Sanity Check - Strategy for Initial Years

[mcaterer]

Hi, I'm new here after being referred on another website for some help on the ACA. I got a lot of great info, so I'm hoping for a sanity check on our particular situation.

Our general situation is that we are 56 and 57 and retired last year. My wife has a small pension and very low earned income from sporadic work. We are targeting an annual budget of around $100k. We have significant Trad IRA, LTCG assets, some Roth, and some HSA dollars available. I estimate we can cover our expenses for the next 4-5 years via LTCG, Roth and HSA. This will still leave about 5 years until we are eligible for Medicare.

This tax year our funding so far as been largely cash on hand. This would easily allow us to keep our taxable income to the $89250 0% cap gains threshold. We will still qualify for a very nice ACA subsidy. My plan is sell as much of the LTCG assets this year as possible to stay below the threshold to fund the last part of the year and reset the basis. Possibly repeat this next year depending on the amount of cap gains left, and then do a Roth recharacterization on anything left up to the limit. Once all the cap gains are taken at 0%, continue to do Roth recharacterizations at least up to the 12% limit.

The downside is that we will run-out of tax-free money before age 65, but I'm not sure if we want to do Roth recharacterization at a higher tax rate. If the ACA cliff returns in 2026 we will lose over $10k in subsidy, so it might make sense, but with this plan the earliest we would have that recharacterized Roth available is nearly at Medicare time. Alternatively, I think we could do much higher recharacterizations for the next 5 years at the expense of paying capital gains and higher taxes, but we would still lose the subsidy for a couple of years.

I've been looking for a CPA with expertise in retirement, but haven't found any in my area accepting new clients. I've tried some of the online calculators, but they seem to be focused on RMD tax impacts and it seems like it would best for us to wait until 65 to more aggressively convert based on the current ACA subsidy. I hoping folks who have gone through this type of scenario could provide their insight and any critical elements I'm missing. Thanks.

 

[SevenUp]

Roth Conversion and Capital Gains On ACA Health Insurance could help you analyze this year, and then repeat for next year, etc. Don't know about off-the-shelf multi-year analysis.

 

[Out-to-Lunch]

Welcome!

so it might make sense, but with this plan the earliest we would have that recharacterized Roth available is nearly at Medicare time.

When you say "recharacterization," you mean converting tIRA dollars to Roth, right? (Most tend to say "Roth conversion" for this process. Recharacterization refers to something else.)

But more importantly, why do you say you would not have access to the Roth monies? Anything you convert would be available to you when you are 59.5.

 

[mcaterer]

Wow! Super helpful. I did not realize that all Roth converted dollars become immediately available at 59.5. I guess I just assumed the 5 year conversion ladder kept going from date of conversion. I'll have to relook at our plans based on this.

Also thanks for the clarification on the recharacterization term. I thought this was basically the act of doing a Roth conversion (recharacterizing traditional IRA dollars to Roth dollars was a Roth conversion).

 

[Out-to-Lunch]

Wow! Super helpful. I did not realize that all Roth converted dollars become immediately available at 59.5. I guess I just assumed the 5 year conversion ladder kept going from date of conversion. I'll have to relook at our plans based on this.

Also thanks for the clarification on the recharacterization term. I thought this was basically the act of doing a Roth conversion (recharacterizing traditional IRA dollars to Roth dollars was a Roth conversion).

I probably should have cited the source for my info. That chart was from this page (which also contains other good information). https://www.bogleheads.org/wiki/Roth_IRA

And here is another useful page from Bogleheads on Roth conversions: https://www.bogleheads.org/wiki/Roth_IRA_conversion

 

[mcaterer]

Thanks again. Despite lots of research, I keep missing key details. It's really helpful to get your input.

