Tax Strategy/Retire Before 59.5

[columbus]

Everyone is so helpful on this forum and I have learned so much reading through the posts over the years!

I am 34, DW and I have a 2 year old and another baby on the way.
Combined we earn around $135/year. I no longer have any 401k options at work but have maxed out my Roth IRA every year and we own 3 rental properties(with mortgages). My DW works for a university where she is able to take advantage of a tax deferred 401k(might actually be a 403b?). We recently learned that she could also open up a tax deferred 457 plan too...and she does not have a traditional or roth ira. We also do not have a coverdale or 529 setup yet for kids college.

My question would be that with child tax credit phase out at $110, investment real estate losses phase out at $100k, and a lower tax bracket at $72,500 would it make sense to invest as much in pretax/tax deferred as possible? (I could do traditional instead of Roth, DW could max 457 and maybe open up a traditional if allowed, on top of her 403b?) I don't think we could get to $72,500 but every dollar towards it would be an automatic 10% savings if we withdraw while we are in lowest tax bracket in retirement right? or is my logic way off? I would then like to at least max out a coverdale for college.

Part 2 of question is if we tried to retire at age 50. How would you recommend withdrawing funds to stay in lowest tax bracket and cover expenses? (Live off rental cash flow and tax deferred accounts only pulling out enough to stay in lowest tax bracket? Sell a property in separate years or 1031 into one multi property we then live in for 2 years and then sell? Then pull our Roth money after 59.5 for big purchases or vacations?

Please let me know all the things I'm not thinking about and where I may be horribly off base. I'm just trying to plan and in the past we have tried to save money for rental properties but now I feel like we may have missed out on some tax savings. I still think rental property opens up a lot of options and could stick to that plan as well? I'm all over the place, help please

 

[38Chevy454]

First you should max out the pre-tax so you can try and get under the cutoff limits in order to be able to take advantage of those. A 457 is a nice way to increase your wife's pre-tax, and it can be withdrawn prior to 59 without penalty, just the tax liability. Unless I am mistaken, the rental loss takes place at much higher for married couple jointly, I believe it is around $160K. So you should review past years and may be able to file amended and get the credits. I am not tax expert, but do my own and have had rental Sch E, and was forced to take carryover loss due to being over that limit. No idea on kid credit, not my case.

As for your second question, Roth should not have any tax effect, it is tax free. That is the whole point, pay tax now and it grows tax free. Also the current tax rules you have to live in house for 2 of 5 years to avoid long term cap gains as investment property. So you could move into rental and work around the tax, but beware that you still have accumulated depreciation that lowers the basis. Which goes against your limit for sale to avoid taxes. Plus given how much the gov't is attacking the wealthier taxpayers, you might not get the same in future. I realize this is unknown, but they may disallow personal gain on house.

Any rental cash positive flow is going to be taxed at whatever your income is. You might keep that lower than a tax rate step, then use Roth or other after tax savings (remember that house you sold??) to supplement living expenses until you need to get into the tax deferred accounts with their tax liability consequences.

Hopefully someone else can pitch in, but this is my $.02 worth of answer if I understand your question correctly.

 

[nun]

FYI I will be funding ER years before 59.5 with rental income, 457 withdrawals and after tax cash/investments. My goal is to stay will within the 15% tax bracket, so that I can go up to that limit with IRA to ROTH rollovers and so that I will get a fairly good ACA subsidy.

 

[columbus]

Thanks for the replies! Does anyone think buying more rental property could be a better option than pretax investments. I feel I have had more luck with investment property than investments but we also have a desire to move away rom this area and not having a bunch of property to hold us down would be nice. I really have just had bad luck with mutual funds through Scottrade. I've tried to get low cost funds, diversify, etc but I have not seen very good returns. I have done much better with individual stock picking. I'm contemplating scrapping all MFs and just buying 10 stocks I feel strongly about for long term returns.

 

[nun]

Thanks for the replies! Does anyone think buying more rental property could be a better option than pretax investments. I feel I have had more luck with investment property than investments but we also have a desire to move away rom this area and not having a bunch of property to hold us down would be nice. I really have just had bad luck with mutual funds through Scottrade. I've tried to get low cost funds, diversify, etc but I have not seen very good returns. I have done much better with individual stock picking. I'm contemplating scrapping all MFs and just buying 10 stocks I feel strongly about for long term returns.

I think you answered your question about getting more rentals. You don't want to get too concentrated in a single area.

I would not go from the diversification of mutual funds to a few individual stocks. Just KISS and buy a Vanguard couch potato portfolio.

 

[InParadise]

"Also the current tax rules you have to live in house for 2 of 5 years to avoid long term cap gains as investment property. So you could move into rental and work around the tax,..."

This was modified in 2009 to a pro-rated approach: "However, a special rule enacted in 2009 limits the $250,000/$500,000 exclusion for homeowners who initially use their home for purposes other than their principal residence, such as a rental or vacation home. The rule requires you to reduce pro rata the amount of profit you exclude from your income based on the number of years after 2008 you used the home as a rental, vacation home, or other “nonqualifying use.” Taxes in Converting Rental Property to Personal Residence | Nolo.com

 

[InParadise]

"Part 2 of question is if we tried to retire at age 50. How would you recommend withdrawing funds to stay in lowest tax bracket and cover expenses? (Live off rental cash flow and tax deferred accounts only pulling out enough to stay in lowest tax bracket? "

I am very interested in this as well. DH will be 56, I will be 52 when we quit. We have a mish mash of Roth, Inherited, and Traditional IRAs, 401K and pensions/SS that will come into play later. We also have taxable funds and some funds/stocks that we can sell that will have significant LT cap gains. Our goal is to delay SS as long as possible, maximizing our Roth's through conversion while keeping as low a tax bracket as possible. Besides maxing our SS income this way, we won't be forced to take RMDs on the Roths which will hopefully minimize SS taxation.

What I am not clear on is how retirement account withdrawals are taxed when you have a combination of pretax and post tax contributions. Can I selectively draw $x from the 401K, which DH will be able to take without penalty since he will be over 55 and have quit, then take $Y from a Roth under Substantially Equal Periodic Payments, so that I know how much will be taxed and how much won't? Or do I have to make some calculation of total retirement assets and apply that calculation to determine % withdrawals taxed? Or in other words can I selectively chose which IRAs to take SEPP from and pay taxes only based on the type account used? We have enough assets to make it past 59.5 without pulling from our IRAs, but wondering how we can use this diversity in account type to our benefit, or indeed how it might bite us back.

TIA,

IP

 

[pixelville]

"....
What I am not clear on is how retirement account withdrawals are taxed when you have a combination of pretax and post tax contributions. Can I selectively draw $x from the 401K, which DH will be able to take without penalty since he will be over 55 and have quit, then take $Y from a Roth under Substantially Equal Periodic Payments, so that I know how much will be taxed and how much won't? Or do I have to make some calculation of total retirement assets and apply that calculation to determine % withdrawals taxed? Or in other words can I selectively chose which IRAs to take SEPP from and pay taxes only based on the type account used? We have enough assets to make it past 59.5 without pulling from our IRAs, but wondering how we can use this diversity in account type to our benefit, or indeed how it might bite us back.

IP

As far as I am aware IRA withdrawals from pre and post tax are pro-rated. You can't pick and choose. All traditional IRAs are treated as a large bucket from which you withdraw. Roth is separate. 401k, 403b, etc are also treated separate. Your IRA accounts are considered separate from spouse's accounts, so you have some flexibility there. If you have had multiple employers and you rolled over from say a 401k to IRA, you might have an option to move it back to a 401k, to give you more flexibility.
If you have post-tax contributions either directly in an IRA or rolled over from a 401k, you must have filed IRS Form 8606. Go through its instructions to understand it and use it for learning how your IRA basis is calculated and carried over from year to year.

