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

[papadad111]

Great discussion. Should be a sticky. The accumulation phase toward ER is what everyone most often discusses, but the draw-down phase is equally, if not more important as a mistake here can be disastrous with the inability to earn more to correct the error.

Had not thought about the IRA to ROTH conversion strategy at age 59.5 so as to avoid a potential MWD tax hit at age 70.5.... thats excellent input for those who have sizeable pre-tax retirement savings and plan/hope to live a long time (dont we all...)

The deferral of SS and then suddenly a "windfall" of SS plus MWD can put someone in a tax-ugly position.

In my 40's I am not thinking along those lines, and of course, rules can and will likely change, but it's important to get this draw-down strategy laid out on a piece of paper or spreadsheet and then run some scenario's....

Perhaps an opportunity for a FIRECALC like tool that simulates after-tax cash impacts of various draw downs .....

 

[LongPrime]

5 more years. 5 more Long years before we may be in a taxable situation at when we will be +70.5 and annuities begin to mature. I tell you, it sucks to be paying 0 taxes

 

[heirloom]

Don't want to be a Debbie downer, but there is always a chance the Roth IRA could be taxed someday.

At one time you didn't have to pay taxes on SS check that you paid into all your life. With 43% of people not working today, the gov. has to get the money somehow to pay them the minimum SS when they reach the age.

 

[Chuckanut]

At one time you didn't have to pay taxes on SS check that you paid into all your life. With 43% of people not working today, the gov. has to get the money somehow to pay them the minimum SS when they reach the age.

More SS taxation is guaranteed simply by the fact that the income threshhold amounts are not indexed for inflation. Right?

 

[rbmrtn]

There are so many moving parts to this. Assumptions about what tax rates will be at age 70. I can see being in a higher bracket at 70 once SS+pension+investment income+RMD all pile up. I'm somewhat happy I didn't max out the 401k ( just enough to get all the matching ).

I'm leaning towards doing partial conversions each year to age 70, to stay in current tax bracket. So how does the 5 year holding apply to partial conversions. Does each conversion have its own 5 year period. Does the holding period go away after 591/2 ?

 

[mpeirce]

There are so many moving parts to this. Assumptions about what tax rates will be at age 70.

I was just poking at ss.gov and using their calculator and looking at the results where it reports "70 in 2031".

I knew this, but being reminded that if I wait until age 70 for SS, it'll be 2031. That. is. a. long. time. And I'm certain tax policy will change a bit by then...

Of course, this is the EARLY Retirement & Financial Independence Community Forum.

 

[kaneohe]

I'm leaning towards doing partial conversions each year to age 70, to stay in current tax bracket. So how does the 5 year holding apply to partial conversions. Does each conversion have its own 5 year period. Does the holding period go away after 591/2 ?

see table by kawill from the fairmark.com site: Each conversion has it's own 5 yr clock but after 59.5 , those individual clocks are replaced by a single 5 yr clock monitoring the oldest Roth account opening. Imagine a semi-colon after every yes/no to make sense of this table.

Roth IRA Distribution Table

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No Penalty-No
Conversions: Tax-No Penalty-Yes (Taxable Portion)
Conversions: Tax-No Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No Penalty-No
Conversions: Tax-No Penalty-No (Taxable Portion)
Conversions: Tax-No Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes Penalty-Yes

OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No Penalty-No
Conversions: Tax-No Penalty-No (Taxable Portion)
Conversions: Tax-No Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes Penalty-No

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Distributions Are Qualified

No Taxes
No Penalties

Note: The table is not applicable to timely distributions of excess contributions or return of regular contributions.

 

[rbmrtn]

see table by kawill from the fairmark.com site:

Very good. I think that is right on target. Some sites seems to say the 5 year holding reset with each conversion even after 59.5. I had been on fairmark earlier but did see the post. I think this is the one

Fairmark Forum :: Retirement Savings and Benefits :: Distributions from RIRA after TIRA transfer

 

[Running_Man]

In doing a quick calculation I am a bit dubious about the savings. If one were to assume 8% annual return on an annual reduction of 1/10 of a portfolio between 60-70 by age 70 the ROTH conversion and IRA remainder portfolio will have 19% less assets than the IRA portfolio, assuming one pays only 15% tax on the distribution. Since the RMD is less than 4% at age 70 would not this mean that most likely the tax savings would not occur until after age 78-80? Tax planning 20 years out seems to be a bigger risk than RMD to me.

My calculations on a million dollar portfolio converted at 85K per year with 8 percent annual return (.3% less than historical return of 8.3% on 50/50 portfolio from 1926 - 2013 per John Bogle) would be the IRA portfolio would still be leading at age 80.

 

[Koolau]

Broadly speaking, there seem to be a couple of camps in the discussion. There are those who will have a very significant amount of assets and/or income who would prefer to keep their taxes as low as possible (mostly 'cause they don't like paying taxes - not so much 'cause it will crimp their living style too much.)

The second camp needs to keep taxes as low as possible just to have enough to FIRE or stay FIRE'd. My guess is that the actual tax "amounts" are relatively small for these folks, but every $ is important when you don't have a lot of them.

I would think I am in the first group and it's probably a good problem to have. Assuming no catastrophe (like rampant inflation) occurs, I'll continue to deplete as much of my "qualified" money at either 15% or even 25% tax rate (either ROTH conversions or living expenses) until I reach 70.5. I'll play it by ear from then on I suppose.

I do hate paying any more taxes than I have to (I don't much like the way the money is spent - but that's another discussion.) Also, I'm pretty much happy with the way we live right now, so when RMDs kick in with SS at 70, I may have to decide whether I prefer to pay Uncle Sam or donate more to charity. Right now, I think I'm gonna get more generous in my old age. YMMV

 

[kaneohe]

In doing a quick calculation I am a bit dubious about the savings. If one were to assume 8% annual return on an annual reduction of 1/10 of a portfolio between 60-70 by age 70 the ROTH conversion and IRA remainder portfolio will have 19% less assets than the IRA portfolio, assuming one pays only 15% tax on the distribution. Since the RMD is less than 4% at age 70 would not this mean that most likely the tax savings would not occur until after age 78-80? Tax planning 20 years out seems to be a bigger risk than RMD to me.

My calculations on a million dollar portfolio converted at 85K per year with 8 percent annual return (.3% less than historical return of 8.3% on 50/50 portfolio from 1926 - 2013 per John Bogle) would be the IRA portfolio would still be leading at age 80.

In these comparisons, are you comparing apples and apples.....that is the after-tax values of both? A very oversimplified example: TIRA at 10K converted to Roth at 15% tax = Roth at 8.5K. Is the TIRA bigger or smaller than the Roth? Obviously the bigger 1M TIRA converted over an extended period is much more complex but the same principle applies.....that is the TIRA is superficially larger but is it? Generally depends on the tax rate at conversion vs the taxation at withdrawal.

 

[Running_Man]

In these comparisons, are you comparing apples and apples.....that is the after-tax values of both? A very oversimplified example: TIRA at 10K converted to Roth at 15% tax = Roth at 8.5K. Is the TIRA bigger or smaller than the Roth? Obviously the bigger 1M TIRA converted over an extended period is much more complex but the same principle applies.....that is the TIRA is superficially larger but is it? Generally depends on the tax rate at conversion vs the taxation at withdrawal.

I am comparing the actual values of both. In retirement the only thing that matters to a retiree should be cash flow and the ability to generate future cash flows. There is an assumption being made that in 20 years there won't be say a 10 percent flat tax and then a value add tax and/or a wealth tax, some of which will be needed just to be able to pay for the retirement and health care systems, required by the sheer math of our government retirement systems. If everyone here plans thinking current tax rules will stay I think that is a low probablity based on the demographics of the USA population.

It will be true at age 80 when assets are equal that the ROTH, assuming tax laws have not changed will be more valuable, but until that point there is no advantage that I will actually be able to take advantage of, just theoretical tax savings for an 80+ year old, which if you were to do an actual cash flow discount model will result in not much Net Present Value of Savings today. Take 20 years of tax savings from 71 -90 get a NPV of that funding 15,000 per year for the next 10 years at 8 percent and you will find I believe there is not much of a NPV you are gaining for the risk being undertaken.

 

[BBQ-Nut]

In these comparisons, are you comparing apples and apples.....that is the after-tax values of both? A very oversimplified example: TIRA at 10K converted to Roth at 15% tax = Roth at 8.5K. Is the TIRA bigger or smaller than the Roth? Obviously the bigger 1M TIRA converted over an extended period is much more complex but the same principle applies.....that is the TIRA is superficially larger but is it? Generally depends on the tax rate at conversion vs the taxation at withdrawal.

And are you factoring in the additional taxes from selling taxable assets to pay the 15% income tax for the amount of the Roth conversion?

I don't have a lot of 'pure cash' laying around to pay for the 15% tax on the Roth conversion, so I have to sell taxable assets - and that needs to be factored in as well even if LTCG - oh and if you live in a state that does not have a preferred tax rate for LTCG sales, then your sale is considered as 'ordinary income'.

 

[daylatedollarshort]

ACA plays into it too. Too many things to try and model and too far away from now which makes possible governmental change likely anyway.

I'm taking it a few years into the future for now. For us, for the next few years at least while the kids are still in college and dependents, low taxes and ACA subsidies are trumping the potential future tax savings of doing Roth conversions.

