Retirement Tax Planning - Income Optimization?

[Souschef]

For those of us on Medicare, the ACA discussions about minimizing MAGI have no relevance, but is very important to ER's.
I have very little wiggle room as far as income due to SS, pension and RMD. which puts me in the 24% bracket.
I guess some would call that a "first world problem"

 

[pb4uski]

.... I guess some would call that a "first world problem"

I would call it a win. When you deferred that income you must have expected to be in a lower tax bracket at retirement than you were when you deferred the income....otherwise you would not have deferred the income.

Since you ended up actually being in the same or a higher tax bracket in retirement then that means that you have been more financially successful than you expected to be.... that's good, right?

 

[Souschef]

I would call it a win. When you deferred that income you must have expected to be in a lower tax bracket at retirement than you were when you deferred the income....otherwise you would not have deferred the income.

Since you ended up actually being in the same or a higher tax bracket in retirement then that means that you have been more financially successful than you expected to be.... that's good, right?

You are absolutely correct I am very fortunate that my IRA has grown more than I ever anticipated
And the best part is I am fully retired!

 

[Midpack]

It's taken over a week to figure out exactly how the Income Strategy software works, but I think I have it down now. I am going to do a 1 hour consult next week to make sure, but the results have been revealing. Here's effective tax rate comparing no Roth conversions, to Roth conversions to 24% between now and 70 for me, followed by DW for 2 years (she's 2 years younger than I am). All else equal (TCJA expiration, SS@70, maintain AA, same withdrawal order, etc.) - and I know no one can guess all the unknowns - we save about 31% in Fed & State taxes if we both live to 96 ("unfortunately" longevity runs in both our families).

 

[pb4uski]

It's taken over a week to figure out exactly how the Income Strategy software works, but I think I have it down now. I am going to do a 1 hour consult next week to make sure, but the results have been revealing. Here's effective tax rate comparing no Roth conversions, to Roth conversions to 24% between now and 70 for me, followed by DW for 2 years (she's 2 years younger than I am). All else equal (TCJA expiration, SS@70, maintain AA, same withdrawal order, etc.) - and I know no one can guess all the unknowns - we save about 31% in Fed & State taxes if we both live to 96 ("unfortunately" longevity runs in both our families).

Just curious, is there a line that shows what it would be with moderate Roth conversions?.... like to the top of the 12% bracket? and how much that would save?

Which strategy results in the highest projected NW?

 

[Midpack]

Just curious, is there a line that shows what it would be with moderate Roth conversions?.... like to the top of the 12% bracket? and how much that would save?

Which strategy results in the highest projected NW?

I modeled converting to 12%, 22%, 24% and 32%, each was progressively better than no conversions. But there was no additional in 32%, so 24% was all we needed for our situation and the years we have left before we turn 70. I also modeled converting a flat $150K/yr until we turn 70, to 24% left us lower taxes and a higher residual/end portfolio value.

I’ll have to swallow hard to convert to 24% after paying extremely low taxes for the past 7 years, but I have until year end to work up to it, and triple check the math. It’s pretty compelling - pay the IRS now for 7 years, of pay them much less for 7 years and way more for the following 23. I don’t want to kick myself for 23 years of April 15ths...

To anyone else reading this - the best answer is unique for each of us, don’t take my plan as useful to anyone else. It’s probably NOT.

 

[RetireBy90]

To anyone else reading this - the best answer is unique for each of us, don’t take my plan as useful to anyone else. It’s probably NOT.

Seems that your findings pretty much mine using spreadsheet. It is difficult for me to consider paying taxes on the conversions in 24% bracket, but clincher for me was to add taxes and extra costs on RMD and then compare it to paying for conversions for 7 years. That and knowing my taxes will be much simpler and less expensive.

 

[Midpack]

Seems that your findings pretty much mine using spreadsheet. It is difficult for me to consider paying taxes on the conversions in 24% bracket, but clincher for me was to add taxes and extra costs on RMD and then compare it to paying for conversions for 7 years. That and knowing my taxes will be much simpler and less expensive.

Yep, exactly what the graph above illustrates very clearly. It’ll take me a while to work up the nerve, but I can’t imagine any realistic changes in my assumptions that will hurt us. I can’t imagine tax rates going down or even staying as they are for that matter. The only risk is if they radically change Roth rules...

 

[SevenUp]

I’ll have to swallow hard to convert to 24% after paying extremely low taxes for the past 7 years, but I have until year end to work up to it, and triple check the math.

Converting in the 24% bracket - if IRMAA is not yet a consideration and if NIIT is not significant - likely beats paying 22% later if one uses taxable funds to pay the tax on a conversion.

