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taxes sooner or later
Old 02-07-2014, 02:50 PM   #1
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taxes sooner or later

Wondering if others have solved this. I recently early retired at 50. For the next several years I will have less income and thus low tax bracket (10% effective). Then at 55 my pension will start and I'll jump up slightly (~13-15% effective). Then around 70 the combination of SS and mandatory withdrawals will push me up significantly (>20% effective).

Is there some strategy I should be using to take advantage of the lower rate in the near term? When I try to run the numbers, I don't come out ahead by small earlier withdrawals of IRA, so I guess the tax deferred growth continues to beat the tax bracket advantage. Am I missing something obvious?
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Old 02-07-2014, 03:07 PM   #2
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Wondering if others have solved this. I recently early retired at 50. For the next several years I will have less income and thus low tax bracket (10% effective). Then at 55 my pension will start and I'll jump up slightly (~13-15% effective). Then around 70 the combination of SS and mandatory withdrawals will push me up significantly (>20% effective).

Is there some strategy I should be using to take advantage of the lower rate in the near term? When I try to run the numbers, I don't come out ahead by small earlier withdrawals of IRA, so I guess the tax deferred growth continues to beat the tax bracket advantage. Am I missing something obvious?
You could consider doing Roth conversions on your IRA during this time as the tax hit will be lower.

This will also reduce the balance you have remaining in your IRA when you hit 70 and any RMDs which might keep you in a lower tax bracket.
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Old 02-07-2014, 03:46 PM   #3
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Yes, absolutely. Do Roth conversions each year up to the bottom of the next tax bracket.
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Old 02-07-2014, 03:48 PM   #4
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Yes, absolutely. Do Roth conversions each year up to the bottom of the next tax bracket.
Keep in mind that the bracket rate is not necessarily the marginal rate. The marginal rate is what matters.
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Old 02-07-2014, 04:02 PM   #5
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Yes, absolutely. Do Roth conversions each year up to the bottom of the next tax bracket.
+1. In fact, go a step further and take a look at what your marginal rates are likely to be as you get farther into retirement. These marginal rates are what is significant, not your effective rates. If, say, you see that your last dollar of income when you are 75 is likely to be taxed at a rate of 28%, then it makes sense to pay tax on that saved dollar today at your present top bracket (15%?) and put it into a Roth IRA if possible. Likewise, if you are in the 10% or 15% bracket you pay zero % on cap gains, so selling "winners" now and resetting their basis so that your tax liability later will be reduced can make a lot of sense.
Also, if you are filing jointly now, take a glance at how the situation changes years down the road if you become a single taxpayer. The hit can be quite significant, again re-inforcing the value of paying taxes today at the lower rate.
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Old 02-07-2014, 04:05 PM   #6
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+1 for ROTH transfers. Best way to see how far up the bracket you can go is to use tax software to model your situation.
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Old 02-07-2014, 04:05 PM   #7
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Yes, absolutely. Do Roth conversions each year up to the bottom of the next tax bracket.
Absolutely, that much we should all probably do.

It may be beneficial to convert even more (if your taxes after 70 are still projecting too high), but that part is a lot trickier as far as I can tell...and then there's Soc Sec taxation to make it even more confusing.
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Old 02-07-2014, 04:13 PM   #8
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+1. In fact, go a step further and take a look at what your marginal rates are likely to be as you get farther into retirement. These marginal rates are what is significant, not your effective rates. If, say, you see that your last dollar of income when you are 75 is likely to be taxed at a rate of 28%, then it makes sense to pay tax on that saved dollar today at your present top bracket (15%?) and put it into a Roth IRA if possible. Likewise, if you are in the 10% or 15% bracket you pay zero % on cap gains, so selling "winners" now and resetting their basis so that your tax liability later will be reduced can make a lot of sense.
Also, if you are filing jointly now, take a glance at how the situation changes years down the road if you become a single taxpayer. The hit can be quite significant, again re-inforcing the value of paying taxes today at the lower rate.
+1. This. Good advice.
Also, if applicable, see how TGH and/or ROTHs conversions affect your ACA subsidy.
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Old 02-07-2014, 05:00 PM   #9
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Thanks to all, very helpful. I think I get it on Roth conversion up to next marginal rate, will read up.

Question on selling "winners" sooner to pay less capital gains. If I am holding index funds in my IRA, do I need to sell the whole fund and then rebuy in order to "reset" the basis?
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Old 02-07-2014, 05:16 PM   #10
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Question on selling "winners" sooner to pay less capital gains. If I am holding index funds in my IRA, do I need to sell the whole fund and then rebuy in order to "reset" the basis?
Oh, no. You'd just sell enough shares to meet your requirements for tax purposes. And that tip (resetting the basis ) applies to your non-IRA/non-401K accounts. You don't have capital gains per se in your traditional IRA accounts--every penny you withdraw or roll into a Roth IRA is taxed at your "regular income" rate. Sorry, but that's the down side of not paying tax on the money when you put it in.
For those non-IRA accounts: You'll need to read up a bit on this, but if you can use the "specific shares" method of identifying your cost basis it will give you the most flexibility in tailoring your capital gains as you go forward. We have a couple of threads on this within the last year, it's very easy to do with the new software installed on most brokers/MF sites.

Edited to add: Here's a recent thread on the use of the "specific shares" method when selling shares. That's just one of several such threads.

Good luck, and don't get discouraged by the seeming thicket of various techniques to save on taxes.
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Old 02-09-2014, 01:10 PM   #11
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Why Roth conversions over 0% LTCG?
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Old 02-09-2014, 01:32 PM   #12
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Why Roth conversions over 0% LTCG?
Midcap started a good thread recently and some of the pros/cons of each route were discussed. You might find some useful stuff there. Much depends on the individual situation, and it's not easy to model, though there are some software packages/spreadsheets out there that claim to help. The devil is probably in the assumptions we have to make.

One factor is the potential of changing filing status from MFJ to Single. From a post in that earlier thread:
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- Survivor/Filing Single Taxes (sorry pb4uski, I don't recall if this applies to you): Assuming you are in the upper portion of the 15% bracket when MFJ, a surviving spouse would probably have marginal rates well into the 25% range. Under the above conditions:
-- Cap Gains harvesting: Every dollar of basis that is reset higher now saves the survivor 15 cents (for others following along, that's the cap gains tax rate for those in the 25% income tax bracket)
-- Roth Conversion: Every dollar converted to Roth now costs 15 cents in present taxes, but saves the surviving spouse from paying 25 cents in taxes. Net benefit: 10 cents.

So, looked at from this angle (minimizing taxes to a surviving spouse), the CG loss harvesting has a 5% edge (or, "provides 50% greater benefit!"). Plus, it keeps more money in your account (because you didn't pay those 15% taxes this year), and that's "pad" against uncertainties of the future. Market returns might stink for 20 years: in that case you'll be glad you kept this money in hand AND you'll avoid high taxes after all
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Old 02-11-2014, 10:03 PM   #13
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Thanks. With all the factors, seems it's hard to be confident either direction is truly right. However, filling up the 15% bracket for sure either way is most important.
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