High 401K Balance, RMD's and Withdrawal Strategies

[pb4uski]

.... I end up in a much higher tax bracket if I withdraw sufficient assets from only my tax deferred account for living expenses in my 60’s (and/or for living and to get the balance down to reduce RMDs later). ....

How does that work?

In our case, once SS starts our income is interest, dividends, pension, 85% of SS and RMDs... and drawing down tax-deferred accounts now by withdrawals or Roth conversions reduces RMDs. That lower income results in less money in the higher tax brackets.

My pension and our SS are fixed irrespective of how I withdraw, there is a minor second order effect on interest and dividends and a significant impact on RMDs.

If I lived off taxable accounts in my 60s my dividends would be lower but RMDs would be higher... and by more... so my income later would be higher and my income would be deeper into that bracket.

Also, dividends from my growing but left alone taxable portfolio are taxed and 0% now the way we manage our income and 15% once SS and RMDs start.... rather than at 12% now or 22% or more later.

It is true that we have heirs to consider and the surviving spouse and/or our kids will get the benefit of the stepped up basis.

 

[Offgrid Organic Farmer]

In 2016, my wife inherited a 401{k} and the company it was with requires that it all had to be withdrawn within 5 years. So we looked at the tax brackets, trying to figure out how we could make five withdrawals and to get each of them to be lower tax brackets.

We could make each annual withdrawal within any of the tax brackets [10%, 15%, 25%, 28%, 33%, 35% or 39.6%]

But doing the math, the majority of the fund was going to be taxed at 39.6% regardless of how we broke it up.

We could have made four withdrawals with 35% taxes, but that last year's withdrawal was still going to be at 39.6% and that was going to be the bulk of the fund.

 

[RunningBum]

My plan allows me to convert more to Roth. From a specific dollar amount drawn from the tax deferred account each year, I won’t be using any of that for living expenses. That is the difference in my plan and what you suggest: mine results in a bigger balance in the Roth account at end of life, and your suggestion results in a bigger balance in the taxable account (I’m not claiming one is better here). I do like that my plan converts more money to a tax free status under the current rates, just in case our tax rates rise significantly in the future.

In my opinion the difference in approaches would be how big the unrealized capital gains are in taxable. You should definitely sell off the losers in taxable. I think you sell the small gainers too, and use that for living expenses while converting more to the Roth. If you have big* gainers in taxable, it's probably better to leave those alone if you expect to leave something to heirs, and let them get a free stepped up basis.

*I haven't done any math to determine what % gain makes it "big".

 

[RunningBum]

In 2016, my wife inherited a 401{k} and the company it was with requires that it all had to be withdrawn within 5 years. So we looked at the tax brackets, trying to figure out how we could make five withdrawals and to get each of them to be lower tax brackets.

We could make each annual withdrawal within any of the tax brackets [10%, 15%, 25%, 28%, 33%, 35% or 39.6%]

But doing the math, the majority of the fund was going to be taxed at 39.6% regardless of how we broke it up.

We could have made four withdrawals with 35% taxes, but that last year's withdrawal was still going to be at 39.6% and that was going to be the bulk of the fund.

But you still spread it over the 5 years, right? Because then you get 5 years where some of it is taxed at 10-35%. Somewhere in the neighborhood of $2M would be taxed in those lower rates, instead of $400,000. From a very rough calc that looks like a savings of over $100,000 in taxes. Just how big was this 401K anyway?

 

[Offgrid Organic Farmer]

But you still spread it over the 5 years, right? Because then you get 5 years where some of it is taxed at 10-35%. Somewhere in the neighborhood of $2M would be taxed in those lower rates, instead of $400,000. From a very rough calc that looks like a savings of over $100,000 in taxes.

The plan was, we were going to take four annual withdrawals that would have been taxed at 35% each, and then on the fifth year the last withdrawal would have been taxed at 39.6%

But, ... she found that she had the option to roll-over some of it into an 'inherited IRA' so she did that with $250k.

Then we came across some commercial real estate that my wife wanted to get, so she withdrew all the rest [paid 39.6% taxes] and bought the real estate.

 

[RunningBum]

The plan was, we were going to take four annual withdrawals that would have been taxed at 35% each, and then on the fifth year the last withdrawal would have been taxed at 39.6%

But, ... she found that she had the option to roll-over some of it into an 'inherited IRA' so she did that with $250k.

Then we came across some commercial real estate that my wife wanted to get, so she withdrew all the rest [paid 30.6% taxes] and bought the real estate.

Doesn't make sense to me, but whatever. Maybe that's a typo and you mean 39.6% to buy the commercial real estate.

I have no idea why you said in a previous post

We could make each annual withdrawal within any of the tax brackets [10%, 15%, 25%, 28%, 33%, 35% or 39.6%]

when apparently you could only withdraw at 35% or 39.6%, and none in those lower brackets that you said you could do.

 

[Offgrid Organic Farmer]

Ooops. I meant thirty-nine point six percent. Thank you for catching that.

 

[Offgrid Organic Farmer]

... when apparently you could only withdraw at 35% or 39.6%, and none in those lower brackets that you said you could do.

