[rescueme]

If I've got more money coming out of the TIRA via RMDs than I want to spend, that money will have to be invested somewhere.

True.

Just remember that not all your income will be taxed at a higher rate (25, 28 or higher % rate) in the future.

It's only the excess beyond the prior table rate that will be taxed at the higher rate.

Some folks look that they must convert as if all their projected income will be subject to a higher (whatever) rate. That's not the way it works.

What is most important is what your total FIT rate is - not just the marginal rate, that may only pertain to a little income overall.