Withdrawal Strategy Advice

[frayne]

I know much has been written about investing and accumulation of wealth as well as safe withdrawal rates but what is the best methodology to tap your portfolio(s). Are there any good rules of thumb for guidance ?

Hypothetical Scenario

Married couple both 62, collecting social security of $22K per year.
Health insurance covered, house paid for, no debt, vehicles good for another ten years.
No major expenditures planned for the near future.
After tax portfolio approx. $300K, mix is 60/40 equities/fixed income.
Traditional IRA $700K, mix is 60/40 equities/fixed income.
Equities primarily in the form of low cost index mutual funds with a few stocks.
Fixed income, in money markets, bond index funds, CDs, and savings account.
No pension or annuities.
Annual living expenses $40-45K after taxes.

Assuming the same living expenses, what would be a good withdrawal strategy ? In addition have no desire to leave much on the table when we expire and for the sake of the exercise I fiqure we both have 25 year left before exiting to the netherworld.

Not too concerned about the rate of withdrawal but the wisdom of tapping before or after tax accoutns and in what proportions.


Appreciate any and all comments, ideas, suggestions in advance.

 

[pb4uski]

Your post suggests each of the taxable accounts and IRA are 60/40. I would load my 40% fixed income into my IRA and spread the equities between the remainder of the IRA and taxable accounts.

I would then draw $18-23k annually from the taxable accounts to supplement SS to provide for living expenses and do Roth conversions as I could up to the top of the 15% bracket.

Since health insurance is covered, optimizing the health insurance subsidy is presumed to not be an issue.

Needless to say, YMMV.

 

[braumeister]

There is often some good insight to be obtained from the calculator on the Optimal Retirement Decision Support website.

 

[David1961]

If you are reinvesting dividends and capital gains in your stocks and funds, you could start getting them in cash. And since you are over age 59 1/2, can't you start withdrawing funds from your IRA?

 

[MasterBlaster]

There is often some good insight to be obtained from the calculator on the Optimal Retirement Decision Support website.

Another vote for the I_ORP calculator. They will tax-optimize your withdrawals.

 

[nun]

Your post suggests each of the taxable accounts and IRA are 60/40. I would load my 40% fixed income into my IRA and spread the equities between the remainder of the IRA and taxable accounts.

I would then draw $18-23k annually from the taxable accounts to supplement SS to provide for living expenses and do Roth conversions as I could up to the top of the 15% bracket.

Since health insurance is covered, optimizing the health insurance subsidy is presumed to not be an issue.

Needless to say, YMMV.

Agreed,

Take dividends, capital gains and then principal from your taxable accounts to make up the difference between SS and your income needs. If you were not already taking SS I would have advocated delaying taking it.
Do ROTH rollovers to the top of the 15% bracket.

Keep an eye on your IRA balance and adjust it so that RMDs won't push you into high tax brackets ie take IRA distributions

 

[frayne]

Thanks all for the advice so far, please explain the Roth roll over to the top of the 15% tax bracket.



Thanks in advance.

 

[pb4uski]

You transfer funds from a taxable IRA to a Roth IRA. The amount transferred is reported to the IRS as taxable income and is taxed as ordinary income. So before you do the Roth conversion you would do a trial tax return to estimate what your taxable income will be before the conversion. The top of the 15% bracket for 2012 is $70,700 for a married couple filing jointly. So the conversion would be $70,700 minus your estimated taxable income prior to the conversion.

I would further reduce this by $1,000 or so as a hedge for any estimating error, because if you go over the 15% bracket, all of your qualified dividends and capital gains would be taxed at 15% - if you stay within the 15% bracket qualified dividends and capital gains are not taxed. If your taxable income doesn't include much qualified dividends or capital gains it would be less of a concern.

YMMV

 

[Alan]

You transfer funds from a taxable IRA to a Roth IRA. The amount transferred is reported to the IRS as taxable income and is taxed as ordinary income. So before you do the Roth conversion you would do a trial tax return to estimate what your taxable income will be before the conversion. The top of the 15% bracket for 2012 is $70,700 for a married couple filing jointly. So the conversion would be $70,700 minus your estimated taxable income prior to the conversion.

I would further reduce this by $1,000 or so as a hedge for any estimating error, because if you go over the 15% bracket, all of your qualified dividends and capital gains would be taxed at 15% - if you stay within the 15% bracket qualified dividends and capital gains are not taxed. If your taxable income doesn't include much qualified dividends or capital gains it would be less of a concern.

YMMV

This is a good explanation of what to do, but I don't think this explains why he should do the conversion since when he starts RMD's in 8 years time their SS + RMD is still within the 15% bracket, or close to it.

If it were me, I would do some conversions in case the 15% rate is increased. Difficult or impossible to guess at the tax structure in 8 years time.