We could have withdrawn small amounts and been taxed and lower rates, But that would have left a really huge amount for the fifth year. The overall average of taxes was going to be high.

 

[LOL!]

I believe there are no 401(k) RMDs if you are still working past age 70.5.

So even a one week / year gig of self-employment and a solo 401(k) gets you there, right? Of course, your heirs get killed on taxes.

 

[RunningBum]

I give up.

 

[kaneohe]

I believe there are no 401(k) RMDs if you are still working past age 70.5.

So even a one week / year gig of self-employment and a solo 401(k) gets you there, right? Of course, your heirs get killed on taxes.

Looks like the first statement if true if it is a company (not yours) 401K but not if it is yours (solo) so 2nd statement is not true.

https://www.sensefinancial.com/solo-401k-rmd-three-quirky-rules-know/

 

[MissMolly]

The plan was, we were going to take four annual withdrawals that would have been taxed at 35% each, and then on the fifth year the last withdrawal would have been taxed at 39.6%

But, ... she found that she had the option to roll-over some of it into an 'inherited IRA' so she did that with $250k.

Then we came across some commercial real estate that my wife wanted to get, so she withdrew all the rest [paid 39.6% taxes] and bought the real estate.

So how did she roll money into an inherited IRA? To my understanding, that is not possible, other than when you inherit a spousal IRA and make it your own. Is that what she did?

 

[Offgrid Organic Farmer]

So how did she roll money into an inherited IRA? To my understanding, that is not possible, other than when you inherit a spousal IRA and make it your own. Is that what she did?

They let her roll-over a portion of her inherited 401[k] into an inherited IRA.

 

[kaneohe]

They let her roll-over a portion of her inherited 401[k] into an inherited IRA.

both inherited from same person?

 

[Offgrid Organic Farmer]

both inherited from same person?

Yes. When my sister-in-law died, she had her sister [my wife] listed as the beneficiary on her 401[k] account, and as the executor of her will, and as the sole heir of her estate.

My sister-in-law as an executive with a publishing company.

My wife got the 401[k], we did the math to try and figure out how to access the money paying the least amount of taxes. But in the end it was futile.

 

[jollystomper]

Interesting. I have exactly the same % in tax-deferred as the OP. We intend to follow a similar strategy in spending down taxable (primarily cash) money before SS hits. My pension though pushes my marginal tax bracket high enough (22%) so that my analysis shows that Roth conversions now will put me into the 24% tax bracket, and I will remain in that bracket when SS and RMDs after Roth hit. However, not knowing what tax rates will be after 2028, and of course no guarantee on how long DW and I will both be around and avoid single person tax rates, I am going to start doing some Roth conversions this year. Overall there are much worse problems to have.

 

[orplanner]

So I just used the basic I-ORP (I haven't explored the advanced version yet). I need to look at this a bit more, but my initial conclusion is that I'm not a fan. Here's why:

- Biggest reason is that I-ORP completely excludes any Roth conversions. This is the big question I was trying to answer. As a justification, they state that a referenced study says that conversions "offer little economic advantage," but the study itself states conversions reduce tax by 19% and increase disposable income by 1%. How is that not advantageous? Maybe for the average person with the average Tax Deferred account, the conversion doesn't matter. Then again maybe it does, even for them, with lower tax rates in effect now. Certainly with 63% of my assets in Tax Deferred status, it has to be a matter considered in my planning.
- It plans for a life expectancy of 92. Joint life tables show a considerable probability that one or the other spouse will live longer than that. I just looked at a joint life probability table: for a "white collar" man and woman, both 60, there is a 53% probability that at least one will be alive at 93. It seems age upon death should be a configurable value in I-ORP since we all have different genes.
- It assumes you sell your house at age 80. Huh? The age thing and the configurable thing again.
- It assumes 2% inflation. That is what I used (and even then we both could be wrong - no way to do any sensitivity analysis in I-ORP on that).
- It assumes a 4% increase in spending in retirement. I have not read the referenced study, but there is other research out there that indicates spending declines significantly over time in retirement. I assumed in my model that spending would be constant, adjusted for inflation.
- It assumes a 7% equity rate of return and 3.5% rate of return on bonds. I believe that in this market, that is too high. I used a blended rate of return of 2% above inflation, both because the market is high (CAPE index) and to be conservative.

I will look at the advanced version of I-ORP, but I'm initially not impressed.

Essential ORP, which you are evaluating here, is intended for novice users. All of the default values you cite are conventional wisdom.

Extended ORP is for users whose own wisdom is preferred to conventional wisdom. Extended ORP allows the experienced user to set any one or all of 108 different parameters, including those cited above..

 

[orplanner]

carpe diem

, ​

quam minimum credula postero
Marc

For those of us who slept through high school Latin:

In Horace, the phrase can be translated as "Seize the day, put very little trust in tomorrow (the future)".​

​

That pretty much sums up the field of retirement planning.​

 

[RIGM]

How does that work?

Please see attached pdf; a post would have been too long. While not my numbers, it discusses a hypothetical couple drawing from the tax deferred account first and using that for living expenses and paying taxes versus drawing from the taxable account first and separately doing Roth conversions from the tax deferred account. There are pros and cons to each, but the latter plan has, I think, some distinct advantages (which may or may not be important or valuable to individuals at differing income levels).

