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withdraw sequence
Old 08-11-2014, 10:47 AM   #1
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withdraw sequence

They say common rule is to withdraw from taxable accounts first, followed by tax deferred, then tax free or roth. But isn't there sometimes a reason to withdraw from tax deferred accounts first? My tax deferred accounts are 3 times larger than my taxable. In my situation I believe it is better to withdraw from the tax deferred first since I believe I will be in a higher bracket because of rmd's.
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Old 08-11-2014, 11:12 AM   #2
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Well, you will face mandatory minimum withdrawals at the age of 70. These may affect your taxable SS as well as other benefits. So, withdrawing from them earlier may make sense, or at least converting some of the tax differed money to Roths.
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Old 08-11-2014, 11:15 AM   #3
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Yup. It all depends on your personal circumstances. The conventional wisdom addresses the needs of "most people" whose taxable income will decrease in retirement. But we are not "most people".

I live in Canada, where the details differ but the principle is the same. There is much debate about this question on Canadian financial forums and there is a Canadian software program called RRIFMetric that can compare the effects of different withdrawal strategies on after tax income and portfolio longevity. I'm sure somebody in the US must have come up with similar software.

If I defer withdrawing from my tax sheltered accounts until I reach the age of RMDs, my income tax payable will radically increase at age 71, and in addition, my Old Age Security payments will be completely clawed back. That's equivalent to paying an extra 15% in taxes. OTOH, deferring withdrawals from tax sheltered accounts allows them to grow faster in the meantime, so I would reach 71 with a higher NW. But, since my fixed income is in those accounts, they still won't be the growth portion of my portfolio. It all depends on many factors including yields, tax policy and cash flow needs. Scenario building suggests that it may be a wash. But I am planning to draw down on some of my tax sheltered funds earlier than required.
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Old 08-11-2014, 11:29 AM   #4
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Also if I withdraw from these tax shelter accounts first I can keep my income down and stay in the 15% bracket and therefore maintain the 0% taxation on qualified dividends and capital gains in taxable as well as possibly leaving a legacy to my kids at the stepped up basis.
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Old 08-11-2014, 11:42 AM   #5
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They say common rule is to withdraw from taxable accounts first, followed by tax deferred, then tax free or roth. But isn't there sometimes a reason to withdraw from tax deferred accounts first? My tax deferred accounts are 3 times larger than my taxable. In my situation I believe it is better to withdraw from the tax deferred first since I believe I will be in a higher bracket because of rmd's.
One thing to remember is that withdrawal sequence is commonly accompanied from ER to SS or pensions by Roth conversions so you need to look at them in combination. Each Roth conversion reduces your tax-deferred amounts by the amount of the conversion with a corresponding increase in tax-free funds (the Roth) and also reduces taxable accounts by the amount of the tax. These reductions in tax-deferred funds has the effect of reducing future RMDs.

What I am now doing is living on taxable accounts and doing Roth conversions to the top of the 15% bracket. Prior to Roth conversions my taxes are nil because most of our income is qualified dividends and LTCG (and foreign tax credits too) but once I do my Roth conversions I pay about 7% on the conversion amount, which I think of as a deal considering my marginal tax rate was 25% when I deferred that income.
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Old 08-11-2014, 12:30 PM   #6
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Most of my income is pension along with my wife's ss to begin in 2 years. So my income will be quite high. I'm just not a fan of roth. Do most people anticipate withdrawing from this type of account or is it a legacy play.
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Old 08-11-2014, 12:42 PM   #7
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Most of my income is pension along with my wife's ss to begin in 2 years. So my income will be quite high. I'm just not a fan of roth. Do most people anticipate withdrawing from this type of account or is it a legacy play.
Yes, to both of your options for the Roth.

You may be at what you think will be a high tax rate now but look at where one of you will be when the other one dies. You'll no longer be able to do a joint return. The 25% marginal bracket starts at $36,900 for a single versus $73,800 for a joint return. That provides an incentive to increase withdrawls into the 25% bracket to reduce the impact of possible 28% or 33% rates in the future.

A Roth allows interest, dividends and capital gains to grow tax free. How can you not be a fan of that?
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Old 08-11-2014, 12:47 PM   #8
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I live in Canada, where the details differ but the principle is the same. There is much debate about this question on Canadian financial forums and there is a Canadian software program called RRIFMetric that can compare the effects of different withdrawal strategies on after tax income and portfolio longevity. I'm sure somebody in the US must have come up with similar software.
For the US, there is the i-orp site, which is supposed to help perform some of this optimization of withdrawals. I've played with it a little bit, but there wasn't enough transparency for me to gain confidence that it was truly doing what I hoped it was doing. I need to check it out some more.
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Old 08-11-2014, 01:48 PM   #9
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Most of my income is pension along with my wife's ss to begin in 2 years. So my income will be quite high. I'm just not a fan of roth. Do most people anticipate withdrawing from this type of account or is it a legacy play.
Both. If we make it to our 90s our projections show we would be drawing from it as our taxable and tax-deferred accounts would be exhausted. If we don't make it to our 90s then our children will get the tax free benefit.

I'm not sure what there is not to be a fan about - it is as close to a free lunch as you can get.
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Old 08-11-2014, 02:04 PM   #10
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Minus the loss of ACA subsidies in exchange for maxing out Roth conversions, but you've already factored that in. I'm still on the max subsidy track because I'm not that concerned about having to donate a lot of income to avoid the tax man after 70 (if I'm lucky enough to live and have that RMD income).
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Old 08-11-2014, 03:35 PM   #11
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Yes, to both of your options for the Roth.

