RMDs are they really something to worry about?

[pb4uski]

.... P.S. I guess the idea is that the Roth is the only vehicle that offers TAX-FREE GRWTH and over an extended period the taxes saved on those funds probably outweighs the early tax hit of conversions.

Roth Conversions allow you to reduce your taxable account and shelter the growth for your lifespans + 10 years. Cutting that annual tax drag becomes a big deal over time. As you model more cases, you will find that the models consistently want you to shelter as many $ as possible, for as long as possible, in tax preferenced accounts.

Not true, but a popular misconception. Let's say that you have $9,500 of income and are in the 22% tax bracket. You can pay $2,090 of tax and put $7,410 in Roth. Let's assume that with investment returns that the Roth doubles in 10 years, then you have $14,820 to spend. Alternatively, you decide to invest the $9,500 in a tax-deferred account and it doubles to $19,000. Once you withdraw the $19,000 and pay 22% tax of $4,180 you have $14,820 to spend.

The tax free growth is only beneficial if the tax rate when withdrawn is higher than the tax rate with the income is deferred... the inverse of the tax benefit of tax deferred funds being where the tax rate when the income is deferred is higher than the tax rate when withdrawn.

With either tax-deferred or tax-free there is only a benefit or detriment if the tax rate changes between contribution and withdrawal.

 

[Exchme]

Not true, but a popular misconception. Let's say that you have $9,500 of income and are in the 22% tax bracket. You can pay $2,090 of tax and put $7,410 in Roth. Let's assume that with investment returns that the Roth doubles in 10 years, then you have $14,820 to spend. Alternatively, you decide to invest the $9,500 in a tax-deferred account and it doubles to $19,000. Once you withdraw the $19,000 and pay 22% tax of $4,180 you have $14,820 to spend.

The tax free growth is only beneficial if the tax rate when withdrawn is higher than the tax rate with the income is deferred... the inverse of the tax benefit of tax deferred funds being where the tax rate when the income is deferred is higher than the tax rate when withdrawn.

With either tax-deferred or tax-free there is only a benefit or detriment if the tax rate changes between contribution and withdrawal.

I walked away from the computer and realized I should have said "all else being equal" you want to shelter as much as possible for as long as possible. Came back to edit my post and you beat me to it.

 

[TheWizard]

My point had little to do with tax arbitrage advantages and everything to do with beating RMDs to the punch and avoiding a much larger tax burden later.

So if you retire at 60 and start pulling out at least 4% of your Deferred Compensation accounts each year then, if you have more income than needed, you might as well put that into your Roth IRA instead of your taxable account.
Once you get to age 73 or 75, depending, you MUST put withdrawals from Deferred Compensation into a taxable account until you've satisfied your RMD for the year.

Not withdrawing from tax-deferred for a decade or more in early retirement can be a mistake from a taxation point of view...

 

[Koolau]

That's a feature, not a bug.

Retirement accounts (Traditional IRA, 401k, etc.) have always been called "tax deferred" for a reason. Uncle Sam is just getting back what you didn't pay in tax for all those years. RMDs are the price we pay for being able to deduct contributions from regular income and not pay capital gains taxes for all those years.

The alternative now is to contribute to Roth IRAs instead or simply invest in taxable accounts and "pay as you go." However, it wouldn't surprise me in the future if some "excess" accumulation excise tax "feature" might be added to Roth IRAs in the future (i.e. if the account gets over $X million in a given year the guvmint will tax Y% of it).

Heh, heh, bite your tongue. I have it on good authority that at least a couple of those extra 87,000 IRS empl*yees monitor this site. SO, mum's the w*rd. Ixne on the axte talk.

 

[LateToFIRE]

...With either tax-deferred or tax-free there is only a benefit or detriment if the tax rate changes between contribution and withdrawal.

I walked away from the computer and realized I should have said "all else being equal" you want to shelter as much as possible for as long as possible. Came back to edit my post and you beat me to it.

Thanks both for the clarifications!

So, seems I've been doing the right thing by loading the dollar max into tax-deferred accounts (i.e. 401K) past 30 years, given I have generally been in or next to highest tax bracket in most years and have lived in a ridiculously high-tax locality (~50% marginal tax ain't no fiction). My marginal tax-bracket will undoubtedly be somewhat lower in retirement. So, from here, its all about sheltering more of the funds I already kinda sheltered before the chickens come home to roost

 

[Koolau]

Thanks both for the clarifications!

