Tax Efficient Withdrawal Strategy

[Islandtraveler]

OK, this may win the dumb question of the year award, but here goes. I am 12 months from fire and am currently in the 39% tax bracket. Once I retire, I will be living off of my savings. I am 55 and will not be receiving any ordinary income from that point forward. I have 2/3 of my money invested in a taxable account and 1/3 in a tax deferred account. I believe that I will be making about 80k per year in dividends (About 36k from bonds in my tax deferred account) and will be withdrawing the balance of my living expenses out of my taxable account which is projected to be about 150k per year. What tax bracket will I be considered in? Does it make sense to take SS early? Additionally, should I convert to a Roth? I was ineligible up to this point. I have been a saver for 35 years and haven’t a clue as to how to draw with an eye on tax efficiency. Does it make sense to enlist the help of a tax professional? If so, any recommendation as to where to find one? My CPA has told me that this is way over his head. Thanks.

 

[RockyMtn]

Don't know that we have enough info to let you know what tax bracket you are in or if you should convert to a Roth. What are your deductions? Are the dividends ordinary or qualified? Are the cap gains on your after tax accounts long term or short term, etc, etc, etc.

 

[Islandtraveler]

I currently have standard marriage and 1 child deduction as well as business deductions. I will not have the business deductions once retired. Dividends and cap gains mostly long term and qualified. About 1 M in bonds in SEP. 350 k in munis in taxable account and 3 M equities in taxable account.

 

[MichaelB]

If your only income is qualified dividends and capital gains your tax projections are pretty straightforward but you can influence how much taxable income you have in any year before RMDs begin. That, plus the opportunity to convert tIRA to Roth is definitely worth spending a few minutes to learn to use the tools. My suggestion would be to buy a copy of TurboTax 2013 Deluxe and use it to look at different combinations of portfolio income and Roth conversion.

 

[LOL!]

For some hints on tax planning, you should read this discussion:
Bogleheads • View topic - How to pay ZERO taxes in retirement with 6-figure expenses

Note that your income is much higher, but the ideas are worthwhile to learn about:

1. Use Retirement Calculator - Parameter Form (i-orp)
2. Use TurboTax (your CPA seems to be worthless in this regard) to see where i-orp might get it wrong.
3. Apparently, you need to learn tax planning on your own.

It does not make sense to take SS early. It will only add to your taxable income that you do not need and reduce future benefits.

It does make sense to convert piecemeal to a Roth, but i-orp will give you info on that.

 

[GrayHare]

25% bracket is my guess. Take SS early if your life expectancy is below average. Convert to Roth if your tax rate will be less at time of conversion than during RMDs. You may not have been eligible to make Roth contributions directly, but since 2010 everyone has been allowed to convert tIRAs to Roth.

 

[Islandtraveler]

Great dialog and suggestions. Thank You all.

 

[walkinwood]

Buy this year's version of Turbo tax and input all your dividends and cap gains (2013) from your taxable accounts & see how much you'll pay. It may surprise you just how little you pay as a percentage of your annual expenses.

You can also play around with ROTH conversions to see if they are worth it.

ESPlanner and iORP are good tools to do "what if?" scenarios with SS, Tax deferred withdrawals and ROTH conversions.

You'll find threads on each of those in this forum too, with many different scenarios - maybe, one will match yours.

I aim to avoid stupid decisions in these matters, but I don't try for the optimum. It is too complicated to have certainty and laws could change.

 

[David1961]

I know most folks here are DIY'ers, but considering your high assets, and the fact that your CPA has said it's over his head, you may want to consider talking to a tax professional. To be honest, this is one of those "do as I say not as I do" recommendations because I have never been to one myself. I know people who have, and their results have been mixed. Some have been very happy and others thought it was not worth it. Maybe your CPA can recommend someone. Or you can ask friends.

 

[kaneohe]

You haven't indicated how highly appreciated your taxable account is......is is mostly principal and not much gains or mostly gains? That's a big uncertainty there. Also not sure what you meant.........are your total expenses 150K and you are getting 36K from tax deferred accounts , 44K in qualified dividends from taxable account and the remaining 70K from selling assets in taxable?

