What you haven’t heard before about the taxation of Social Security benefits

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I'm guilty as charged. Sometimes I have to step back from complexity and smell the roses.

On the Bogleheads Forum site, there was a mildly fierce (if ever there were such a thing) debate regarding the merits of devising a complex variable percentage withdrawal method for PF decumulation. