Which Way to Go????

[talltrees]

I hope to make this simple, so please bear with me.

I'm 63, as is my wife. We are retired, and I have a partially cola'd pension. ( state government)

Our spending needs are about $65000 per annum, including taxes. ( no state income tax)

My wife is taking SS at 66. Currently, she's projected to receive $1565 a month. I'm waiting until 70, when I would get $2410 per month.

Pension is currently $28200 per annum.

We have $1330000 in taxable and $590000 in traditional IRA's.

The question:

Should we take the cash we need now from taxable (of which 45% is tax free munis) or our IRA's, thereby diminishing the potential tax hit down the road when RMD meets Social Security?

Your input, as a community , is invaluable to so many.

TIA

[Animorph]

Consider converting some of the IRA money into Roth's. That will help with the taxes down the road. Now is a good time, while your income is probably close to its lowest. It should be better than spending the IRA's now and saving the taxable accounts.

The benefit will depend on how the tax brackets line up now and in the future, so it's not a simple problem. In general, you want to convert enough to bring you to the top of the tax bracket your IRA will be taxed in when you are withdrawing in the future.

[LOL!]

I'll make it even simpler: Use this calculator: Optimal Retirement Calculator and Retirement Decision Support System
Also convert some money to Roth IRA each year. You probably should've been doing this for the last several years.

[Independent]

I think the issue you're thinking about is likely tax rates when the RMDs start. I'll give you an approach, but you might prefer to use LOL's calculator.

My conclusion is that instead of the two options your list, try option 3 which is to spend your taxable assets today while converting your traditional IRA to a Roth IRA. That keeps your future investment income in a tax shelter, while taking advantage of your current low tax bracket to get money out of the Traditional IRA.

All the stuff below just tries to estimate current and future tax rates. If you already have numbers that you're comfortable with, you can quit reading here.

I would reason like this: using the 2009 FIT factors, which include a standard deduction of $11,400 and a combined personal exemption of $7,300, the breakpoint between the 10% and 15% marginal rates is $35,400 of adjusted gross income. Similarly, the breakpoint between 15% and 25% is $86,600. So it looks like you can generate your target $65,000 and stay within a 15% bracket. As long as the brackets are indexed to inflation, you can stay in the 15% bracket until SS kicks in.

So I'll jump to age 70. If there were no inflation, you'd have $47,700 of SS plus a $28,200 pension for $75,900 of income. But only $12,800 of the SS would be taxable (using current law), so you'd stay in the 15% bracket and you could absorb some RMDs. My calculations say that if you had $25,000 of RMD, the taxable portion of your SS would increase to $34,100, your AGI would go to $87,300, and you are just over the 25% border.

If your traditional IRA balance at that point is $685,000, you'd have RMD of $685,000 x 1/27.4 = $25,000. Over the next few years, the RMD requirement would go up (unless investment returns were poor).

If there is inflation, the tax brackets, standard deductions, SS, and apparantly your pension are all indexed. The only tax item that's not indexed is the factor for the taxable portion of SS. Inflation increases the taxable portion of SS and makes more of your RMDs taxable at the 25% rate.

So, if you think you'll have more than $685,000, you'd have some RMDs subject to the 25% tax rate. Since you don't need your IRA to meet your near term income needs (not much at any rate, your taxable assets seem to cover most of your income gap before age 70), you'll probably have more than $685k.

All this says you're safely in the 15% bracket for the next few years, but you'll probably have some IRA withdrawals subject to 25% when you start RMDs.

This is the classic circumstance where people decide to do the Roth conversion.

Caveat: all the numbers above are no better than my research and calculation skills, which have been shown to be fallible in the past. So do your own math. Also, it doesn't look like you would need to move an awfully lot of your traditional IRA - that depends on future investment returns, so it's worth looking at the math every year. Finally, I'm sure I don't understand your complete situation -- it looks to me like you are in a 10% or 15% marginal tax bracket today, but 45% of your non-IRA assets are in tax free munis.

[LOL!]

Don't forget that tax-exempt muni bond interest counts toward the income that decides how much of your SS benefits are taxed.

If you want to minimize tax hit, your IRAs should probably be 100% fixed income and your taxable should be tax-efficient low-expense ratio stock index funds. You should not have bonds in taxable (tax-exempt or otherwise), unless your IRAs have absolutely no equity funds in them. That is, you have no more space in IRAs for bonds. This might be the case if your asset allocation in 75% fixed income and 25% equities. I did not do any math this early in the morning.