 

[InParadise]

" As far as I am aware IRA withdrawals from pre and post tax are pro-rated. You can't pick and choose. All traditional IRAs are treated as a large bucket from which you withdraw. Roth is separate. 401k, 403b, etc are also treated separate. Your IRA accounts are considered separate from spouse's accounts, so you have some flexibility there."

Please bear with me, as I am not sure I have this straight.

What I understand from your post is as follows:

1. I have no control over pulling out post tax contributions to my Traditional IRAs, withdrawals from these will be taxed on a prorated basis.

2. However, I can pull an untaxed amount from my Roth without concern for taxation based on the amount in my Traditional.

3. So I can selectively chose between the different types of IRA/retirement accounts when it comes to withdrawals, and control my taxes that way, with the caveat that taxation of the Traditional IRA withdrawals will be determined by the ratio of pre/post tax contributions.

Thanks for the reminder re spouse's IRA being separate. Spending decades co-mingling all our assets, it is easy to forget that though we file taxes jointly, we have to still look at these accounts individually. We can target my Traditional IRAs for Roth conversion first, and have less in taxes to pay since my pre-tax contributions are smaller than his.

 

[Animorph]

A typical tax strategy in retirement might look something like this:

Use taxable accounts to live on at first.

Roth convert (early in retirement) or withdraw (if no taxable funds left) from tIRA's up to the top of a tax bracket or other tax rate change or ACA threshold. You can Roth convert any amount of a tIRA that you choose. The 0% capital gains tax may also be a factor in this. This will depend on what total income you need and what your taxes will look like at age 70 when you have to take RMD's. Draw down tIRA accounts from the oldest spouse first to minimize RMD's later. The idea is to minimize your tax rate throughout retirement. This is the part that will depend on your specific tax situation and where your assets are located. It's nearly impossible for us to give you detailed advice on this.

Use Roth withdrawals to cover any expenses above what tIRA withdrawals will cover, after taxable funds are depleted.


In order to do this, you should estimate your taxes when RMD's start. All you need is enough accuracy for a good guess at what your marginal tax rate will be. As you deplete tIRA assets, keep this future tax rate up to date. Then, if you can Roth convert at a marginal tax rate equal to or less than your RMD's will see, do the conversion. You don't have to be exact in this process. A bit of slop in either direction won't throw you off a cliff.

 

[InParadise]

A typical tax strategy in retirement might look something like this:

Use taxable accounts to live on at first.

Roth convert (early in retirement) or withdraw (if no taxable funds left) from tIRA's up to the top of a tax bracket or other tax rate change or ACA threshold. You can Roth convert any amount of a tIRA that you choose. The 0% capital gains tax may also be a factor in this. This will depend on what total income you need and what your taxes will look like at age 70 when you have to take RMD's. Draw down tIRA accounts from the oldest spouse first to minimize RMD's later. The idea is to minimize your tax rate throughout retirement. This is the part that will depend on your specific tax situation and where your assets are located. It's nearly impossible for us to give you detailed advice on this.

Use Roth withdrawals to cover any expenses above what tIRA withdrawals will cover, after taxable funds are depleted.


In order to do this, you should estimate your taxes when RMD's start. All you need is enough accuracy for a good guess at what your marginal tax rate will be. As you deplete tIRA assets, keep this future tax rate up to date. Then, if you can Roth convert at a marginal tax rate equal to or less than your RMD's will see, do the conversion. You don't have to be exact in this process. A bit of slop in either direction won't throw you off a cliff.

Thanks. Not really looking for personal detailed advice, though what you write is essentially what I have in mind to do. Wanted mostly to verify I could do it based on tax law.

Between our pensions and SS our taxes will most likely be high enough. Would love to get all the Tiras converted to Roth if I can before RMDs become required.