So, seems I've been doing the right thing by loading the dollar max into tax-deferred accounts (i.e. 401K) past 30 years, given I have generally been in or next to highest tax bracket in most years and have lived in a ridiculously high-tax locality (~50% marginal tax ain't no fiction). My marginal tax-bracket will undoubtedly be somewhat lower in retirement. So, from here, its all about sheltering more of the funds I already kinda sheltered before the chickens come home to roost

Heh, heh, you could also move to a lower tax state. I did that - without realizing it. So much of my income is shielded from state taxes and RE taxes are a pittance. Helps make up for $8 milk and $5 gas. YMMV

 

[LateToFIRE]

My point had little to do with tax arbitrage advantages and everything to do with beating RMDs to the punch and avoiding a much larger tax burden later.

So if you retire at 60 and start pulling out at least 4% of your Deferred Compensation accounts each year then, if you have more income than needed, you might as well put that into your Roth IRA instead of your taxable account.
Once you get to age 73 or 75, depending, you MUST put withdrawals from Deferred Compensation into a taxable account until you've satisfied your RMD for the year.

Not withdrawing from tax-deferred for a decade or more in early retirement can be a mistake from a taxation point of view...

Ahhhh, thanks, did not realize the RMD worked that way.

 

[Montecfo]

Well, since tIRA and 401(k) accounts are basically DEFERRED COMPENSATION, you should be withdrawing from those accounts starting the year you retire, either for living expenses or Roth conversions.



Otherwise, you're setting up for the dreaded Tax Torpedo.



Once you get money into a Roth or taxable account you're in good shape wealth-wise, since withdrawals from a Roth are never taxed and money in a taxable account gets stepped up basis...

Tax Torpedo??

I really thought we had settled this Wizard Man!

 

[Koolau]

Tax Torpedo??

I really thought we had settled this Wizard Man!

Perhaps a retired submariner?

 

[jldavid47]

Frankly, if you are in a situation where an RMD is going to push you into the "tax hump" or induce IRMAA and you are over 70.5, then using QCDs to reduce the impact is probably the best course.

 

[mpeirce]

+1 I don't think that they would necessarily tax excess withdrawals. More likley that they would require any excess over $x million to be withdrawn within a certain period to limit the amount that can generate tax-free returns.

I'm kinda surprised they haven't done this yet. There are some notable ROTHs out there.

For example, Peter Thiel put $1,700 into his ROTH, then used it to buy shares of PayPal at $0.001 per share. As of 2019 its supposedly worth $5,000,000,000 after rolling his profits into various startups.

Then there is Ted Weschler. He started funding his ROTH in 1984 and investing it all in Berkshire Hathaway. Last year it was reportedly worth $264,000,000.

No RMDs for them!

 

[Car-Guy]

I'm kinda surprised they haven't done this yet. There are some notable ROTHs out there.

For example, Peter Thiel put $1,700 into his ROTH, then used it to buy shares of PayPal at $0.001 per share. As of 2019 its supposedly worth $5,000,000,000 after rolling his profits into various startups.

Then there is Ted Weschler. He started funding his ROTH in 1984 and investing it all in Berkshire Hathaway. Last year it was reportedly worth $264,000,000.

No RMDs for them!

Of course the other side of that coin is "also" all the money the government has lost in bad investments made in tIRA's and 401k's. I'm surprised they have not done something about that too.

Example, you have 1m in a tIRA and/or 401k when you are 65. You buy and sell stocks for the next 8 years in those tax deferred accounts and end up losing half the money. So when RMD's start you only have 500k to pull from and pay taxes on. (That will show them .) Of course I don't think many folks would do that on purpose but I'm sure it does happen a lot.

 

[TheWizard]

Tax Torpedo??

I really thought we had settled this Wizard Man!

No.
The previous tax torpedo discussion was really about SS tax humps.

This one is about excess ordinary income due to RMDs, taxed at your marginal rate.
Two different torpedoes...

 

[mpeirce]

Of course the other side of that coin is "also" all the money the government has lost in bad investments made in tIRA's and 401k's. I'm surprised they have not done something about that too.

It's a lot less interesting story.

Imagine Peter Thiel's dumber brother, He puts $1,700 into his ROTH and invested it into, say Worldcom, just as it went into bankruptcy. He'd have lost $1,700.

Yawn

 

[Car-Guy]

It's a lot less interesting story.

Imagine Peter Thiel's dumber brother, He puts $1,700 into his ROTH and invested it into, say Worldcom, just as it went into bankruptcy. He'd have lost $1,700.

Yawn

True, but, but, but, there are very, very few Peter Thiel's out there and "ton's" of dumber brothers.

 

[Texas Proud]

Market variations hit all your accounts, minimizing taxes is on top of that, sort of the same as if you earned money. My Roth plan is projected to save hundreds of thousands, that would have taken me years of extra work to save that much. To me, that seems worthwhile to invest some hours in making a model.