As an aside, I found this issue to be nearly inscrutable. The spending sequencing options available are numerous. There are some clearly wrong ways to sequence the spending, but I found that the differences were not so great among many other sequencing options. As general guidance, it seems the best plan is to try to level load the tax rate throughout retirement.

To the point of level loading the tax rate, I've also included two charts. One shows my average tax rate under the sequencing plan I intend to follow, and the second shows my average tax rate if I do no spending from the tax deferred account in my 60's (no Roth conversions or draws for living expenses - this is one of those "clearly wrong" plans).

 

[H2ODude]

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. Why? because longevity is unknown (but admittedly one can adjust estimates based on past health and family), tax rates can change, etc. And of course there's market performance and inflation. I used to think I was pretty financially savvy but have lost interest planning these decisions out; I guess one reason being that a ~3% WR for us generates more income than we need or care to spend. Yeah, there'll be a bunch left. I do care about steering it to as good an end result as is likely, but have decided to a)switch to full SS at 70 because we're both pretty healthy and b) now in late sixties have and will continue to Roth convert about what the calculators say our MWD would be if we were 70-1/2 this year. So that levels out the taxable income regarding IRA withdrawals, and when our SS jumps from~$18k to ~$40k we'll just plan that a bunch will go to taxes for the torpedo.

I don't think slicing and dicing all the alternatives is likely to reveal a substantially reliable improvement for us. Years ago I plugged through that I-orp and it had me converting all our tiRA (about 1.6mm) to Roth and that made no sense to me. Meanwhile tax rates have been lowered so had that been known how would that have affected the model? I spent my career trying to predict water demands and source sufficiency (which actually bears a lot of similarities to retirement financial planning) and I guess I've been infected with a strong case of the "eh, who knows?" Add to that the fact I retired in 2011 and the markets have skewed our income sustainability WAY up in that time, and I just don't seem to have the interest in predictions since the past have been way conservative. As they say, YMMV, and perhaps all these analytics will result in some great benefits for many. Meanwhile we'll just spend all we care to and likely leave a bunch to charity and the kids, and yeah we might have paid a tad more to the tax man if we'd modeled it all better.

 

[RIGM]

I completely agree that there are a lot of unknowns, and those can change plans massively. Still, most of us got here through planned actions in the past, and uncertainty to me isn’t a reason this should be not be planned going forward. I wasn’t going to spend a lot of time on this decision, but then realized differences in plans would be hundreds of thousands of dollars. That was worth a couple of days of my time.

 

[Hermit]

One other thing to look at is IRMAA. Even with indexing starting next year, I think we will be just over the IRMAA cliff when we start Medicare in 2022/2023. Although I aim to stay right below the top of the 22% bracket (income for living and any ROTH conversions), I am thinking I might have to move up to 24% bracket in alternating years just to halve the impact of IRMAA; I think it will be around $270 per month for the two of us if we go over the cliff.

Marc

If you do not include the effects of possible IRMAA fees (taxes) your calculations post age 65 may be way off. I have not seen any discussion on this part of the equation except the above post. 28% tax bracket is IRMAA territory. This is especially painfull if one spouse dies.

 

[target2019]

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. Why? because longevity is unknown (but admittedly one can adjust estimates based on past health and family), tax rates can change, etc. And of course there's market performance and inflation.

I bolded one part of your post for explanation. Those things are knowable, IMO, but only at the end of each tax year, or in the month(s) leading up to a decision. Take Roth Conversion, for example.

Something like i-ORP goes way beyond "what I need to know this year." 30-year projection is ok for overall understanding, but there is just one decision to make. So I appreciate all the reports and columns of i-ORP, but my own choice(s) need to be driven by something home-grown. That's why I value this thread. Some actually shared how there decision was made.

 

[H2ODude]

Maybe my post was more generic than specific to the exact topic of the thread. You're right that annual decisions can be fact based, I'm more saying that the tendency to analyze over long futures has to rely on assumptions of a lot of factors.

 

[orplanner]

Something like i-ORP goes way beyond "what I need to know this year." 30-year projection is ok for overall understanding, but there is just one decision to make. So I appreciate all the reports and columns of i-ORP, but my own choice(s) need to be driven by something home-grown. That's why I value this thread. Some actually shared how there decision was made.

This Journal of Financial Planning paper recognizes that retirement planning is done in the context of a 30 year plan but executed one year at a time:


[FONT=&quot]A Three Step Procedure for Sustainable Retirement Savings Withdrawals[/FONT]

[FONT=&quot]Anecdotal evidence indicates that some ORP users run ORP annually to determine their savings withdrawals for the current year and their disposable income for the year's spending budget. This study demonstrates that from a historical perspective this is a safe and efficient policy.[/FONT]
[FONT=&quot]Journal of Financial Planning 30 (8): Pages 45-55.
[/FONT]
[FONT=&quot]https://www.onefpa.org/journal/Page...stainable-Retirement-Savings-Withdrawals.aspx
[/FONT]
​