Retirement Tax Planning - Income Optimization?

[RME1958]

I think this is mostly an exercise in futility. No matter how clever your software is, it won't be able to come up with a strategy to put 10 pounds of potatoes into a 5 pound bag. The best it can do is help you put 4.9999 pounds instead of 4.95.

The IRS has a claim on X% of the money in your IRA/401K. And the richer you are, the stronger their claim and the larger X is going to be.

The deeper I get in retirement, the more I realize that all that I was doing was just shuffling money around, and changing the timing of *when* I paid the taxes.

The biggest tax-related thing is when one spouse of a married couple dies and the survivor gets shifted to the Single Filing Status. That shifts the start of the 22% rate from $79K to $40K, thus exposing up to $39K that will be taxed at 22% instead of 12%. That's another $3900 in tax.

That's the main reason to do Roth conversions. And none of the clever software in the world can do anything about that.

The main benefit of these software products is to advise you not to do stupid stuff. Okay. But you can figure that out for free.

I spent $20 initially and did a 1 hour consult for $125 with Income Strategy. It gave me something to play with for a couple of weeks but I have the same conclusion as above and probably should not have spent the money. Besides the question of whether the taxes will be paid under married filing jointly or single, is the question of what will happen with future tax rates. Of course if they go up, you will be better paying more under the lower rates now than in the future after they go up. But who knows if/when that will happen?

For me I have a few years until age 65 so I am managing income to take advantage of ACA tax credits then it is Roth conversions up to 22% until RMDs. Then I hope I am complaining because my RMDs have me and my wife in the 32% tax bracket due to the booming stock market.

 

[pb4uski]

Aren't their actually two different types of tax arbitrage in play here? The first is the difference between your marginal tax rate when you put the money in your IRA and your rate when you remove it. The second is the difference between your marginal tax rate now and your rate when you are required to take RMDs. We can know the first with certainty, but we can only take a guess at the second.

From my point of view, I enjoy taking the money out at a rate less than when I put it in. It means the IRA served its essential purpose. Going forward, Roth conversion may be a wash, as Midpack's charts show, but the likelihood of increased tax rates and the certainty of the widow tax penalty both inspire me to convert to the top of the 22% bracket while I can. (We're already low in the 22% bracket due to pension and social security).

I think of it as different sides of the same coin.

Most of my contributions were put in at 28% or higher marginal tax rate. So even if we withdraw at 22% after SS starts we will save 6% or more. That is good.

However, if for a brief period of time I can withdraw at 8.5% as I have, I'll save 19.5%+ (28%+ less 8.5%). That is better!

And if marginal tax rates revert in 2025 then the savings are 3% lower across the board.

 

[RME1958]

What your tax rate was at the time of contributing to your IRA/401k is really irrelevant. I think of it in the same terms as a sunk cost. It is what your current tax rate is vs your future rate that is relevant.

 

[pb4uski]

I see where you are going, but the tax rate at the time of contribution to your IRA/401k is relevant to determining whether contributing was a good decision and the amount of any savings as a result of having done so. But you are right in that decision to contribute is sunk.

I like to frame it that if your tax rate in retirement is less than your tax rate while contributing then congratulations... you won and saved money in taxes. If not, then congratulations.. you because you deferred income thinking that you would be in a lower tax rate in retirement and because you are in a higher tax bracket than when you were working means that you have been more financially successful than you expected to be when you deferred that income. So heads you win and tails you win.

Your current and future marginal tax rates are relevant to deciding whether current tIRA withdrawals or Roth conversions are beneficial or not.

 

[Midpack]

Putting aside the survivor and heirs tax benefit, it's still not a waste of time to look into Roth conversions for many IME.

I'm not the brightest bulb here but some cocktail napkin calcs in posts above seem to assume you'll be in the same marginal tax bracket no matter what you do (e.g. 20% whether you convert or not). You can't assume that, it won't be the case for everyone by any means. In fact, seeking to balance marginal tax rates before and after age 70 when RMD/Soc Sec kick in is the crux of considering Roth conversions - or so I thought.