The value of Roth Conversions depends on your tax bracket. If you will never be out of the 12% bracket, there won't be much value. But if you can shift income across one of the big "jumps" in tax rate, say from 22% to 12% or 32% to 24%, that is significant.

I will 100% agree... that is some big time tax savings... I doubt that is the norm in savings...


I did a quick back of the envelope calculation and I just do not have that much tax savings.. I will be doing ROTH conversions starting next year as I think there are other benefits to doing so than tax savings...

 

[Koolau]

Frankly, if you are in a situation where an RMD is going to push you into the "tax hump" or induce IRMAA and you are over 70.5, then using QCDs to reduce the impact is probably the best course.

I agree, but if you have no tIRAs (only 401(k)) you have to open a tIRA, fund it with 401(k) money and then do the QCD. (Unless I'm wrong again.)

 

[TheWizard]

I will 100% agree... that is some big time tax savings... I doubt that is the norm in savings...


I did a quick back of the envelope calculation and I just do not have that much tax savings.. I will be doing ROTH conversions starting next year as I think there are other benefits to doing so than tax savings...

Correct on other benefits, even if your marginal tax rate later will be the same as when you do those conversions.

One thing we seldom hear about is that Roth conversions allow folks with zero Earned Income to effectively put additional funds in their Roth IRA, assuming they pay taxes with other money, not from their tax-deferred account.

My present marginal tax rate is 24% + 5% = 29%. So this means that $1000 in my 403(b) is the same as $710 in my Roth when it comes to eventual spending money.
So by paying the $290 tax on that conversion with "other money", I'm able to sneak the entire $1000 into the Roth...

 

[Koolau]

Correct on other benefits, even if your marginal tax rate later will be the same as when you do those conversions.

One thing we seldom hear about is that Roth conversions allow folks with zero Earned Income to effectively put additional funds in their Roth IRA, assuming they pay taxes with other money, not from their tax-deferred account.

My present marginal tax rate is 24% + 5% = 29%. So this means that $1000 in my 403(b) is the same as $710 in my Roth when it comes to eventual spending money.
So by paying the $290 tax on that conversion with "other money", I'm able to sneak the entire $1000 into the Roth...

Yes, this is the "hidden" advantage of Roth conversions. You end up with more "value" in your account when you've paid the taxes. That benefit isn't free (you have to pay some taxes now - and you need to do it from some already taxed money.) So it's not painless. But it may well be worth a look.

 

[Montecfo]

I'm kinda surprised they haven't done this yet. There are some notable ROTHs out there.

For example, Peter Thiel put $1,700 into his ROTH, then used it to buy shares of PayPal at $0.001 per share. As of 2019 its supposedly worth $5,000,000,000 after rolling his profits into various startups.

Then there is Ted Weschler. He started funding his ROTH in 1984 and investing it all in Berkshire Hathaway. Last year it was reportedly worth $264,000,000.

No RMDs for them!

And? They took risk and it paid off. All within the rules.

 

[SevenUp]

I will be doing ROTH conversions starting next year as I think there are other benefits to doing so than tax savings...

Counting IRMAA as a tax (it walks and quacks like one), what "other benefits to doing so than tax savings" do you have in mind?

 

[Koolau]

And? They took risk and it paid off. All within the rules.

Sorta like buying a lotto ticket, I suppose.

 

[NW-Bound]

No.
The previous tax torpedo discussion was really about SS tax humps.

This one is about excess ordinary income due to RMDs, taxed at your marginal rate.


Two different torpedoes...

Two different torpedoes?

My gosh, I'd better do some serious planning, lest the torpedoes sink my boat.

In a different thread, I mentioned the tax bomb that will happen when my I-bonds matured after 30 years, causing a 6-figure compounded interest to become taxable at once.

Two torpedoes + 1 aerial bomb!

 

[pb4uski]

And? They took risk and it paid off. All within the rules.

True, all within the rules. But I don't think that when it created tax-free Roth retirement savings accounts that Congress had in mind that people would load it with highly speculative stock that sometimes would end up hitting mega home runs and result in 8 or 10-figure tax-free balances.

If they had thought that far ahead I'm betting they would have said "Hell no!" and included some limitations on it.... which is why if they wanted to amend the law to prevent such abuses going forward I wouldn't have any problem with such a change.

If it were me I would require that any balance greater than $10 million at the end of a calendar year be withdrawn or in-kind transferred to a taxable account within 90 days... or something along those lines. That would remove the tax-free status of most of the megaRoths balances.

While we hear about the home runs, I'm sure we don't hear about the losers.

 

[CardsFan]

If they had thought that far ahead I'm betting they would have said "Hell no!" and included some limitations on it....

Yeah. Probably the same can be said about millionaires (like some here) getting very inexpensive HI under the ACA by controlling income.

The law of unintended consequences.