SS at 70 and RMDs - double tax 'whammy'?

[BBQ-Nut]

The ever growing and complicated spreadsheet I've created allows me to break expenses and taxes into life phases.

I've artificially created 4 phases; 55-62, 62-70, 70-90, 90-end game (which I can plug whatever age in for that).

I can also make runs with different SS ages of 62 or 70 to bracket how my portfolio would fare.

And I have a lookup table for RMDs starting at age 70 that pulls my 401 and IRA balances over from the earlier phases.

What I am noticing is a 'double whammy' at age 70 if I defer taking SS until then and when RMDs *hit*.

My portfolio survives, yes, but the tax hit is very significant.

For those that have actually experienced this - any advice, tips, or secrets?

Or any pro-active strategy to reduce this double whammy?

Thanks for sharing!

[edit: oops - posted in the wrong forum - could one of the mods please move this? sorry]

 

[Ready]

Ideally you will have a good number of years between full retirement and the 70.5 age of RMDs. If you were to retire at 55, that would give you 15 years to convert your traditional IRA to a Roth IRA, while keeping your income low enough to have a minimal amount of taxes due during those years. If possible you want all of your IRA converted to Roth before RMDs come due. That's my plan at least.

 

[W2R]

Good thinking - - RMDs do require some thought and usually some tax planning before reaching age 70 and 1/2.

This is why I have been taking monthly payments from my TSP for the past 4.5 years since I retired. I don't need to do this, since most of my nestegg is in taxable investments.

Still, I am almost 66 and I want to reduce the amount that I have in the TSP now, which in turn will reduce my RMDs when I hit 70 and 1/2.

 

[omni550]

What I am noticing is a 'double whammy' at age 70 if I defer taking SS until then and when RMDs *hit*.

My portfolio survives, yes, but the tax hit is very significant.

+1

Being single with most of my savings in tIRAs, and from a long-lived gene pool (which seems to make SS at 70 the logical choice) puts me squarely in the cross-hairs of the IRS.

I've started doing conversions from tIRAs to Roths, but there's not a lot of "head space" in the tax tables for a singleton.

Would love to hear what strategies others here are using/planning.

omni

 

[pb4uski]

I suspect the double whammy you may be referring to is that RMDs push your income up which makes a higher percent (up to 85%) of your SS taxable. If that is what you are referring to, it is a fairly well known issue.

My "solution" is to maximize Roth conversions from ER until I begin SS and RMDs begin. Even so, I'll still be in a higher tax bracket for some years once RMDs start.

If you are eligible, you could also contribute to a HSA which would also increase the amount of Roth conversions you can do.

 

[Ed_The_Gypsy]

Congrats. You have found the Tax Torpedo.
I found it not long ago myself and you may find my posts on it.
My solution will be to convert my IRAs totally to Roths before I take SS at 70 or 70.5, regardless of the marginal tax rates.
Take a look at what it it will do to your survivor when they are in that situation and they don't have two standard deductions (they get one free in the year following your demise, but that's all, folks).
Surprise!
Thank you, David Stockman, may you rot in Hell.

 

[Midpack]

One of my favorite questions, I've asked several times (posted a tax torpedo article), but no easy answers. Right or wrong, I've begun to think the best broad strategy is to try to keep annual taxable income constant (inflation adjusted) throughout retirement irrespective of age, regardless of spending. For me at least that seems to mean withdrawing from taxable and deferred throughout (before and after age 70), and much more from our portfolio before we start SS and RMDs. Depleting taxable first and delaying deferred, as is often suggested, doesn't appear to make sense for us. If we do that, our RMDs project to be higher than our spending needs, so we get whacked on RMD and SS taxes. It's a complex question thanks to sequence of returns, future rates relative to now, Roth conversions, spending (inflation) projections and a host of other variables. It never seems to get easier...but maybe I'm missing the forest for the trees.

 

[MichaelB]

Good thinking - - RMDs do require some thought and usually some tax planning before reaching age 70 and 1/2.

This is why I have been taking monthly payments from my TSP for the past 4.5 years since I retired. I don't need to do this, since most of my nestegg is in taxable investments.

Still, I am almost 66 and I want to reduce the amount that I have in the TSP now, which in turn will reduce my RMDs when I hit 70 and 1/2.

Right or wrong, I've begun to think the best broad strategy is to try to keep annual taxable income constant (inflation adjusted) throughout retirement irrespective of age, regardless of spending. For me at least that seems to mean withdrawing from taxable and deferred throughout (before and after age 70), and much more from our portfolio before we start SS and RMDs. Depleting taxable first and delaying deferred, as is often suggested, doesn't appear to make sense for us.