 

[Travelwanted]

My CPA has told me that this is way over his head. Thanks.

I'd start with a new tax pro. That is something I would expect of them.

And, you can sign up for free account on turbo tax to plug in the numbers and see.

 

[Islandtraveler]

You haven't indicated how highly appreciated your taxable account is......is is mostly principal and not much gains or mostly gains? That's a big uncertainty there. Also not sure what you meant.........are your total expenses 150K and you are getting 36K from tax deferred accounts , 44K in qualified dividends from taxable account and the remaining 70K from selling assets in taxable?

Good question. The taxable account has appreciated about 400k after accounting for an extensive tax loss harvesting since the 2008 meltdown. That puts my current appreciation at about 13% long term.

 

[Islandtraveler]

The expenses of 150k represent my anticipated draw annually. The 36k will remain in the qualified account until I have a need to draw on it or when RMDs require me to. I am expecting this approach to bring me more heavily weighted on bonds as I age.

 

[kaneohe]

Sounds like a good time to start learning about taxes.......you might find something appropriate in the Idiot or Dummies series of books at your local library. Generally those books are quite good.

It looks like you might be in the 15% bracket:

36K from deferred accounts taxable as ordinary income
44K dividends from taxable (assumed to be qualified dividends)
70K from selling shares in taxable account (avg 10K CG if 13% appreciation)

That makes your AGI 36 + 44 + 10 = 90K
With std deduction of 12K and exemptions of 3x4K =12K
Your taxable income is 90K -24K = 66K

That would put you in the 15% bracket (until taxable income of 73.8K).
If all of your dividends are Qualified and all your CG are long term, they would not be taxed so you would be taxed only on 12K of ordinary income which would not be too much.

You can play around with Taxcaster https://turbotax.intuit.com/tax-tools/calculators/taxcaster/ to model various conditions. Note that
Taxcaster assumes all dividends are qualified so you have something different, you need to put only the qualified dividends into the dividend block and put the non-qualified dividends elsewhere (such as interest).

Try adding more ordinary income to the mix as would happen if you did Roth conversions. You will see that once you add more than 8K, the marginal tax rate will jump to 30% for a while and then come return to 25%.

 

[pb4uski]

Do (or have your CPA do) a projected return for 2014 and 2015 based on your new circumstances. As others have said, it seems likely that you will be in the 15% bracket in 2015. At which point you should consider either Roth conversions or capital gain harvesting to the top of the 15% tax bracket - you can use those pro forma returns to get an idea of the tax bite of each (but the tax gain harvesting should result in 0 taxes for federal). Be sure to cover off state taxes to if they apply.

 

[retire2020]

OK, this may win the dumb question of the year award, but here goes. I am 12 months from fire and am currently in the 39% tax bracket. Once I retire, I will be living off of my savings. I am 55 and will not be receiving any ordinary income from that point forward. I have 2/3 of my money invested in a taxable account and 1/3 in a tax deferred account. I believe that I will be making about 80k per year in dividends (About 36k from bonds in my tax deferred account) and will be withdrawing the balance of my living expenses out of my taxable account which is projected to be about 150k per year. What tax bracket will I be considered in? Does it make sense to take SS early? Additionally, should I convert to a Roth? I was ineligible up to this point. I have been a saver for 35 years and haven’t a clue as to how to draw with an eye on tax efficiency. Does it make sense to enlist the help of a tax professional? If so, any recommendation as to where to find one? My CPA has told me that this is way over his head. Thanks.

You can use this calculator to estimate tax on earned/unearned income.
Tax Calculator - Estimate Your Income Tax for 2014 - Free!

 

[gerntz]

Once I retire, I will be living off of my savings. I am 55 and will not be receiving any ordinary income from that point forward.

Ultimately you will have ordinary income as you withdrawal from you IRA's & I presume SS payments.

 

[LiveBelowMeans]

I like to play what if games with this free calculator.

1040 Tax Calculator

 

[adrift]

1. Use Retirement Calculator - Parameter Form (i-orp)
2. Use TurboTax (your CPA seems to be worthless in this regard) to see where i-orp might get it wrong.