• If your TIRA is substantial, RMD and Soc Sec taxes may be considerable factors. If your TIRA is small, it won't matter much.
• Almost everyone should convert up to the 12% level, the benefits are greater there. Many here can't avoid higher brackets period (good problem to be sure).
• And the Roth conversions don't matter advocates assume marginal Fed tax rates and state tax rates will remain largely the same, I don't think that's remotely possible over the long term. Current Fed rates are an anomaly.

My table below is my actual results with everything factored in, real numbers. Assumes TCJA rates to 2025 and then reversion to 2017 tables, overly optimistic IMO. I don't care to share my exact numbers, so I've shown taxes and ending balance 100% for the No Roth conversion case. As you can see it makes a considerable difference in taxes paid.

The rub is it does not make nearly as much of a difference in ending balance (presumably the primary goal), I've touched on why before so I won't repeat it. All these tax savings won't improve my bottom line much.

Case	Fed Marg Rate B4 age 70	Fed Marg after 70	Fed & State Taxes	Tax Reduction	Ending Balance
No Roth conv	10-12%	25%	100%		100%
Conv to 22%	22%	15%	82%	-18%	101.4%
Conv to 24%	24%	15%	72%	-28%	102.6%

 

[RetireBy90]

As far as tax rate when we contributed, sure it makes sense to get deduction when you are in higher bracket and draw when you are in lower bracket. However that was like forever ago and mostly it was a good reason to do contributions. I never figured 35 years ago that we would be in financial position we are today. For me, what I would have paid is good for history books. All I can control or influence is today and tomorrow. My reason for converting into 24% bracket is to reduce tax hit when RMDs kick in and having a fund of $$ that I can draw on without having to think about the tax hit.

 

[HI Bill]

I think this is mostly an exercise in futility. No matter how clever your software is, it won't be able to come up with a strategy to put 10 pounds of potatoes into a 5 pound bag. The best it can do is help you put 4.9999 pounds instead of 4.95.

The IRS has a claim on X% of the money in your IRA/401K. And the richer you are, the stronger their claim and the larger X is going to be.

It depends. I have a significant chunk of assets (1/3) in taxable accounts. MFJ, I can withdraw up to $80K annually in LTCGs, and pay $0 taxes. Since my cost basis is about 60% of the taxable accounts, this means I can withdraw up to $200K annually, and pay no Federal taxes. By doing so for 5 years, I will have escaped paying taxes on something like $400K of LTCGs. At the same time, I'm withdrawing $ from an inherited IRA, at an amount equal to the standard deduction for 2...making the total 'income' ~$225K annually, with no federal tax.

 

[MileKing]

My table below is my actual results with everything factored in, real numbers. Assumes TCJA rates to 2025 and then reversion to 2017 tables, overly optimistic IMO. I don't care to share my exact numbers, so I've shown taxes and ending balance 100% for the No Roth conversion case. As you can see it makes a considerable difference in taxes paid.

The rub is it does not make nearly as much of a difference in ending balance (presumably the primary goal), I've touched on why before so I won't repeat it. All these tax savings won't improve my bottom line much.

Case	Fed Marg Rate B4 age 70	Fed Marg after 70	Fed & State Taxes	Tax Reduction	Ending Balance
No Roth conv	10-12%	25%	100%		100%
Conv to 22%	22%	15%	82%	-18%	101.4%
Conv to 24%	24%	15%	72%	-28%	102.6%

If you don't mind, what rate of return did you assume for stocks and bonds?

 

[Midpack]

If you don't mind, what rate of return did you assume for stocks and bonds?

Not sure why it’s that important but:

 

[rayvt]

However, if for a brief period of time I can withdraw at 8.5% as I have, I'll save 19.5%+ (28%+ less 8.5%). That is better!

There is no 8.5% tax bracket. You have to compare the marginal rates; your tax brackets at the two different times.

 

[rayvt]

The rub is it does not make nearly as much of a difference in ending balance (presumably the primary goal), I've touched on why before so I won't repeat it. All these tax savings won't improve my bottom line much.