This thinking makes sense to me. Tax rates on withdrawals and pensions are progressive so I would guess trying to even the inflation adjusted income over time would result in a lower average rate.

It makes even more sense for married couples, as the loss of one can lead to a sharply higher rate in the future.

 

[pb4uski]

....For me at least that seems to mean withdrawing from taxable and deferred throughout (before and after age 70), and much more from our portfolio before we start SS and RMDs. Depleting taxable first and delaying deferred, as is often suggested, doesn't appear to make sense for us. If we do that, our RMDs project to be higher than our spending needs, so we get whacked on RMD and SS taxes. It's a complex question thanks to sequence of returns, future rates relative to now, Roth conversions, spending (inflation) projections and a host of other variables. It never seems to get easier...but maybe I'm missing the forest for the trees.

But isn't living on/withdrawing from taxable and maximizing Roth conversions up to the top of your favorite tax bracket accomplish the same thing as withdrawing from both taxable and deferred?

Also, maximizing HSA contributions helps double in that it allows you to contribute to tax-free savings and do more Roth conversions since the HSA contribution reduces taxable income.

 

[samclem]

Take a look at what it it will do to your survivor when they are in that situation and they don't have two standard deductions (they get one free in the year following your demise, but that's all, folks).
Surprise!

+1 on this. A few minutes looking at the standard deductions, personal exemption, and tax brackets for single taxpayers is a good exercise for anyone doing long range planning for a couple. Moving $$ to a Roth is a big help. Heck, if a person knew their health was declining fast, it would make sense to help out the surviving spouse by taking higher withdrawals from a tIRA in the final years (taking advantage of the higher MFJ brackets, up to the bottom of the tax rate the survivor would be paying) and just put the money in a regular taxable account for the survivor's use later (at the CG or Div/interest rate tax rates),

Ideally you will have a good number of years between full retirement and the 70.5 age of RMDs. If you were to retire at 55, that would give you 15 years to convert your traditional IRA to a Roth IRA, while keeping your income low enough to have a minimal amount of taxes due during those years. If possible you want all of your IRA converted to Roth before RMDs come due. That's my plan at least.

Yes, this is a good approach. I wouldn't convert all of my tIRAs to Roth's, but if possible I'd convert enough so that, with prudent assumed growth rates and the existing tax brackets, my RMDs won't drive me into a higher bracket than I'd normally be in--at least until I'm about 80.

Why 80? If my investments do well and our portfolio seems assured of getting us through the end of our lives, I'll be less concerned about the tax rates from then on out. I'm concerned about them now primarily because tax money I pay today (and the $$ it would have spawned if left in my account) might really be needed by us in the coming decades. There's a lot of unknowable stuff, so I try to minimize taxes. If we make 80 and the portfolio is healthy, then paying an increased percentage to Uncle Sam would be okay--it will have served its purpose. Paying taxes won't be pain free and do think I could think I could put it to more worthy uses than Uncle Sam will, but the cost and tricks needed to defer taxes further probably aren't worth it.

 

[Looking4Ward]

I'm struggling with how much can actually be converted to a Roth in the 15 year time span between 55 and 70.

What I mean is, if one is pulling expenses from after-tax savings during those 15 years, has no other taxable income besides capital gains and dividends from those savings, and wants to convert as much tIRA as possible to Roth in a manner that is more favorable now tax-wise rather than later when RMD's and SS kick in at 70................How much could/should realistically be converted in years 1 thru 15?

Is that where ORP is useful?

 

[gardenfun]

+1

Being single with most of my savings in tIRAs, and from a long-lived gene pool (which seems to make SS at 70 the logical choice) puts me squarely in the cross-hairs of the IRS.

I've started doing conversions from tIRAs to Roths, but there's not a lot of "head space" in the tax tables for a singleton.

Would love to hear what strategies others here are using/planning.

omni

I am in a similar situation to you, omni--single and most of my savings are in tIRA's. Conversions to Roth are taxable.
I'm also trying to keep my MAGI under the threshold for ACA subsidies.
I agree that there isn't much head space--I'm feeling a bit cramped!

 

[timo2]

Right or wrong, I've begun to think the best broad strategy is to try to keep annual taxable income constant (inflation adjusted) throughout retirement irrespective of age, regardless of spending. .

That is my plan for now. We are not planning on spending all of of our yearly withdrawals, but it will already have been taxed and in a cash account.