I'm sure both of your points are well intentioned. But, the first is almost certainly ill advised. The OP has income from a taxable portfolio. The developer of i-orp says that it doesn't really consider the tax code for a taxable portfolio.

I do strongly concur with trying TurboTax to model your situation.

 

[urn2bfree]

Sounds like a good time to start learning about taxes.......you might find something appropriate in the Idiot or Dummies series of books at your local library. Generally those books are quite good.

It looks like you might be in the 15% bracket:

36K from deferred accounts taxable as ordinary income
44K dividends from taxable (assumed to be qualified dividends)
70K from selling shares in taxable account (avg 10K CG if 13% appreciation)

That makes your AGI 36 + 44 + 10 = 90K
With std deduction of 12K and exemptions of 3x4K =12K
Your taxable income is 90K -24K = 66K

That would put you in the 15% bracket (until taxable income of 73.8K).
If all of your dividends are Qualified and all your CG are long term, they would not be taxed so you would be taxed only on 12K of ordinary income which would not be too much.

You can play around with Taxcaster https://turbotax.intuit.com/tax-tools/calculators/taxcaster/ to model various conditions. Note that
Taxcaster assumes all dividends are qualified so you have something different, you need to put only the qualified dividends into the dividend block and put the non-qualified dividends elsewhere (such as interest).

Try adding more ordinary income to the mix as would happen if you did Roth conversions. You will see that once you add more than 8K, the marginal tax rate will jump to 30% for a while and then come return to 25%.

I am confused. Why take the dividends from the tax deferred account? As long as they stay in the tax deferred account they are not subject to taxes.

Why not take the $44 in dividends from the taxable side and sell $106k from the taxable account? (87% is return of principle and not taxable) making
AGI = 44+ 14 (13% being the CG of the 106k) =58K, less deductions and exemptions of 24k makes taxable income of $32k... after that this leaves you with room to withdraw from the tax deferred and pay taxes as you convert it to a Roth account up to the top of this very low tax bracket...the Roth gives you money later that will be completely tax free!
The numbers do not quite work because to end up with $150k after takes you have to take more than that, but the amount more varies by what tax bracket you are in. The point is having more in your taxable accounts gives you more flexibility to structure the withdrawal in a way to lower your tax burden.

 

[kaneohe]

urn2befree.............excellent point......I was so focused on trying to translate OP's question (which I may have misinterpreted) into a tax answer that I myopically forgot to take the higher level view that you did. Except for a minor math error in your final calculation, I agree with you.

 

[mathjak107]

one area most folks screw up is in going by rules of thumb and not their own situation.

common wisdom says spend tax deferred money last and let it grow and taxable accounts first. but for many that is poor advice.

uncle sam gives a 65 year old couple the ability to not only take over 20k a year in tax free income every year but the ability to take almost 42k and pay as little as 1800 bucks tax on it.

folks let that ability go unused year after year by spending money they already paid taxes on or the little bit of distribution income they get in taxable accounts while letting that tax free money ability go unused.

someone delaying ss to 70 can actually pull 320k out of retirement money and pay very very little tax on it.

 

[Islandtraveler]

I am confused. Why take the dividends from the tax deferred account? As long as they stay in the tax deferred account they are not subject to taxes.

Why not take the $44 in dividends from the taxable side and sell $106k from the taxable account? (87% is return of principle and not taxable) making

Sorry for the lack of clarity. That is exactly my intention. At my current allocation of 70/30, I feel it prudent to scale down the equity portion of my portfolio. My anticipated draw of 150 on the taxable portion of the portfolio should accomplish this. I just mentioned the dividends from the deferred account from a standpoint of the tax question.

 

[Islandtraveler]

BTW, Great suggestions from all. I have already ordered a copy of the 2013 TurboTax as well as started playing around with those online calculators. I already feel that I have a better understanding of what I will be dealing with. I am amazed at the small amount of tax that I should have to pay! This will be a refreshing change from those giant checks that I have been writing each year! Thanks to all.