Yes. An exercise in futility. It largely depends on future tax brackets---which is impossible to predict.

As you can see it makes a considerable difference in taxes paid.

Which is reducing a cost that is immaterial.
The goal is to have the most money (after tax), not to pay the least taxes.

 

[Midpack]

Yes. An exercise in futility. It largely depends on future tax brackets---which is impossible to predict.

Impossible to predict yes, but I’m convinced future rates will be higher and I’m acting on that. YMMV

Which is reducing a cost that is immaterial.
The goal is to have the most money (after tax), not to pay the least taxes.

I agree, but earlier you claimed conversions couldn’t change the taxes you pay, that’s simply not true. You can pay X% or significantly less than X% and I shared exactly how much in my case.

The IRS has a claim on X% of the money in your IRA/401K. And the richer you are, the stronger their claim and the larger X is going to be.

The deeper I get in retirement, the more I realize that all that I was doing was just shuffling money around, and changing the timing of *when* I paid the taxes.

 

[RetireBy90]

Impossible to predict yes, but I’m convinced future rates will be higher and I’m acting on that. YMMV

I agree, but earlier you claimed conversions couldn’t change the taxes you pay, that’s simply not true. You can pay X% or significantly less than X% and I shared exactly how much in my case.

This has been covered and there are those that believe tax rates will go up and those that believe you can't know. I agree with both, I can't know but then I can believe and act on it without seeing it. Either way, I'm converting into 24% bracket now rather than at 70 with my SS income and RMDs. There is a principle that you need to get paid for risk. Thus a 30 year bond with 30 years of risk has higher return than 2 year with less risk. If I pay my tax today there is less risk to my monthly income than if I wait another 8 years. I'm not getting paid for the risk, so why take it ?


Just one opinion, but since it is my $$ it gets 2 votes.

 

[corn18]

My spreadsheet calculates taxes by year out to age 100 and accounts for % SS taxed (it is comprehensive). This tax question is easily answered for my particular situation:

Convert up to top of the 12% and then 15% tax bracket until age 70 (in 2019 dollars):

$444,719 total taxes paid

Do no conversions and let RMDs kick in @ 70:

$626,514 total taxes paid

That is not chump change and makes my decision easy.

 

[PatrickA5]

My spreadsheet calculates taxes by year out to age 100 and accounts for % SS taxed (it is comprehensive). This tax question is easily answered for my particular situation:

Convert up to top of the 12% and then 15% tax bracket until age 70 (in 2019 dollars):

$444,719 total taxes paid

Do no conversions and let RMDs kick in @ 70:

$626,514 total taxes paid

That is not chump change and makes my decision easy.

That's a huge amount of tax savings. Just curious though, how much of that is due to the savings being calculated out to 100, versus a normal life expectancy of 80ish? Thanks.

 

[corn18]

That's a huge amount of tax savings. Just curious though, how much of that is due to the savings being calculated out to 100, versus a normal life expectancy of 80ish? Thanks.

Great question. The answer is revealing:

100% conversion:

$258,730 total taxes paid

0% conversion:

$234,497 total taxes paid

Not nearly as big a difference. Something to consider.

 

[LRDave]

Great question. The answer is revealing:

100% conversion:

$258,730 total taxes paid

0% conversion:

$234,497 total taxes paid

Not nearly as big a difference. Something to consider.

So LESS taxes paid with 0% conversion?

 

[Rianne]

Have not read all 17 pages of thread, but this is an interesting link to historical tax rates going back from 1913 - 2013. The early to late 90's, pretty scary.


https://taxfoundation.org/us-federa...2013-nominal-and-inflation-adjusted-brackets/

 

[corn18]

So LESS taxes paid with 0% conversion?

You are right, I didn't even notice that! Hmmmm.... That is VERY interesting.

I just ran some scenarios where I die early and it always results in paying less total taxes if I do no conversions. This is assuming we are both dead @ 80. Need to rethink this whole conversion thing.

 

[PatrickA5]

Thanks, Corn18. We're back to the same ole' question. When will I die? Personally, I doubt I'll even make it to 80+, but who knows.