Reassessing our plans, it looks like doing Roth conversions up to the top of the 12% rate should give us plenty of tax-free money to last until 65. I could do an estimate of lower Roth conversions to increase our ACA subsidy, but if the cliff returns in 2026 we will need some more conversions in the first years to be able get a subsidy until Medicare (assuming we stop conversions in 2026). I think we have to assume the cliff returns since Congress would need to act to prevent that.

Conversions to get ACA subsidy in future years seem to make sense, but if we run out of tax-free money, then does it make sense convert to the 12% limit and then basically use that money to pay our bills? I guess this is where I need to understand the RMD tax impacts, but I wasn't planning to consider this until we get closer to 65.

All of this still assumes we execute on capturing the 0% cap gains rate this year. Really simplistically, I think foregoing this to do more Roth conversion this year would sort of be trading a 15% tax savings on our LTCG gains money vs. a 10% tax impact of more Roth conversion next year. We don't have enough Roth currently available, so we will need to sell the LTCG before we get to 2026 and likely lower our taxable income enough for the subsidy and 0% cap gains.

 

[Bigdawg]

Lots of unknowns in your plan. #1. ND or VT? Unless there is another Williston out there that I don't know about. Check your state healthcare website to wrap your head around your options. Graph out (excel spread sheet) your yearly income sources for each year from now until SS and medicare. Play with those sources and strategies to figure out your best path forward. Sounds like your spend is kind of a guestimate. I would solidify that spend #. How much of that is have to and how much is discrectionary. Could you flex down to 80k if needed? Other options? Part time work? Consulting? Maybe go big on conversions one year then back to a lower amount for a few years. Lots of levers to pull. Lots of good info on this site. Many members talk about a tool "Pralana Gold". https://pralanaretirementcalculator.com/pralana-gold/

I think they say it is $100+. Good luck and congratulations on ER.

 

[mcaterer]

Thanks. This is VT, and my first post on this forum was about understanding the ACA. I've spent a lot of time on the state's website, so I've got a pretty good understanding of costs and subsidy calculations. The budget could probably go down a bit, but then I'm not sure I'd want to be retired. I'm not worried that we'll run out of money, I'm just trying to determine the most tax efficient way of withdrawing. Being able to make our taxable income almost anything I want has resulted in many hours of research, but I'm still getting surprised by tax details I had missed. The insight I've gotten here as already been very helpful.

I had not heard of Pranala Gold, but I just watched their video and it does seem to include a lot of tax detail. I'll have to research further.

 

[xlf11]

Reading and understanding ACA rules are important first step, but we found much more details are needed for finding the best plan available offered in your local area. So finding a reputable local agent would help a lot in this regard and it's free. We went through the process for several years on ACA and continued to get help for two of us to transition to Medicare as well.

 

[mcaterer]

Thanks. We would like help choosing a plan. How do we find a local agent?

 

[SecondCor521]

The 0% LTCG are nice except they add to AGI and therefore impact your ACA subsidies, and they are typically taxed as ordinary income at the state level.

You might also look into a 72(t) plan - either a small one to supplement your funds from elsewhere, or a larger one to mostly cover your spending needs. The main advantage to a 72(t) is early penalty-free access to your traditional IRA.

The main drawback to a 72(t) is that once you start one, you have to keep going for a certain amount of time. Given your ages, you would have to keep it going for 5 years. The main concern would be if you started one for, say, $75K a year and then for whatever reason your spending dropped or your other income increased (you or your spouse going back to work at a lucrative job, or an inheritance would be two likely examples). There are ways to minimize this problem, if you're interested I could elaborate.

72(t) withdrawals are taxed as ordinary income. They would also serve to create AGI for ACA subsidies in the same way Roth conversions (and LTCG for that matter) do.

 

[xlf11]

Thanks. We would like help choosing a plan. How do we find a local agent?

Start with Healthcare.gov and/or your state website with your zipcode. Or ask around your local area who have used ACA/Medicare agent etc. This is pretty much like finding an insurance broker for your car and/or home (actually they are technically trained for healthcare trade per sa and paid by the healthcare companies). Another one could be the state run free agent for help in your local area. What we found the most valuable thing for using local agent is they seem to know what is the best plan and the most economic income level (if you have control over that) and the plan only available for that range.