Future tax issues are too nebulous for me to comprehend; DW & I don't have survivors; and we don't have a gigantic amount of money. We plan on withdrawing 2/3 of the taxable retirement accounts (401K, TSP) by the time I am 70, leaving only a 457 as a survivor account for DW, whose RMD will be small. So in our 70's, this small 457 RMD, plus my SS at 70 and the spousal benefit, plus FERS pension will make my withdrawal amount after I'm 70 the same as the withdrawals from the retirement accounts before 70. Which will be about $100k per year, gross (depending upon when DW finishes her OMY period).

 

[GrayHare]

Welcome to the tIRA/401k tax trap. The Hindsight Department reports it would have been better to invest in non-dividend growth stocks outside the tIRA/401k trap: no RMDs and no taxes unless you sell, and then the tax is only the CG rate.

 

[RunningBum]

I'm struggling with how much can actually be converted to a Roth in the 15 year time span between 55 and 70.

What I mean is, if one is pulling expenses from after-tax savings during those 15 years, has no other taxable income besides capital gains and dividends from those savings, and wants to convert as much tIRA as possible to Roth in a manner that is more favorable now tax-wise rather than later when RMD's and SS kick in at 70................How much could/should realistically be converted in years 1 thru 15?

Is that where ORP is useful?

I figure this is usually something that can be better figured using a spreadsheet or modeling with TurboTax or some other tax program. Figure in your own deductions and exemptions to keep in the desired tax bracket. Note that if you want the 15% bracket with 0% on LTCGs and qualified dividends, you need to keep the entire amount under the 15% cap. Once you start going over, each $1 converted is taxed at 15% plus $1 of LTCGs/divs is pushed into a 15% tax for 30% rate on that $1. I'm not sure a tool like ORP can get that detailed for your specific case.

 

[Independent]

Looking on the bright side, remember that SS is taxed at lower rates than ordinary income. The "double whammy" simply refers to losing some of the tax benefits given to SS beneficiaries. In the worst case, I still only include 85% of my SS benefit in AGI.

Another bright side, if the driving force of my tIRA withdrawals is RMD rules, instead of what I need/want to spend, then I must have more than enough to cover my needs/wants. That's good news again.

But, having said those two things, I still want to minimize my taxes. The only thing that I've seen is to try to equalize taxable income to stay out of high brackets. So I've done some traditional to Roth rollovers. I've thought that as I get closer to 70, I might do that even though I'm in a marginal 25% bracket because the double impact of RMDs can put me in a higher effective bracket. That depends on too many variables for me to analyze until I'm pretty close.

Given your spreadsheet skills, I doubt that this is anything new to you.

 

[thefinancebuff]

Looking on the bright side, remember that SS is taxed at lower rates than ordinary income. The "double whammy" simply refers to losing some of the tax benefits given to SS beneficiaries. In the worst case, I still only include 85% of my SS benefit in AGI.

Another bright side, if the driving force of my tIRA withdrawals is RMD rules, instead of what I need/want to spend, then I must have more than enough to cover my needs/wants. That's good news again.

Exactly. Also remember the tax on RMDs is simply repaying your "original sin" for not having paid tax way back when. If you treated the government as a silent partner in your IRA, they have been really patient. They only ask to get their share out, and nothing on "your" gains.

 

[Animorph]

I'll be Roth converting as long as the after-tax accounts hold out and withdrawing from the tIRA after that, even to the point of taking more than needed and adding it to a taxable account. I have about 10 years before age 70.5.

The main guiding principle is to Roth convert anything you can take out of the tIRA now at a tax rate equal to your 70.5+ RMD + SS tax rate. After your taxable account zeros out, withdraw whatever you can from your tIRA at a tax rate that is below your after 70.5 rate, whether you need it or not. Invest the excess or maybe use it to Roth convert some of the next withdrawal. You are maximizing the amounts you withdraw from the tIRA at lower tax rates.

If you current tax rate is higher than your age 70.5 tax rate then it probably won't be worth Roth converting or withdrawing from the tIRA at all.

Doing that, I can keep RMD's and age 70 SS and a small pension within the 15% tax bracket for a decade or more and fill in with the Roth as needed. Depending on what growth rates you assume. According to my retirement projections this also gives me the most after-tax income to spend. In order to do that, I'm Roth converting into the 25% tax bracket (avoiding AMT and $250k AGI tax bumps), which will reduce the RMD's that would have otherwise hit the 25% tax bracket after age 70.5. 25% now and additional after-tax value into a Roth with tax-free growth should be better than 25% later.

You can adjust this to account for higher survivor tax rates for a couple, but that's a second layer of assumptions.

 

[LongPrime]

Welcome to the tIRA/401k tax trap. The Hindsight Department reports it would have been better to invest in non-dividend growth stocks outside the tIRA/401k trap: no RMDs and no taxes unless you sell, and then the tax is only the CG rate.

