Timing Withdrawals/Tax Brackets

[marko]

Hi. New here so please forgive if this is/has been covered elsewhere. If so can someone please steer me there?

I'm trying to figure out the benefits of perhaps withdrawing (let's say) three year's worth of cash requirement from an IRA distribution, paying the 28% tax rate and then not paying any tax for 3 years afterwards --or worst case, falling into the 15% bracket.

If I take it year by year, I'll be in the 25% bracket as my spouse still has a good paying job. If I take nothing we should be in the 15% bracket, but we need the extra cash from the IRA to fill the gaps.

(yes, yes, I realize the tax changes coming in 2013)

What I'm trying to do is 'toggle' in and out of a higher tax bracket.

Does any of this make sense or am I wayyyy over thinking this?

 

[rayvt]

Why pay tax any sooner than you need to? Especially since you'll pay more tax, being in a higher bracket.

 

[MasterBlaster]

You need to go to the "Optimal retirement Planner - ORP" website.

Optimal Retirement Calculator and Retirement Decision Support System

They'll give you a tax-optimal withdrawal strategy using your before tax , after tax, and ROTh accounts. Their strategy goes beyond what you posted.

click on the "run ORP" link.

 

[Independent]

Maybe I don't understand the situation, but I can't see the advantage. Generally, graduated tax rates favor levelizing income. You didn't provide any numbers so I'll make up some.

Your spouse has enough income to put you in a 15% marginal bracket without IRA withdrawals. That means somewhere between $17k and $68k taxable (after all exemptions and deductions). Lets say $40k of taxable income.

You want to withdraw $120k from the IRA over the next three years.

If you do it all in one year, the marginal tax on the withdrawal will be
.15*(68k-40k) + .25*(137k-68k) + .28*(160k-137k) = $4,200 + $17,250 + $6,440 = $27,890.

If you do the withdrawals as $40k per year, the tax on each withdrawal will be
.15*(68k-40k) + .25*(80k-68k) = $4,200 + $3,000 = $7,200. Do that for three years and the total tax is $21,600.

Does that make sense?

 

[marko]

Maybe I don't understand the situation, but I can't see the advantage. Generally, graduated tax rates favor levelizing income. You didn't provide any numbers so I'll make up some.

Your spouse has enough income to put you in a 15% marginal bracket without IRA withdrawals. That means somewhere between $17k and $68k taxable (after all exemptions and deductions). Lets say $40k of taxable income.

You want to withdraw $120k from the IRA over the next three years.

If you do it all in one year, the marginal tax on the withdrawal will be
.15*(68k-40k) + .25*(137k-68k) + .28*(160k-137k) = $4,200 + $17,250 + $6,440 = $27,890.

If you do the withdrawals as $40k per year, the tax on each withdrawal will be
.15*(68k-40k) + .25*(80k-68k) = $4,200 + $3,000 = $7,200. Do that for three years and the total tax is $21,600.

Does that make sense?

You're making sense. My thinking was to 'fill the bracket' and pay the tax, then use the extra cash over the next 2-3 years 'tax free' in a lower tax bracket.

Check out what this guy has to say:
» Retirement Withdrawal Strategies

I"m not sure where he's wrong or if I'm just missing something. Comments welcome!

 

[marko]

Here's my thinking: My wife's employer takes taxes her at the 25% rate. After our deductions, --and if I take no IRA distributions, we end up nicely in the 15% rate. For this year we got a nice refund of over $6K. If I take even a modest distribution, we are back at 25%.

My thought would be to 'fill' the 25% bracket (take more from the IRA than we need) seeing as we'll be there anyway and bank the extra money we don't need for the following year, take no distribution that second year and drop back to 15% with a nice refund.

Now in full disclosure, I am 'mathematically challenged' so, I could be missing some big point here!!

 

[RunningBum]

Independent is mostly correct. What you need to keep in mind is that being in the 25% bracket doesn't mean that ALL of your income is taxed in that bracket.

Basically, what you really want to do is make sure you fill up the 15% bracket every year. Then it doesn't really matter which years you have income in the 25% bracket. Spread out or all in one year, it doesn't matter.

The one caveat to this is that cap gains and dividends are untaxed if you are in the 15% bracket, but only that part which, when combined with income, keeps you in the 15% bracket. If your wife's income is already close to the top of the 15% bracket, don't even worry about this. Otherwise you might be able to keep enough caps gains untaxed to make an uneven withdrawal strategy work.

You can run some scenarios through Turbo Tax or whatever tax program you use to see how it all works, and if it's worthwhile.

 

[RunningBum]

WRT your second post, look at the total tax paid each year, not the amount of refund. A refund is just an interest-free loan you given the government.

 

[rayvt]

Well, the first thing that caught my eye was that you mentioned "...a nice refund..." twice. If you are getting a significant refund you are not managing your witholdings properly. The financially best outcome is for you to have to pay a small amount. That implies to me that your finacial decisions are more likely to be made on the basis of "feels good" rather than on the basic of actual dollars.

You didn't mention your age but since your wife is still working I'd guess that you are much younger than 70 1/2 when you are required to start withdrawing from your IRA. If that is the case, then withdrawing the money early is almost always a Bad Idea.

I suspect that it would be a good idea for you to sit down with a tax planner.

 

[Animorph]

Take enough to fill up the 15% tax bracket each year, even if it's a couple of years early. If you need more, take it as late as possible. No need to rush withdrawals that will be taxed at 25% regardless of your timing.

 

[meierlde]

Re the issue of refunds: This year because of the very low interest rates on bank deposits for the first time I have seen recommendations that a refund or changing amounts withheld are pretty much the same thing. Once we get back to more normal interest rates yes, but consider that on a refund you may be giving up a huge .5% interest (before taxes). So thats why they say right now its a wash.

 

[RunningBum]

Re the issue of refunds: This year because of the very low interest rates on bank deposits for the first time I have seen recommendations that a refund or changing amounts withheld are pretty much the same thing. Once we get back to more normal interest rates yes, but consider that on a refund you may be giving up a huge .5% interest (before taxes). So thats why they say right now its a wash.

So you see no value in having the money available to you in case of an emergency, rather than letting the govt holding it? Or being able to invest it where you might get a better return? Not to mention the windfall effect, where some people treat a refund as an excuse to buy a luxury they don't need.

Anyway, my point was to optimize the strategy for total taxes paid, which may or may not be the same thing as the amount of refund received.

 

[Independent]

You're making sense. My thinking was to 'fill the bracket' and pay the tax, then use the extra cash over the next 2-3 years 'tax free' in a lower tax bracket.

Check out what this guy has to say:
» Retirement Withdrawal Strategies

I"m not sure where he's wrong or if I'm just missing something. Comments welcome!

The article seems to say you should take your withdrawals in more level amounts, not in lumpy amounts. That's what I was saying.

The bracket you want to "fill up" is the lowest one. Take out enough to get to the top of the 15% bracket. Don't take out so much that you push yourself into the 28% bracket, that's a territory that you can avoid visiting forever. (assuming the numbers I made up, I don't know yours)