I've been looking at the Fidelity RIP income and expense details. They have a year by year estmated tax expense column and RMD column for 50 years out, or whatever end date you plug in.

 

[gardenfun]

And are you factoring in the additional taxes from selling taxable assets to pay the 15% income tax for the amount of the Roth conversion?

I don't have a lot of 'pure cash' laying around to pay for the 15% tax on the Roth conversion, so I have to sell taxable assets - and that needs to be factored in as well even if LTCG - oh and if you live in a state that does not have a preferred tax rate for LTCG sales, then your sale is considered as 'ordinary income'.

I'm in the same boat--have to sell taxable assets to pay the tax. And the conversion counts as taxable income, which I have to minimize to get the ACA subsidy. All this makes my hair hurt.

Ah what the heck, it's only money. Just found out my second grandchild is a girl and they're naming her after me. Life is good, whatever my tax rate is!

 

[Independent]

I am comparing the actual values of both. In retirement the only thing that matters to a retiree should be cash flow and the ability to generate future cash flows. There is an assumption being made that in 20 years there won't be say a 10 percent flat tax and then a value add tax and/or a wealth tax, some of which will be needed just to be able to pay for the retirement and health care systems, required by the sheer math of our government retirement systems. If everyone here plans thinking current tax rules will stay I think that is a low probablity based on the demographics of the USA population.

It will be true at age 80 when assets are equal that the ROTH, assuming tax laws have not changed will be more valuable, but until that point there is no advantage that I will actually be able to take advantage of, just theoretical tax savings for an 80+ year old, which if you were to do an actual cash flow discount model will result in not much Net Present Value of Savings today. Take 20 years of tax savings from 71 -90 get a NPV of that funding 15,000 per year for the next 10 years at 8 percent and you will find I believe there is not much of a NPV you are gaining for the risk being undertaken.

I'm trying to keep up here. Putting some numbers on your first post, I think you were comparing two options:

A) Leave $1 million in a traditional IRA, earning 8%.
This provides a tIRA balance of about $2,159,000 at the end of 10 years.

B) Remove 10% of the tIRA balance each year, pay 15% tax, move the 85% to a Roth IRA. Then, earn 8% on both the Roth and the amount remaining in the tIRA.
This provides a tIRA balance of $753,000 and a Roth IRA balance of $1,195,000 at the end of 10 years. (Assuming the transfer is at the beginning of each year.

You said that $2,159,000 > ($753,000 + $1,195,000). That's correct.

Kaneohe said, "Yes, but ...". In either case, if you want to spend the tIRA balance, you'll have to pay tax on it. This also makes sense to me.
In fact, if the tax rate were 15%, the two approaches give identical after-tax spendable cash of $1,835,000.

I'm not sure that I understand your reply.

 

[daylatedollarshort]

I'm in the same boat--have to sell taxable assets to pay the tax. And the conversion counts as taxable income, which I have to minimize to get the ACA subsidy. All this makes my hair hurt.

Ah what the heck, it's only money. Just found out my second grandchild is a girl and they're naming her after me. Life is good, whatever my tax rate is!

Great news on the grandchild and the name. What a nice honor.

You are right about the tax rates. As my kids always tell me, first world problems.

The ACA does bring in a new paradigm shift to the world of ER income and tax planning, for many of us in a good way, but it still requires a lot of thought and spreadsheet modeling.

 

[BBQ-Nut]

Great news on the grandchild and the name. What a nice honor.

You are right about the tax rates. As my kids always tell me, first world problems.

The ACA does bring in a new paradigm shift to the world of ER income and tax planning, for many of us in a good way, but it still requires a lot of thought and spreadsheet modeling.

I have tried to do this.

I have about 100K left in a roll over IRA that I want(ed) to convert to a Roth after I retire and in a lower tax bracket.

In the spreadsheet I've concocted, I model the taxes on doing the Roth conversion over several years and also model the selling of taxable assets (paying federal LTCG and CA tax on these as 'ordinary income').

Then that is factored into the rest of my model for expense profiles, 'real' return, ss age, death....

And when I crunch the numbers, I end up with less by doing the Roth than just keeping that 100k as is - not by much.

Using SS=70, Real Return of 2%, death at 92, the results are about 10K less by doing the Roth vs not.

It sounds great on a financial website article for 'strategies', and maybe I'm modeling something wrong, but you gotta crunch the numbers....and in my case, it results in less not more. Go figure...

 

[KingB]

I have tried to do this.

I have about 100K left in a roll over IRA that I want(ed) to convert to a Roth after I retire and in a lower tax bracket.

In the spreadsheet I've concocted, I model the taxes on doing the Roth conversion over several years and also model the selling of taxable assets (paying federal LTCG and CA tax on these as 'ordinary income').