 

[mcaterer]

The 0% LTCG are nice except they add to AGI and therefore impact your ACA subsidies, and they are typically taxed as ordinary income at the state level.

Yes, VT taxes LTCG (after a $5000 exclusion) so we'll have a bigger state tax bill maximizing LTCG the first year, but I think we could only save the tax on the exclusion by spreading the gains over 2-3 years.

Regarding the ACA subsidy, we really only need the cheapest possible HSA plan as we have no medical needs right now. Even at the 0% cap gains limit we can get about a $850/month subsidy and end up paying $435/month. So we could net another $5220/year but we'd need an AGI of less than $65k. We might be able to manage to that AGI for a few years by using existing Roth, but we couldn't do much conversion and be left with no tax-free income during the years after the cliff returns.

You might also look into a 72(t) plan - either a small one to supplement your funds from elsewhere, or a larger one to mostly cover your spending needs. The main advantage to a 72(t) is early penalty-free access to your traditional IRA.

The main drawback to a 72(t) is that once you start one, you have to keep going for a certain amount of time. Given your ages, you would have to keep it going for 5 years. The main concern would be if you started one for, say, $75K a year and then for whatever reason your spending dropped or your other income increased (you or your spouse going back to work at a lucrative job, or an inheritance would be two likely examples). There are ways to minimize this problem, if you're interested I could elaborate.

72(t) withdrawals are taxed as ordinary income. They would also serve to create AGI for ACA subsidies in the same way Roth conversions (and LTCG for that matter) do.

Thanks for mentioning 72(t). I have only briefly seen reference to this. I'll do some more research, but I'm not sure we really need penalty-free withdrawals from our IRAs. I have a sizable chunk of traditional IRA money available now from my last 401k and we aren't that far from 59.5 to access the rest. I don't see how pulling IRA money now helps with ACA subsidies or taxes on Roth conversions.

 

[Alex The Great]

I'm not sure how my plan fit you but at least there is some idea. I'm 56 and the plan is to retire later this year. I do have around $500K in tax-deferred accounts invested primarily in bonds. Nothing terrible but might be still a tax problem later. I already took a personal leave for a few months therefore doing some Roth conversions this year because of income reduction. I also plan to do Roth conversion next year but remain in reasonable federal tax bracket. Most likely will be on Cobra and don't care about ACA/MAGI limits. After that, I plan to do small Roth conversions ~10K annually till 65 to manage ACA subsidies carefully. Then once on Medicare 65 to 70 will do large Roth conversions every year but still keeping MAGI under IRMAA limit. Currently it is $97K for individual and it will be higher by that time. Finally will apply for SS at 70 and revert Roth conversion back to small (or even non-existent) before RMD kick in which I hope will be of size manageable for tax purpose.
The plan is kind of complicated but it is important to fund Roth IRA as early as possible, and allow more time for it to grow tax free rather than postpone all conversions to later times.

 

[SecondCor521]

I don't see how pulling IRA money now helps
with ACA subsidies or taxes on Roth conversions.

That makes sense. It's a long string of logic and I made some assumptions since you didn't actually give dollar figures.

You seem pretty focused on getting ACA subsidies since you've mentioned them a number of times on this thread.

Reading between the lines, it also seems like you are developing a plan where you don't pay much, if any, taxes the next several years.

You mentioned a significant traditional IRA in your original post, and also appear to be married.

Putting all of those things together, it seems like you may be heading towards a situation where your RMDs plus SS result in a high tax bracket when you're 73 and later. Especially after the first of you passes away and the survivor has to contend with single tax brackets and rates.