You could use either or both of the spreadsheets mentioned in the linked section to check the math.

 

[Perryinva]

Converting $150k/yr for 7 years means over $1M taxed at a lower rate, so I can imagine the savings are significant. Congratulations on such a first world problem!

If I can convince myself to convert even half that, I’d be a happy camper. In my case, I did defer assuming I’d be in a lower tax bracket in retirement and while I did do much better than I ever thought, I can’t take credit for ever figuring out what tax bracket I might be in in retirement. I just assumed it would be lower because everyone said so!! That, and tax rates, programs, and SS & pension rules changed so drastically from 1980 to now, that it’s almost dumb luck we are where we are. I was astonishingly slow on the realization that I should be socking way more in after tax accounts to prevent what has happened. The other first world problem with that, is there is a false sense of savings size when 3/4s of your portfolio is pre tax. I have to force myself to only think in post tax terms, both for what I was used to spending while working, and comparing that to what will be/is available in retirement.

 

[Midpack]

An addendum to post #104 above showing the breakeven for us between no Roth conversions, and converting to the 24% bracket between now and age 70 for both of us. It clearly shows why it's so hard to bite the bullet (I know I'm not alone) and pay big taxes now, despite higher portfolio residuals and saving 31% in taxes the long(evity) run. Converting less aggressively just means we save less in the long run, and the breakeven comes even later.

And if we pass away at age 85 or so, it won't have made ANY difference in taxes had we done conversions or NOT, and a bigger portfolio won't make any difference when we're gone...

Tough call, for me anyway, but I have until year end or more to pull the trigger. DW is oblivious, and insists on same.

 

[RunningBum]

I guess I don't think about Roth conversion having a breakeven point. If I do conversions but die early, my heirs will get the advantage of my having paid the taxes. Part of the calculation, if you think you will leave some behind, is to guesstimate your heirs tax bracket in the future as well as your own. I want to optimize my holdings, whether over my lifetime or my heirs, and other things being equal, the best way to do that is to minimize taxes for the holdings over the time they exist, if that makes sense.

 

[Midpack]

I guess I don't think about Roth conversion having a breakeven point. If I do conversions but die early, my heirs will get the advantage of my having paid the taxes. Part of the calculation, if you think you will leave some behind, is to guesstimate your heirs tax bracket in the future as well as your own. I want to optimize my holdings, whether over my lifetime or my heirs, and other things being equal, the best way to do that is to minimize taxes for the holdings over the time they exist, if that makes sense.

We’re not particularly concerned about heirs, but you make a very good point. While we’d breakeven on taxes around my age 85, it would make a big difference to heirs for many people.

I should also qualify tax assumptions. My charts assume we revert to the the tax brackets and cap gain rates we had when TCJA expires. I assume tax rates will be significantly more confiscatory in my lifetime, and SS and Medicare will change - not for the better.

 

[Perryinva]

It does. And my heirs will never be in as high a bracket as I am. So prepaying taxes for them is a no win scenario. An age 85 plus break even is a rough call. No one in my family ever made it past 92. DF just passed at 81 last month. May have to consider a pass on conversions past the 12% bracket.

 

[jimbee]

Wow, this site is still a great resource. Thanks for sharing the graphs, Midpack. Very interesting data.

 

[bingybear]

An addendum to post #104 above showing the breakeven for us between no Roth conversions, and converting to the 24% bracket between now and age 70 for both of us. It clearly shows why it's so hard to bite the bullet (I know I'm not alone) and pay big taxes now, despite higher portfolio residuals and saving 31% in taxes the long(evity) run. Converting less aggressively just means we save less in the long run, and the breakeven comes even later.

And if we pass away at age 85 or so, it won't have made ANY difference in taxes had we done conversions or NOT, and a bigger portfolio won't make any difference when we're gone...

Tough call, for me anyway, but I have until year end or more to pull the trigger. DW is oblivious, and insists on same.

Have you looked at what happens if a spouse dies at different times?

Does this software support that? What about adding assets at a later date?

What does access to the software cost?

 

[Midpack]

Have you looked at what happens if a spouse dies at different times?

Does this software support that? What about adding assets at a later date?

What does access to the software cost?

You can terminate spouses at any age, and develop as many plans-detailed reports as you want. You can vary spending and saving/adding assets as you please. That’s not to say there aren’t any shortcomings, there are a few IMO. But it does a lot of things well, that would be a nightmare to develop myself IME, and I’m pretty good with Excel. At $20/mo for basic (all I bought) or $50/mo for premier with no subscription required it’s a great value to me. And they offer one on one consults for $125/hr if you want.