Last year I converted well into the 22% bracket. This year, I think I've talked myself out of it and will convert to the top of the 12% bracket. My taxable account is getting low, so I might just start taking withdrawals instead of conversions starting next year.

 

[pb4uski]

There is no 8.5% tax bracket. You have to compare the marginal rates; your tax brackets at the two different times.

Ray.... you are right that there is no 8.5% tax bracket.

But you are wrong in comparing ONLY the marginal tax rate (though that does work in many cases so your error is understandable).

8.5% is the effective incremental rate that I paid on the $386k of Roth conversions that I did over the last 7 years... with the rate calculated as (tax after conversion less tax before conversion) divided by the conversion amount.... and is appropriate since the conversion crosses a number of tax brackets.... some is 0% because it is offset by the standard deduction, some is at 10% and the rest is at 12% (formerly 15%).

Once I start SS at 70 and RMDs start at 70 1/2 we will be solidly in the 22% tax bracket so if I did no Roth conversions that money would end up in higher RMDs and would be taxed at 22%... and DW alone or my heirs will be in the 22% bracket... so the savings will be the difference between what I pay on current Roth conversions and 22% (and 28%+ if compared to what I saved when I deferred that income). And if tax rates revert to 2017 levels or higher as many people expect then those savings are 3% higher.

If our future tax rate is 22% I have saved over $50k compared not converting, almost $64k if the future tax rate is 25%.... hardly an exercise in futility.

 

[tenant13]

Yes. An exercise in futility. It largely depends on future tax brackets---which is impossible to predict.

Which is reducing a cost that is immaterial.
The goal is to have the most money (after tax), not to pay the least taxes.

This thread is about optimizing income so in that narrow sense the goal is indeed to have the most money. But the broader goal - at least for me - is maximizing enjoyment in retirement. Will I care about having saved extra 100-200k
in taxes - or having the most money - when I'm 90? Not particularly. As long as I have enough to take care of myself the amount of money I leave behind is irrelevant.

 

[RunningBum]

Great question. The answer is revealing:

100% conversion:

$258,730 total taxes paid

0% conversion:

$234,497 total taxes paid

Not nearly as big a difference. Something to consider.

But don't forget, someone still needs to pay the tax on the money left in the IRA in the 0% conversion case, unless you bequeath it to charities. Some may say their heirs should be grateful for anything they get, taxed or not. I think it's foolish not to do some estate planning to reduce heirs taxes. Also, you died with money left in a tax deferred account that you couldn't spend from, so it's not like you optimized your own situation.

If your heirs seem likely to be in a lower tax bracket than you are in retirement, it may make sense to let them pay the taxes. But now they have to withdraw it all in 10 years, so that will likely bump up their tax bracket if the amount left is significant.

 

[corn18]

Thanks, Corn18. We're back to the same ole' question. When will I die? Personally, I doubt I'll even make it to 80+, but who knows.

Last year I converted well into the 22% bracket. This year, I think I've talked myself out of it and will convert to the top of the 12% bracket. My taxable account is getting low, so I might just start taking withdrawals instead of conversions starting next year.

You are brilliant. I have found an issue with my spreadsheet that allows my Roth balance to go negative, which should not happen. That would require withdrawals from my 401k to keep that from happening (and a taxable event that I am not accounting for). That might explain why the taxes are less. Will explore a fix and report back.

 

[RunningBum]

This thread is about optimizing income so in that narrow sense the goal is indeed to have the most money. But the broader goal - at least for me - is maximizing enjoyment in retirement. Will I care about having saved extra 100-200k
in taxes - or having the most money - when I'm 90? Not particularly. As long as I have enough to take care of myself the amount of money I leave behind is irrelevant.

That just baffles me. Do you ignore price tags and money issues in everything you do? This is such a simple thing to do to save yourself 100K or more (I'm sure this varies from case to case) I don't know why you would ignore it. Why would you even spend time on a tax planning & income optimization thread if you just don't care? And how can you be sure you have enough? What if you need extended time with in home nursing care, for example?