What a number of people have figured out is that it actually makes sense to voluntarily pay more taxes now - either with Roth conversions, SEPPs, or regular IRA distributions - in order to reduce those high tax brackets at 73+. It can be counterintuitive after a lifetime of avoiding taxes, and there are obvious risks, but people here do it (including me).

If you use a 72(t) to pull money from your IRA that will always be taxable anyway, you get access to it before 59.5, you avoid the penalty, it provides spending money, and it can provide AGI to get you to the ACA subsidy level you want. It can also supplant that money you were getting from LTCG harvesting and other sources - and if you can defer LTCG until death, you don't have to pay federal or VT taxes on them. Finally, it helps reduce the eventual size of your IRA, which reduces your RMD, which helps avoid large tax brackets at 73+. It also might help you avoid IRMAA, which functions like an additional income tax.

I would recommend building a spreadsheet with SS, RMDs, IRMAA, and your basic tax situation over the next thirty years or so. When I did that, I found I'd be forced to be paying taxes at about 25% to 33% marginal federal rate. It's making sense to me to pull a lot of those dollars forward into my 50's where they can get taxed more lightly.

When building the spreadsheet and thinking about this 30 plus year long picture, I find it very helpful to look at the ACA subsidies as an additional, parallel tax system. You might find illuminating the various articles by seattlecyclone here:

https://seattlecyclone.com/marginal-tax-rates-under-the-aca/
https://seattlecyclone.com/aca-premium-tax-credits-2021-edition/

I have a sizable chunk of traditional IRA money available now from my last 401k and we aren't that far from 59.5 to access the rest.

I'm curious - how do you have a sizeable chunk of traditional IRA money available now from your last 401(k)? If you're referring to the rule of 55, I'm fairly certain that only applies if the money stays in the 401(k). Once you've rolled it to your IRA, which it sounds like you have, then you're stuck waiting until 59.5.

The other option is that maybe you have IRA basis, but that's pretty rare, and based on everything else you've said I'd be surprised if that's the case.

I guess a third option is NUA, but I haven't heard of anyone who's used that technique in a long while, and I think that also doesn't apply once the money is rolled to an IRA.

 

[orbops]

I assume that since you have an HSA, you're deducting the $9,750 from your AGI each year?

 

[mcaterer]

Thanks. Our taxable investments are mostly stocks, so our capital gains will likely be higher than bonds. On COBRA with low capital gains, I would think it would make sense to do Roth conversion at least us to the top of the 12% bracket (maybe more). Unfortunately, my COBRA coverage last year started after significant earned income so I didn't due any conversion then.

Regarding longer-term, I haven't tried to model that in any detail because it seems like so much could change in 10 years. I've been planning to follow the same general strategy you shared. It's very helpful to see someone else has reached a similar conclusion.

 

[SevenUp]

...I would think it would make sense to do Roth conversion at least us to the top of the 12% bracket (maybe more).

Yes, when expecting to be in the 22% or higher bracket later, doing Roth conversions instead of tax gain harvesting in the 12% bracket now usually comes out a little better.

In the same spreadsheet covered in the Finance Buff article about ACA marginal rates is another tab, '0% LTCG or t->R', that you could use to check your situation.

 

[mcaterer]

I assume that since you have an HSA, you're deducting the $9,750 from your AGI each year?

Yes. Thanks for checking.

 

[mcaterer]

Reading between the lines, it also seems like you are developing a plan where you don't pay much, if any, taxes the next several years.

Right now my plan is that we basically cover our expenses with tax-free money and then pay taxes on Roth conversions at least up to top of the 12% bracket. This leaves us a decent ACA subsidy; however, assuming the cliff returns, I'm thinking we may want to reduce the conversions until 65. I think moving the conversions later would mean that money is taxed at a 10-12% higher rate (22% or 24% vs. 12%) and there is slightly less time for tax-free Roth growth, but the value of the subsidy in our case would be worth about $15k/year (estimate for 2026 assuming we reduce conversion to stay under 400% FPL). I think this means that any additional conversion of less than $125k results in lower overall tax.