You may be at what you think will be a high tax rate now but look at where one of you will be when the other one dies. You'll no longer be able to do a joint return. The 25% marginal bracket starts at $36,900 for a single versus $73,800 for a joint return. That provides an incentive to increase withdrawls into the 25% bracket to reduce the impact of possible 28% or 33% rates in the future.

A Roth allows interest, dividends and capital gains to grow tax free. How can you not be a fan of that?
I thought I had covered all my bases but failed to take this into consideration. Thank you for bringing this up. It looks like I have some numbers to crunch to figure a higher Roth conversion. I only have 3 more years before my wife starts RMD.

Cheers!
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Old 08-11-2014, 03:44 PM   #12
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You can file as widower for 2 years after a spouse death to maintain the tax bracket. But yes, after that, your on you own in the irs's eyes.


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Old 08-11-2014, 04:01 PM   #13
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You can file as widower for 2 years after a spouse death to maintain the tax bracket. But yes, after that, your on you own in the irs's eyes.


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So the year they die and the next one?
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Old 08-11-2014, 05:01 PM   #14
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Qualifying Widower has several conditions....

From 2013 IRS 1040 Instructions

Line 5
Qualifying Widow(er) With
Dependent Child
You can check the box on line 5 and use
joint return tax rates for 2013 if all of
the following apply.
Your spouse died in 2011 or 2012
and you did not remarry before the end
of 2013.
You have a child or stepchild you
can claim as a dependent. This does not
include a foster child.
This child lived in your home for
all of 2013. If the child did not live with
you for the required time, see Exception
to time lived with you, later.
You paid over half the cost of
keeping up your home.
You could have filed a joint return
with your spouse the year he or she died,
even if you did not actually do so.
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Old 08-11-2014, 10:39 PM   #15
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I'll be doing Roth conversions as long as the taxable accounts last. After that, we'll withdraw from an IRA up to a lower tax bracket and cover the rest of expenses from the Roth. If we live a really long time we'll be withdrawing completely from Roths. That's what looks like the optimum for us, maximizing yearly spending.
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Old 08-12-2014, 06:46 AM   #16
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Minus the loss of ACA subsidies in exchange for maxing out Roth conversions, but you've already factored that in. I'm still on the max subsidy track because I'm not that concerned about having to donate a lot of income to avoid the tax man after 70 (if I'm lucky enough to live and have that RMD income).
For those who might take advantage of them, the ACA subsidies change the equation quite a bit. Prior to ACA, the common wisdom was to do Roth conversions up to the top of your current tax bracket. When the bracket is 15%, this allows for tax-free capital gains and qualified dividends.

But the subsidy cliff kicks in at 62K MAGI (for a family of 2). This is significantly lower than the top of the 15% bracket, and it seems to me that the cost of losing the subsidies would far outweigh the advantages of Roth conversions that would take one over the cliff while still staying in the 15% bracket.
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Old 08-12-2014, 08:36 AM   #17
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Yes, to both of your options for the Roth.

The 25% marginal bracket starts at $36,900 for a single versus $73,800 for a joint return. That provides an incentive to increase withdrawls into the 25% bracket to reduce the impact of possible 28% or 33% rates in the future.
The 15% tax brackets for 2014 are $39,150 single / $82,250 married

Tax bracket is applied on income after deducting personal $3,950 each and standard $6,200/$12,400 (or itemized) deductions.

A single can earn $45,745 and remain in the 15% bracket

Married couples can earn $102,550 and remain in the 15% bracket
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Old 08-12-2014, 09:57 AM   #18
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For those who might take advantage of them, the ACA subsidies change the equation quite a bit. Prior to ACA, the common wisdom was to do Roth conversions up to the top of your current tax bracket. When the bracket is 15%, this allows for tax-free capital gains and qualified dividends.

But the subsidy cliff kicks in at 62K MAGI (for a family of 2). This is significantly lower than the top of the 15% bracket, and it seems to me that the cost of losing the subsidies would far outweigh the advantages of Roth conversions that would take one over the cliff while still staying in the 15% bracket.
+1 same problem here. Everyone's retirement scenario is pretty much as unique as their fingerprints. We have no pensions, and no govt./megacorp supplemental healthcare until Medicare. We rely on the ACA for healthcare (BCBS canceled our individual plans when the ACA started up). We have sufficient retirement and taxable accounts to live off for the rest of our lives. Currently withdraw only dividends off taxable accounts and Roths, along with SS to manipulate our income for ACA subsidy. It's not just Federal, but state taxes that come into play for us. Imagine things will continue to get complicated as time goes by (like the ACA subsidy being modified to take into consideration all of ones SS, and not just what was Federally taxed).
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Old 08-12-2014, 10:12 AM   #19
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The 15% tax brackets for 2014 are $39,150 single / $82,250 married

Tax bracket is applied on income after deducting personal $3,950 each and standard $6,200/$12,400 (or itemized) deductions.

A single can earn $45,745 and remain in the 15% bracket

Married couples can earn $102,550 and remain in the 15% bracket
I don't know where you got your tax bracket figures but this is where mine came from.

http://www.taxpolicycenter.org/taxfa...dual_rates.pdf

I agree with your personal exemption and standard deductions. If I limit myself to $94,100 of taxable income, I won't make a serious dent in my IRAs before I take my first RMD. Using your numbers won't make a meaningful difference in my situation.
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Old 08-12-2014, 10:27 AM   #20
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You may be at what you think will be a high tax rate now but look at where one of you will be when the other one dies. You'll no longer be able to do a joint return. The 25% marginal bracket starts at $36,900 for a single versus $73,800 for a joint return.
Plus the increased Medicare parts B and D premium threshold falls from $170K to 85K.
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