 

[pb4uski]

This is a good explanation of what to do, but I don't think this explains why he should do the conversion since when he starts RMD's in 8 years time their SS + RMD is still within the 15% bracket, or close to it.

If it were me, I would do some conversions in case the 15% rate is increased. Difficult or impossible to guess at the tax structure in 8 years time.

Agreed, in this case taxation of RMDs would not seem to be much of an issue. To me the more important benefit is converting earnings on assets from a ~15% tax rate (even if tax deferred) to tax-free in the Roth.

 

[Alan]

To me the more important benefit is converting earnings on assets from a ~15% tax rate (even if tax deferred) to tax-free in the Roth.

I agree, it is hard to resist. I-ORP recommends that I convert large sums even though I am in the 25% bracket. I can't bring myself to do anywhere close to what the calculator says, but I do some, convincing myself that these funds were saved when I was in a tax bracket 10% higher so I have already been a winner.

Tax policy roulette.

 

[pb4uski]

Yeah, I hear you. I'm still trying to figure out the logic implicit in I-ORP as it applies to my situation. Until I see the logic I am hesitant.

Luckily for me the health insurance subsidy is in play so my not getting the I-ORP logic doesn't keep me up at night, but the OP indicates that their health insurance is covered.

 

[67walkon]

Isn't the answer that you spend already taxed money first, then tax free money and then tax deferred money? If you have enough already taxed money and tax free money to supplement SS or whatever other income, wouldn't you let the tax deferred accounts grow as long as possible?

 

[braumeister]

I-ORP recommends that I convert large sums even though I am in the 25% bracket. I can't bring myself to do anywhere close to what the calculator says, but I do some.

The way I look at it (and I'm a very long way from being smart in this area), if you have a big traditional IRA, the RMD amounts could put you into the next bracket for a long time. Taking the hit by making big conversions early might save you from that problem in later years.

 

[Animorph]

The way I look at it (and I'm a very long way from being smart in this area), if you have a big traditional IRA, the RMD amounts could put you into the next bracket for a long time. Taking the hit by making big conversions early might save you from that problem in later years.

And if you're going to take a bunch out of an IRA at 25% tax rate (for that marginal amount), you might as well pay 25% taxes now while protecting a larger after-tax value in the Roth than you had in the traditional IRA. All things being equal, the Roth still wins because you can effectively stuff more into it.

 

[pb4uski]

I found this article interesting. Making Money Last in Retirement - eXtension

particularly that the conventional withdrawal order of taxable/tax-deferred and tax-free might not apply where the taxable account has significant unrealized appreciation so withdrawals result in taxes.

 

[Alan]

The way I look at it (and I'm a very long way from being smart in this area), if you have a big traditional IRA, the RMD amounts could put you into the next bracket for a long time. Taking the hit by making big conversions early might save you from that problem in later years.

Correct. My rollover IRA (zero basis) is ~$500k, so not huge, but I-ORP would have me paying a lot of taxes for over 10 years and I find it hard to do that given how easily tax policy can change in the 13 years before I begin RMD's. If I were 70.5 next year the first RMD would be ~18k which, added to my SS, would still leave me well inside the 25% bracket as the brackets are defined today.

 

[nun]

Being single my 15% tax bracket only goes up to $35k. My annual income requirement is also about $35k as I'm frugal and have no mortgage or other debt. If I was to ER now I estimate I could generate $24k in rental income, dividends and gains and I'd take $11k of principal from my taxable accounts to bridge the gap. With standard deductions I'd be taxed on about $14k so I'd roll over about $20k from my IRA to my ROTH making my taxable income $34k and keeping me in the 15% tax bracket. This achieves a couple of things: it currently keeps my capital gains and qualified dividends tax free and I reduce the balance in my IRA making RMDs less of a tax issue. I'll continue to do this until the taxable accounts have about a year's budget left in them and then start funding all of my spending from the IRA, assuming I'm over 59.5. I would do that and defer SS until 70 so as to minimize RMDs and maximize my SS check.

 

[nun]

Correct. My rollover IRA (zero basis) is ~$500k, so not huge, but I-ORP would have me paying a lot of taxes for over 10 years and I find it hard to do that given how easily tax policy can change in the 13 years before I begin RMD's. If I were 70.5 next year the first RMD would be ~18k which, added to my SS, would still leave me well inside the 25% bracket as the brackets are defined today.

I-orp has me doing big IRA to ROTH rollovers and spending down my taxable accounts for the first 5 years. Then living mostly off the IRA until 62 and then mostly off the ROTH until 70. At 70 I start RMDs from the IRA

 

[obgyn65]

Thank you for sharing. This is a very clear article. Just saved it as a "Favorite" in my Internet Explorer.