What a number of people have figured out is that it actually makes sense to voluntarily pay more taxes now - either with Roth conversions, SEPPs, or regular IRA distributions - in order to reduce those high tax brackets at 73+. It can be counterintuitive after a lifetime of avoiding taxes, and there are obvious risks, but people here do it (including me).

I guess I need to do more modelling of our 65+ years now. I have previously used some online tools that indicated exactly what you are saying, but I don't remembering them covering the ACA subsidy.

Roughly, I expect we'll have about $2.5M in our IRAs when we are both 65. If we do Roth conversions to the IRMAA limit every year until 75, I'm estimating we'll have about $1.5M left. A simple online calculator gave me RMD amounts starting around $60k/year and going up to a little over $100k/year. This assumes we both live to 100, but this has been our plan based on health and family genetics. I haven't done the SS estimates yet, but it doesn't seem like we would be above the 22% bracket. Do these numbers seem to make sense?

When building the spreadsheet and thinking about this 30 plus year long picture, I find it very helpful to look at the ACA subsidies as an additional, parallel tax system. You might find illuminating the various articles by seattlecyclone here:

https://seattlecyclone.com/marginal-tax-rates-under-the-aca/
https://seattlecyclone.com/aca-premium-tax-credits-2021-edition/

Thank you for these. I'll need to study them, but they appear to address some of the issues I'm working on.

I'm curious - how do you have a sizeable chunk of traditional IRA money available now from your last 401(k)? If you're referring to the rule of 55, I'm fairly certain that only applies if the money stays in the 401(k). Once you've rolled it to your IRA, which it sounds like you have, then you're stuck waiting until 59.5.

Yes - Rule of 55 left in company 401k. This would allow me around $600k of penalty-free withdrawals without the 72(t), but it still seems like this would push up my taxable income now, it would reduce or eliminate any ACA subsidies, and it would push Roth conversions into the 22 or 24% bracket.

Thanks so much for your input. Much appreciated.

 

[mcaterer]

In the same spreadsheet covered in the Finance Buff article about ACA marginal rates is another tab, '0% LTCG or t->R', that you could use to check your situation.

Thanks. I'm not sure exactly which Finance Buff article you mean, but I think you might be referring to the Case Study Spreadsheet (CSS). I've seen this before, but haven't been able to try it yet (no more Excel since retirement, but I'll probably get a copy).

 

[xlf11]

You can use ORP to simulate both Roth conversion and ACA if not done before:
Optimal Retirement Planner - Extended Parameter Form

 

[SevenUp]

Roth Conversion and Capital Gains On ACA Health Insurance could help you analyze this year, and then repeat for next year, etc. Don't know about off-the-shelf multi-year analysis.

In the same spreadsheet covered in the Finance Buff article about ACA marginal rates is another tab, '0% LTCG or t->R', that you could use to check your situation.

Thanks. I'm not sure exactly which Finance Buff article you mean, but I think you might be referring to the Case Study Spreadsheet (CSS). I've seen this before, but haven't been able to try it yet (no more Excel since retirement, but I'll probably get a copy).

It's the article linked in the first post quoted here, and yes it's the CSS. Too bad that free spreadsheet tools don't have the Excel functionality exploited by that tool.

 

[SecondCor521]

Right now my plan is that we basically cover our expenses with tax-free money and then pay taxes on Roth conversions at least up to top of the 12% bracket. This leaves us a decent ACA subsidy; however, assuming the cliff returns, I'm thinking we may want to reduce the conversions until 65. I think moving the conversions later would mean that money is taxed at a 10-12% higher rate (22% or 24% vs. 12%) and there is slightly less time for tax-free Roth growth, but the value of the subsidy in our case would be worth about $15k/year (estimate for 2026 assuming we reduce conversion to stay under 400% FPL). I think this means that any additional conversion of less than $125k results in lower overall tax.

