High 401K Balance, RMD's and Withdrawal Strategies

[LawyerMarkham]

NEW LAW MAKES MAJOR CHANGES TO IRAs.
The "Setting Every Community Up for Retirement Enhancement Act of 2019" will go into effect after December 31, 2019.
Age cap repeal. The Act removes the age cap for traditional IRA contributions, which is currently 70 1/2. This change would allow older workers to stash a chunk of their earned income in a traditional IRA, just as they can currently in a Roth IRA.
RMD age increase. The House bill increases the starting age for required minimum distributions from retirement accounts to 72, from 70 1/2 currently.
Stretch IRA loss. Although the Secure Act may benefit some retirement account owners, it’s not so friendly to nonspouse heirs. The legislation erases these heirs’ ability to stretch out required minimum distributions from inherited retirement accounts over the nonspouse heirs’ own life expectancies—a move that allows more of the money to grow tax-deferred and minimizes the heirs’ income tax bill. Instead, the legislation mandates that the inherited assets be withdrawn within 10 years.

I also want to respond directly to the RIGM's post concerning High 401K Balance, RMD's and Withdrawal Strategies, but I thought it would be important for everyone to consider these IRA law changes in their future planning.

 

[SecondCor521]

The above post implies something prematurely. It will only "go into effect" if it is enacted. According to the following link, the bill has only passed the House as of now.

https://www.congress.gov/bill/116th-congress/house-bill/1994

 

[LawyerMarkham]

You are absolutely correct. I apologize. I should have said that it only passed the house. Yet, the Act has bi-partisan even among Senators. I can't find any comentators who say it won't pass. In fact, all I've seen say it will pass.
Until it does, it doesn't hurt to be aware that its out there.

 

[RunningBum]

And we are aware:

http://www.early-retirement.org/forums/f28/rmd-going-to-72-a-97142.html

 

[2177V]

People should be aware that an inherited IRA can taxed as retirement income by your children so having a very large IRA may be a future tax liability on your children...especially if your children is a high earner and has the potential of a higher retirement pay.

On the other hand, an inherited property has a "stepped up basis" tax advantage at the time of death of the surviving husband or wife. This means if the inherited property is sold by your children, there is potentially less of a future tax liability. This assumes that the property does not trigger the ridiculously high estate tax threshold of $11.4M.

I am currently reducing the money in my IRA and increasing the number of properties that I own. My additional properties provide rent income which replaces some of the income from my IRA.

Consider some estate planning to avoid letting the government getting more money from your estate than the government deserve.

 

[pb4uski]

.... Consider some estate planning to avoid letting the government getting more money from your estate than the government deserve.

WADR, for tax deferred money the government would only be getting the tax that you voluntarily avoided when you deferred that income.... why do you think that they don't deserve to ultimately collect ta on that income.

So by reducing your IRA contributions now you are paying more taxes now which means that your heirs will get less, albeit without any tax liability.

The only way your reduction of tax-deferred contributions comes out ahead is if the taxes that you pay now are less than what they would pay later... IOW, if their marginal tax rate is more than yours.

 

[SecondCor521]

You are absolutely correct. I apologize. I should have said that it only passed the house. Yet, the Act has bi-partisan even among Senators. I can't find any comentators who say it won't pass. In fact, all I've seen say it will pass.
Until it does, it doesn't hurt to be aware that its out there.

To allude to an old fable, maybe the horse will talk.

 

[jollystomper]

Not being critical, but it seems a lot of people here spend a lot of effort in trying to know the unknowable. Things like when to take SS, how much Roth conversion, minimizing tax implications of withdrawals. It seems to me the likely answers depend on individual circumstances, but the definitive answer is still questionable.

One reason I spend the effort is not so much trying to know the unknowable, but to what degree the unknowable options really make a difference that I feel is worth it.

For example, suppose my scenarios for analyzing whether or not to do 401K to Roth IRA conversions shows that the difference may be $100K savings over a lifetime based on various assumptions. My questions becomes, is it worth it? Sure, some feel that every nickel of taxes they can avoid is worth it... but if the difference is not going to impact your retirement lifestyle, or it means means you leave your heirs 1.5 million instead of 1.6 million, why worry about the topic anymore, just say "what happens, happens" and do not worry about doing the conversions.

So for me, it is less about finding the definitive answer, and more about seeing if even matters to find a definitive answer.

 

[Hermit]

NEW LAW MAKES MAJOR CHANGES TO IRAs.
The "Setting Every Community Up for Retirement Enhancement Act of 2019" will go into effect after December 31, 2019.
Age cap repeal. The Act removes the age cap for traditional IRA contributions, which is currently 70 1/2. This change would allow older workers to stash a chunk of their earned income in a traditional IRA, just as they can currently in a Roth IRA.
RMD age increase. The House bill increases the starting age for required minimum distributions from retirement accounts to 72, from 70 1/2 currently.
Stretch IRA loss. Although the Secure Act may benefit some retirement account owners, it’s not so friendly to nonspouse heirs. The legislation erases these heirs’ ability to stretch out required minimum distributions from inherited retirement accounts over the nonspouse heirs’ own life expectancies—a move that allows more of the money to grow tax-deferred and minimizes the heirs’ income tax bill. Instead, the legislation mandates that the inherited assets be withdrawn within 10 years.

I also want to respond directly to the RIGM's post concerning High 401K Balance, RMD's and Withdrawal Strategies, but I thought it would be important for everyone to consider these IRA law changes in their future planning.

The SECURE act will screw up my planning totally. All of my retirement stash was moved from a 401k to an IRA a couple of years ago in preparation for doing QCDs starting in 2020. I don't have anything outside of the IRA. My income, including IRA withdrawal, is at the top of the 22% bracket and just under IRMAA. In other words, converting to Roth would trigger major additional taxes. A donation to the charity using a withdrawal from the IRA will also trigger those additional IRMAA taxes but would keep the charity's plans on schedule while adding thousands of dollars to my taxes. So far as wealth transfer, it looks like Uncle Sam has just made himself a much larger bennificiary to my estate.

 

[audreyh1]

The SECURE act will screw up my planning totally. All of my retirement stash was moved from a 401k to an IRA a couple of years ago in preparation for doing QCDs starting in 2020. I don't have anything outside of the IRA. My income, including IRA withdrawal, is at the top of the 22% bracket and just under IRMAA. In other words, converting to Roth would trigger major additional taxes. A donation to the charity using a withdrawal from the IRA will also trigger those additional IRMAA taxes but would keep the charity's plans on schedule while adding thousands of dollars to my taxes. So far as wealth transfer, it looks like Uncle Sam has just made himself a much larger bennificiary to my estate.

I do not believe a QCD from the IRA will trigger additional IRMAA payments.

Is the proposed legislation changing how QCDs are taxed?

Or is it simply that the timeline is pushed back a year or two?

 

[GTFan]

For someone thinking they will use the stepped up basis at death, especially if they wouldn’t have high taxes in their 60s, your plan likely would work better (bigger balance to heirs at the end). Since I have no close family heirs, I have very little concern about stepped up basis. Upon death, both my taxable and tax deferred remaining assets can go to charity and so both will receive favorable tax treatment. Remaining Roth assets can go to distant relatives.

In that case the simple answer is to QCD all of your RMDs, assuming you don't need the money.

 

[2177V]

Life is hard, then you die

WADR, for tax deferred money the government would only be getting the tax that you voluntarily avoided when you deferred that income.... why do you think that they don't deserve to ultimately collect ta on that income.

So by reducing your IRA contributions now you are paying more taxes now which means that your heirs will get less, albeit without any tax liability.

The only way your reduction of tax-deferred contributions comes out ahead is if the taxes that you pay now are less than what they would pay later... IOW, if their marginal tax rate is more than yours.

IRA contributions do not apply to me since I am retired and I am no longer contributing. My point: Stepped up basis for inherited property is an option to avoid a large inherited IRA for your children. Inheritance does not appear to apply to RIGM so this issue is academic to some people.

However, for people who do reach their financial goals, people should consider what is more important in your life. In my case, family is more important than money. This is why I purchased a house with an in-ground swimming pool and spa. Expensive yes. But my children and grand children now visit me more often.

Another example: I will be buying a vacation condo in Hawaii in the near future so that my children and grand children can enjoy Hawaii without breaking their budget. I prefer doing this...than having a large number in my IRA account. When they inherit this vacation condo, the stepped up basis on inherited property will help them tax wise.

I do not recommend being obsessed with getting a larger number in your IRA account, taxible mutual funds , bank accounts etc when there are more important things in life that you should enjoy. The worst thing that can happen is that you accummulate wealth in your accounts and then you die unexpectly without enjoying the money that you earned.