I found this article interesting. Making Money Last in Retirement - eXtension

particularly that the conventional withdrawal order of taxable/tax-deferred and tax-free might not apply where the taxable account has significant unrealized appreciation so withdrawals result in taxes.

 

[frayne]

Thanks for all the good advice, links, etc. Playing around with a tax program the couple could actually take their SS of $22K and $18K from their traditional IRA and not have any tax liability ! The balance needed for living expenses could be taken from after tax accounts to the tune of about $5K to achieve the annual living expense of $45K.

The rub will be higher taxes due to RMDs down the road, hence the advice to convert the traditional IRA to a Roth ?

Am I on the right track and is my logic sound ?

Assuming the numbers above if money is rollover and there is a tax event does the amount rolled over add to 1040 income and if is does it would change the entire complexion of the return such as making ss taxable, etc.

Hope this all makes sense. Again thanks for the input.

 

[Finance Dave]

I know much has been written about investing and accumulation of wealth as well as safe withdrawal rates but what is the best methodology to tap your portfolio(s). Are there any good rules of thumb for guidance ?

Hypothetical Scenario

Married couple both 62, collecting social security of $22K per year.
Health insurance covered, house paid for, no debt, vehicles good for another ten years.
No major expenditures planned for the near future.
After tax portfolio approx. $300K, mix is 60/40 equities/fixed income.
Traditional IRA $700K, mix is 60/40 equities/fixed income.
Equities primarily in the form of low cost index mutual funds with a few stocks.
Fixed income, in money markets, bond index funds, CDs, and savings account.
No pension or annuities.
Annual living expenses $40-45K after taxes.

Assuming the same living expenses, what would be a good withdrawal strategy ? In addition have no desire to leave much on the table when we expire and for the sake of the exercise I fiqure we both have 25 year left before exiting to the netherworld.

Not too concerned about the rate of withdrawal but the wisdom of tapping before or after tax accoutns and in what proportions.


Appreciate any and all comments, ideas, suggestions in advance.

The "general" approach most recommend is to leave tax-deferred accounts as long as you can, although this definitely does not work well in my situation.

Part of your decision will hinge on whether you think tax rates will go up or down later in life. I think our gov't will have to raise rates in the future, so for most people I'd advise paying taxes today.

However, there is merit in the "tax diversification" philosophy, IMO, such that you make sure to have some money in both buckets. This will allow you to adapt to the tax laws in place at the time.

For our situation, we will withdraw from tax-deferred accounts up to some marginal tax-bracket breakpoint (perhaps 15%?), then take any remaining we need from taxable accounts. This is a strategy you should consider.

 

[Alan]

Assuming the numbers above if money is rollover and there is a tax event does the amount rolled over add to 1040 income and if is does it would change the entire complexion of the return such as making ss taxable, etc.

Not sure I understand the question. Even if you are paying taxes on other income in any one year, a rollover to an IRA does not cause any additional taxable income to be added to the 1040.

 

[Finance Dave]

I found this article interesting. Making Money Last in Retirement - eXtension

particularly that the conventional withdrawal order of taxable/tax-deferred and tax-free might not apply where the taxable account has significant unrealized appreciation so withdrawals result in taxes.

That is a good article, but I hate it when they leave out the fact that working while taking SS does not actually reduce the amount of SS you get...it only delays it. If you take a reduction in benefits now due to working, those benefits will be added to your payments later, either once you stop working or after FRA (Full Retirement Age).

Here is the link explaining the process:
Retirement Planner: Getting Benefits While Working

"After you reach full retirement age we recalculate your benefit amount to leave out the months when we reduced or withheld benefits due to your excess earnings. "


Another article:
Top 6 Myths About Social Security Benefits

"Any benefit reductions are only deferred, and Social Security will credit those amounts to your benefits record when you reach full retirement age."


And yet another:
How Work Impacts Social Security Benefits - US News and World Report

"Benefits are not permanently withheld. The money deducted from your Social Security payments if you earn too much isn't withheld forever. Once you reach your full retirement age, your checks are recalculated to give you credit for the reduced benefits."
​

 

[mathjak107]

The "general" approach most recommend is to leave tax-deferred accounts as long as you can, although this definitely does not work well in my situation.

Part of your decision will hinge on whether you think tax rates will go up or down later in life. I think our gov't will have to raise rates in the future, so for most people I'd advise paying taxes today.

However, there is merit in the "tax diversification" philosophy, IMO, such that you make sure to have some money in both buckets. This will allow you to adapt to the tax laws in place at the time.

For our situation, we will withdraw from tax-deferred accounts up to some marginal tax-bracket breakpoint (perhaps 15%?), then take any remaining we need from taxable accounts. This is a strategy you should consider.

Same here ,we will take up to 15% marginal rate or so. recent studies are starting to realize that reducing rmd's early on up to a point may be the better way to go.