I realized this about 10 years ago when I started to trade stocks more frequently.

Why non-div stock?

I advice mid 20 son a few years ago to forego the 401k, except for the match, and then do Roth. Take the excess money to tax efficient indexes, by stock for longterm and a couple utilities for the dividends and trading potential near exdiv. As a side benefit he is building a home purchase fund fast.

Personally it is my goal to pay taxes when the annuities mature and I can start enjoying life rather than scrimping and paying no taxes.

 

[pb4uski]

I'm struggling with how much can actually be converted to a Roth in the 15 year time span between 55 and 70.

What I mean is, if one is pulling expenses from after-tax savings during those 15 years, has no other taxable income besides capital gains and dividends from those savings, and wants to convert as much tIRA as possible to Roth in a manner that is more favorable now tax-wise rather than later when RMD's and SS kick in at 70................How much could/should realistically be converted in years 1 thru 15?

Is that where ORP is useful?

What I would do is start with the taxable income for the tax bracket you want to stay in, add your exemptions and deductions (or the standard deduction if higher), add your HSA contribution deduction if applicable and then reduce it buy your capital gains and dividends.

So for a couple, the top of the 15% bracket for 2014 is $73,800 + 2 exemptions at $3,950 each + standard deduction of $12,400 + HSA deductions of $8,550 would mean total income of $102,650. Subtract your dividends and capital gains and other income from that any you get a rough estimate of what you can convert and stay in the 15% bracket. Then multiply by 15 years.

In reality, the amount will increase somewhat each year assuming that you are reducing your taxable funds and your dividend and capital gain income plus the various elements above increase periodically for inflation.

Obviously, you need to adjust it to your specific tax situation.

 

[Looking4Ward]

What I would do is start with the taxable income for the tax bracket you want to stay in, add your exemptions and deductions (or the standard deduction if higher), add your HSA contribution deduction if applicable and then reduce it buy your capital gains and dividends.

So for a couple, the top of the 15% bracket for 2014 is $73,800 + 2 exemptions at $3,950 each + standard deduction of $12,400 + HSA deductions of $8,550 would mean total income of $102,650. Subtract your dividends and capital gains and other income from that any you get a rough estimate of what you can convert and stay in the 15% bracket. Then multiply by 15 years.

In reality, the amount will increase somewhat each year assuming that you are reducing your taxable funds and your dividend and capital gain income plus the various elements above increase periodically for inflation.

Obviously, you need to adjust it to your specific tax situation.

Thanks, that made perfect sense to me.

 

[GrayHare]

Why non-div stock?

Because then you'll pay no taxes until you sell. Choose a company that does a good job of investing in itself what it would have paid out in dividends and you'll get tax-free growth. This is Buffett's approach with Berkshire Hathaway, and why BRK-A and BRK-B do not pay dividends.

 

[donheff]

My math and spreadsheet skills are too rudimentary to test out Midpack's approach. DW and I have sufficient taxable pension income to keep us from taking any advantage of Roth conversions and the like. By withdrawing additional funds solely from taxable we are able to keep AGI within the 25% bracket for now. If we were to add, or even mix in, much in the way of IRA withdrawals we would slip over into 28%. My thinking has been that any extra taxes I pay now are current expenses that deplete the portfolio. While this may be evened out later with reduced future taxes I worry more about sequence of returns risk. I strikes me that the longer we can keep the portfolio up the likelier we will survive any sudden downturns in the relatively early years. Also, as we get older (~75-80) it is likely that our travel expenses will drop as we chill out. Bottom line is we will get torpedoed big time when DW reaches 70.5 and I'm not sure whether what we are doing is the best approach or not.

 

[SteveL]

What some forget, is that growth of values may continue amidst a series of partial Roth conversions. Over the time I have been converting, the tax deferred account has grown enough to exceed the amount converted. This despite the 2008 recession. I've a couple of years left before 70.5, but it is kind of hopeless. I am going to just have to suck it up and pay the tax. It is kind of funny, because all the tax deferred bucks came from my employer which had a very generous retirement scheme, and from my floating along with the market. If interest rates increase, it will just mean more tax to pay!

 

[braumeister]

What some forget, is that growth of values may continue amidst a series of partial Roth conversions. Over the time I have been converting, the tax deferred account has grown enough to exceed the amount converted.

This is why my Fido rep recommended maximizing the non-equity proportion in my trad IRA. He saw that I was concerned about higher taxes at RMD time, and pointed out that this would help the TIRA balance to not grow so much, thereby keeping the RMD amounts down.