 

[harley]

You can terminate spouses at any age

DW assures me this is not an acceptable option.

 

[bingybear]

You can terminate spouses at any age, and develop as many plans-detailed reports as you want. You can vary spending and saving/adding assets as you please. That’s not to say there aren’t any shortcomings, there are a few IMO. But it does a lot of things well, that would be a nightmare to develop myself IME, and I’m pretty good with Excel. At $20/mo for basic (all I bought) or $50/mo for premier with no subscription required it’s a great value to me. And they offer one on one consults for $125/hr if you want.

Thanks. I'm in year 2 of larger conversions. It did take a bit to write the check.... but it seems obvious in my case when I consider the extended details.

 

[RunningBum]

Thanks. I'm in year 2 of larger conversions. It did take a bit to write the check.... but it seems obvious in my case when I consider the extended details.

This is why I discount my tIRA in my personal net worth statement by the future tax liability. It helps me realize that the entire tIRA is not mine, but will eventually be taxed. If I've estimated the tax liability correctly, a conversion has no impact on what I consider to be my net worth. So it's easy for me to write a big check now for taxes if that optimizes my long term situation.

The way I see it, if I wind up spending all of my money, I want to make sure I've gotten the most out of it, by paying the least taxes over my life. Of secondary importance is leaving my heirs with the best taxable situation. Of no consequence at all is trying to die with the biggest pile of pre-tax worth. There's no value in that. There's also no value in optimizing my current situation if it isn't best for my future. So again, I don't hesitate to write a check now to shed that tax liability if it works out best for me, and possibly my heirs.

 

[Scrapr]

DW assures me this is not an acceptable option.

I caught that one too! Just be careful not to pitch her as you can knock me off early and your next husband will live a life of luxury

 

[bingybear]

This is why I discount my tIRA in my personal net worth statement by the future tax liability. It helps me realize that the entire tIRA is not mine, but will eventually be taxed. If I've estimated the tax liability correctly, a conversion has no impact on what I consider to be my net worth. So it's easy for me to write a big check now for taxes if that optimizes my long term situation.

The way I see it, if I wind up spending all of my money, I want to make sure I've gotten the most out of it, by paying the least taxes over my life. Of secondary importance is leaving my heirs with the best taxable situation. Of no consequence at all is trying to die with the biggest pile of pre-tax worth. There's no value in that. There's also no value in optimizing my current situation if it isn't best for my future. So again, I don't hesitate to write a check now to shed that tax liability if it works out best for me, and possibly my heirs.

I think Midpack showed in post #111 that doing roth conversions can change total tax paid over the rest of their life. It is not a fixed value. It is dependent on conversion times and amounts and how long you live. ..

 

[pb4uski]

You can terminate spouses at any age....

I'm interested, please provide details.

 

[Montecfo]

I guess I don't think about Roth conversion having a breakeven point. If I do conversions but die early, my heirs will get the advantage of my having paid the taxes. Part of the calculation, if you think you will leave some behind, is to guesstimate your heirs tax bracket in the future as well as your own. I want to optimize my holdings, whether over my lifetime or my heirs, and other things being equal, the best way to do that is to minimize taxes for the holdings over the time they exist, if that makes sense.

Well there is the breakeven, which is aimed at optimizing after tax net worth. But there is also the payback period, which seems to be quite long for Roth conversion strategies, assuming you are collecting RMDs over a 20-30+ year remaining lifetime.

Pay taxes now, reduce future RMDs, but it takes you quite a few years to actually realize the benefit if your early tax payment in cash.

I see that Midpack explored this somewhat. But do most folks calculate this or just take the balance sheet approach i.e., paying early at theoretically lower rates nets higher net worth over time?

Like social security math, you have to live long enough to personally realize the benefits. Heirs could, but that is really reaching far into the future.

 

[Montecfo]

An addendum to post #104 above showing the breakeven for us between no Roth conversions, and converting to the 24% bracket between now and age 70 for both of us. It clearly shows why it's so hard to bite the bullet (I know I'm not alone) and pay big taxes now, despite higher portfolio residuals and saving 31% in taxes the long(evity) run. Converting less aggressively just means we save less in the long run, and the breakeven comes even later.

And if we pass away at age 85 or so, it won't have made ANY difference in taxes had we done conversions or NOT, and a bigger portfolio won't make any difference when we're gone...

Tough call, for me anyway, but I have until year end or more to pull the trigger. DW is oblivious, and insists on same.

Hi Midpack, just re-read posts 104 and 111. I think if you convert less aggressively, the theoretical tax savings would be less but the payback would be quicker, due to a larger differential and tax brackets. Is that in fact what you found?