Similar plan to mine. I would really encourage you to view the ACA subsidy as an additional marginal tax. It simplifies the Roth conversion math quite a bit and I think you will end up closer to an optimal path. Although it's hard to make predictions, especially about the future, so that optimal path can be a moving target depending on what happens with tax laws and investment returns and spending plans.

I've been constrained in past years by FAFSA EFC, but this year is the first year I won't be. I expect to do Roth conversions up until the interaction between refundable tax credits, ACA subsidies, LTCG, and underlying federal marginal tax rate result in a marginal rate of about 25%. The 25% just happens to be my particular cutoff because my projections show I'll pay that rate in my late 70s and more than that in my early 80s if (a) I live that long and (b) things turn out as I am guessing they will.

I guess I need to do more modelling of our 65+ years now. I have previously used some online tools that indicated exactly what you are saying, but I don't remembering them covering the ACA subsidy.

Many tools don't. ACA is more complicated to model well, it's a relatively newer tax planning issue, and they have been tweaking and changing the ACA subsidy rules the last several years.

The CSS can account for ACA, but only on a current year basis. I don't know of any other tools that do; I'm sure they're out there.

Roughly, I expect we'll have about $2.5M in our IRAs when we are both 65. If we do Roth conversions to the IRMAA limit every year until 75, I'm estimating we'll have about $1.5M left. A simple online calculator gave me RMD amounts starting around $60k/year and going up to a little over $100k/year. This assumes we both live to 100, but this has been our plan based on health and family genetics. I haven't done the SS estimates yet, but it doesn't seem like we would be above the 22% bracket. Do these numbers seem to make sense?

They could make sense. I think you should look up what your SS and your spouse's SS will be. I would recommend using opensocialsecurity.com and choose the optimal claiming strategy from that website as a baseline plan.

I think you may be surprised at how much your SS will be. IIRC, the estimates that they give are in todays dollars, so if you model it you'd want to increase them over the next 10-15 years. And 85% of your SS will likely be taxable, plus RMDs.

The second thing that will affect the numbers quite a bit is the real rate of return you assume on your investments, and generally how you handle inflation adjustments in your plan. Personally I am one of the more relentlessly optimistic people here, so I project forward at about a 7% real rate of return. This assumption will bias me towards more Roth conversions and realizing taxable income earlier than someone with more conservative investments or assumed rates of return.

Based on the above and my general approach of a mostly flat marginal rate but willing to pay higher marginal rates later means I will target the base IRMAA amount, the top of the 22%, or the first IRMAA tier from age 65 through 85.

Thank you for these. I'll need to study them, but they appear to address some of the issues I'm working on.

I would encourage you to study and understand the graphs showing the ACA marginal rate effects that I think are in those links. Or, even better, use the CSS to model your specific tax situation because it will include the ACA rates with your underlying federal taxes and also account for any refundable credits you might have (and in general your overall tax situation).

Yes - Rule of 55 left in company 401k. This would allow me around $600k of penalty-free withdrawals without the 72(t), but it still seems like this would push up my taxable income now, it would reduce or eliminate any ACA subsidies, and it would push Roth conversions into the 22 or 24% bracket.

Ah, OK, so the money isn't in an IRA, that was what confused me.

Yes, spending money from either the 401(k) or a 72(t) would have those effects that you cite. My larger point - which I think you get - is that may be preferable to paying 32% in your 80s or after the first of you passes away.

 

[mcaterer]

Thanks for all the input. This should keep me busy today.

Yes, spending money from either the 401(k) or a 72(t) would have those effects that you cite. My larger point - which I think you get - is that may be preferable to paying 32% in your 80s or after the first of you passes away.

One other thought concerning one spouse dying earlier and leaving the surviving spouse with much higher RMD tax impacts as a single filer, would it be possible to just name the children as beneficiaries of the IRAs to avoid this?