 

[Hermit]

I do not believe a QCD from the IRA will trigger additional IRMAA payments.

Is the proposed legislation changing how QCDs are taxed?

Or is it simply that the timeline is pushed back a year or two?

Yes. My problem would be taking cash from the IRA to fund the promised charitable donation which would trigger IRMAA. With RMDs being pushed back, it is my guess that QCDs may be pushed back too. QCDs are not directly tied to RMDs so this may not be the case. If QCDs are not specifically mentioned in the law, I should be able to do QCDs at 70.5 as previously planned without hiccups. That would be nice.

 

[yclipse]

I have a different view

I have run some numbers, and I have concluded that a married couple who has a post-retirement annual income of $100,000 in 2019 will find that their total tax burden (Federal taxes paid divided by income) is roughly 9%, and that is without any consideration of the portion of social security benefits that are tax-free or the favorable rates applied to dividends and capital gains. If you double the figure to $200,000, the tax burden is about 15%. Both rates are entirely unobjectionable, in my view. At these levels, I believe that there is not much to be gained by trying to adjust between taxable and tax-deferred accounts when trying to prepare for life after age 70. The caveat is that we cannot guarantee that the current tax rates will not be increased in the next 5-10 years.

 

[googily]

I have run some numbers, and I have concluded that a married couple who has a post-retirement annual income of $100,000 in 2019 will find that their total tax burden (Federal taxes paid divided by income) is roughly 9%, and that is without any consideration of the portion of social security benefits that are tax-free or the favorable rates applied to dividends and capital gains. If you double the figure to $200,000, the tax burden is about 15%. Both rates are entirely unobjectionable, in my view. At these levels, I believe that there is not much to be gained by trying to adjust between taxable and tax-deferred accounts when trying to prepare for life after age 70. The caveat is that we cannot guarantee that the current tax rates will not be increased in the next 5-10 years.

Though you can't guarantee you'll always be a couple, in which case getting a bunch of money into Roth will be a huge gift to the survivor, who will be filing as single. Run those same numbers for a widow and see what it looks like.

 

[target2019]

Though you can't guarantee you'll always be a couple, in which case getting a bunch of money into Roth will be a huge gift to the survivor, who will be filing as single. Run those same numbers for a widow and see what it looks like.

It won't seem so great, that's certain. After death, the survivor goes to single tax rate in many cases.

But I still don't trust politicians to leave the Roth untapped for public coffers.

 

[Spock]

I have run some numbers, and I have concluded that a married couple who has a post-retirement annual income of $100,000 in 2019 will find that their total tax burden (Federal taxes paid divided by income) is roughly 9%, and that is without any consideration of the portion of social security benefits that are tax-free or the favorable rates applied to dividends and capital gains. If you double the figure to $200,000, the tax burden is about 15%. Both rates are entirely unobjectionable, in my view. At these levels, I believe that there is not much to be gained by trying to adjust between taxable and tax-deferred accounts when trying to prepare for life after age 70. The caveat is that we cannot guarantee that the current tax rates will not be increased in the next 5-10 years.

With bond rates are crashing back to 2%, the tax rate drawfs the single year return, so managing the taxes is almost more important than choosing the bond (ignoring defaults).

 

[pb4uski]

... But I still don't trust politicians to leave the Roth untapped for public coffers.

Perhaps, but any changes to Roths we would get advanced notice and if the changes were onerous enough we could just take it all out tax-free and plunk it in munis and make corresponding changes in tax-deferred accounts to rebalance AA.

The only way they could screw us is to somehow tax Roth withdrawals retroactively to a legislative change... and they rarely make bad changes retroactive and it would be subject to court challenge.

Overall very remote risk IMO.

 

[On My Own]

RIGM
Thanks for the thorough analysis of this perplexing optimization.
While this is a dynamic issue subject to the whims of the latest politicians I agree that making the best plan we can with current information and adjusting as necessary going forward is the best hope we have to minimimize the tax bite.

Any chance you could share your spreadsheet template for those of us spreadsheet junkies who trust our own analysis more than the "cannned" versions?