Then that is factored into the rest of my model for expense profiles, 'real' return, ss age, death....

And when I crunch the numbers, I end up with less by doing the Roth than just keeping that 100k as is - not by much.

Using SS=70, Real Return of 2%, death at 92, the results are about 10K less by doing the Roth vs not.

It sounds great on a financial website article for 'strategies', and maybe I'm modeling something wrong, but you gotta crunch the numbers....and in my case, it results in less not more. Go figure...

I did the same modeling with different result. With Roth conversion, I can see that my total taxes is lower than without conversion and that my EOL (99 yo) asset is larger than without Roth conversion. I am also using 2% return.

 

[pb4uski]

+1 our age 100 NW is 26% higher if I do Roth conversions vs not. I use a 2.5% real return.

Plus, if I don't do Roth conversions there would be tax-deferred funds left that would be subject to tax when withdrawn by our heirs whereas if I do Roth conversions the withdrawals by heirs would all be tax free. This benefit is not included in the 26% above.

 

[springnr]

Simple Roth concept model:

Withdraw $50k at end of each year, $42,500 convert to Roth, $7,500 Tax @ 15%
Return used is 8%, doesn't matter

  [COLOR=black][FONT=Calibri]tIRA                     iIRA+Roth           tIRA                     Roth[/FONT][/COLOR]
  [COLOR=black][FONT=Calibri]$500,000            $500,000            $500,000            $0[/FONT][/COLOR]
  [COLOR=black][FONT=Calibri]$540,000            $532,500            $490,000            $42,500[/FONT][/COLOR]
  [COLOR=black][FONT=Calibri]$583,200            $567,600            $479,200            $88,400[/FONT][/COLOR]
  [COLOR=black][FONT=Calibri]$629,856            $605,508            $467,536            $137,972[/FONT][/COLOR]
  [COLOR=black][FONT=Calibri]$680,244            $646,449            $454,939            $191,510[/FONT][/COLOR]
  [COLOR=black][FONT=Calibri]$734,664            $690,665            $441,334            $249,331[/FONT][/COLOR]
  [COLOR=black][FONT=Calibri]$793,437            $738,418            $426,641            $311,777[/FONT][/COLOR]
  [COLOR=black][FONT=Calibri]$856,912            $789,991            $410,772            $379,219[/FONT][/COLOR]
  [COLOR=black][FONT=Calibri]$925,465            $845,690            $393,634            $452,057[/FONT][/COLOR]
  [COLOR=black][FONT=Calibri]$999,502            $905,846            $375,124            $530,721[/FONT][/COLOR]
  [COLOR=black][FONT=Calibri]Minus 15%                                      Minus 15%         [/FONT][/COLOR]
  [COLOR=black][FONT=Calibri]$849,577            $849,577            $318,856            $530,721[/FONT][/COLOR]
  [COLOR=black][FONT=Calibri]Tax                      Tax                      Tax                      Tax[/FONT][/COLOR]
  [COLOR=black][FONT=Calibri]$149,925            $123,769            $56,269              $67,500[/FONT][/COLOR]

 

[RetiringAt55]

The big advantage of a Roth comes when you use money from your taxable account to pay the tax. Pay the tax on the TIRA by taking money from a taxable account so the whole amount goes to the Roth, not just 75% or 85%. This is what many people seem to be missing here in their calculations.

I recommend reading "The Roth Revolution" by James Lange to get a better handle on this aspect of saving with a Roth.

 

[GrayHare]

A reason to NOT convert to Roth is if you anticipate having significant Schedule A deductions during the future. Those deductions can offset the taxes on the ordinary income generated by tIRA and t401k. If someone has little taxable income Sch A deductions will go to waste.

 

[RetiringAt55]

A reason to NOT convert to Roth is if you anticipate having significant Schedule A deductions during the future. Those deductions can offset the taxes on the ordinary income generated by tIRA and t401k. If someone has little taxable income Sch A deductions will go to waste.

The decision is not whether one should convert to a Roth or not. The question is how much to convert. For many people, converting part of their TIRA gives them flexibility. For example, if you still have money in a TIRA you can donate some of your RMDs directly to charity (after age 70.5), keeping your income level down. If you have money in a Roth, you can tap into that in years with very large expenses to keep from bumping up into a higher tax bracket.

For us, we are aiming to convert most of DHs 401K to a Roth but leave mine as is. For us, we are aiming for an equal split between taxable, tax-deferred, and tax free. We will only touch the Roth if it makes sense tax wise for a particular year. We have high deductions due to our high property tax but will have pension income as well as SS.

 

[tessaduncan]

FYI The charitable donation of IRAs expired at the end of2013 and have not been extended.. yet.