 

[RIGM]

I have run some numbers, and I have concluded that a married couple who has a post-retirement annual income of $100,000 in 2019 will find that their total tax burden (Federal taxes paid divided by income) is roughly 9%, and that is without any consideration of the portion of social security benefits that are tax-free or the favorable rates applied to dividends and capital gains. If you double the figure to $200,000, the tax burden is about 15%. Both rates are entirely unobjectionable, in my view. At these levels, I believe that there is not much to be gained by trying to adjust between taxable and tax-deferred accounts when trying to prepare for life after age 70. The caveat is that we cannot guarantee that the current tax rates will not be increased in the next 5-10 years.

I agree. The benefit of early Roth conversions only comes into play when the looming RMD's are large: beyond, say, $300,000- $400,000 per year. By paying taxes in one's 60's via Roth conversions, the benefit could be substantial. Yet it is beneficial only to a small group of people, those with multi-million dollar pre-tax savings. With 401K's now a key savings vehicle, this might affect an increasing number of early retirees in the future.

 

[RIGM]

RIGM Any chance you could share your spreadsheet template for those of us spreadsheet junkies who trust our own analysis more than the "cannned" versions?

I'm back on this thread after a long absence. My first thought is that getting to know someone else's spreadsheet can be more difficult than just doing your own: tons of assumptions, complex formulas, etc. As a spreadsheet junkie, you probably know this. Yet, let me take a look at mine and see if it is worth posting. I'd prefer to just put it in your hands alone and see if you think it is not so inscrutable as to be useful to a larger audience. I don't know how to do that.

Beyond a complex spreadsheet, I'd just look at my anticipated RMD's first and see if I even have a problem. Most people won't. Yet if I do, I can try to figure out how much Roth conversion to do to level out the taxable income, bringing up the tax in my 60's and thus reducing my tax in my 70's and 80's.

Let me know what you think - I'm willing to share, but it might be more trouble on both ends than it is worth.

 

[RIGM]

CD

In that case the simple answer is to QCD all of your RMDs, assuming you don't need the money.

If I have life/death expenses covered beyond all expectations, QCD's are an option. I think I do, but QCD's do increase my risk somewhat if I end up having really high end of life costs, as my net worth would have been eroded somewhat by the giving.

Still, good thought.

 

[RunningBum]

I agree. The benefit of early Roth conversions only comes into play when the looming RMD's are large: beyond, say, $300,000- $400,000 per year. By paying taxes in one's 60's via Roth conversions, the benefit could be substantial. Yet it is beneficial only to a small group of people, those with multi-million dollar pre-tax savings. With 401K's now a key savings vehicle, this might affect an increasing number of early retirees in the future.

Small gains add up. If you're only willing to consider substantial benefits, you might not do anything. Find enough small things, they might make a noticeable difference. Besides, as someone noted earlier, if you are married, when one of you goes the other will face a higher tax bracket, which makes earlier Roth conversations more favorable.

 

[gwraigty]

I agree. The benefit of early Roth conversions only comes into play when the looming RMD's are large: beyond, say, $300,000- $400,000 per year. By paying taxes in one's 60's via Roth conversions, the benefit could be substantial. Yet it is beneficial only to a small group of people, those with multi-million dollar pre-tax savings. With 401K's now a key savings vehicle, this might affect an increasing number of early retirees in the future.

I disagree with the bolded (mine) above. For example, we're currently in the 22% federal tax bracket for MFJ. My current projections show that when my husband retires, we'll drop to the 12% tax bracket. When we start SS, 85% will be taxable. RMDs (on a bit less than a multi-million $ pre-tax balance) will range from around $40K to $80K through age 90, increasing each year. Our tax bracket will go back to 22% through our late 70s, then go up to 24%.

If I tweak it so that more of our investment income is more tax-advantaged or tax-exempt, rather than taxable at ordinary income rates, the benefit would become even greater. I could drop us into the 0% bracket.

I suspect others feel the same way, due to the many questions on this topic.

 

[gwraigty]

Small gains add up. If you're only willing to consider substantial benefits, you might not do anything. Find enough small things, they might make a noticeable difference. Besides, as someone noted earlier, if you are married, when one of you goes the other will face a higher tax bracket, which makes earlier Roth conversations more favorable.

+1 to all the above.

If I understand it right, let's say that an RMD amount (say $45K) will land squarely in the 22% bracket. That's $9,900 to the federal tax man. Converting to a Roth in the 12% bracket (assume the 10% bracket is full) is $5,400, a savings of $4,500!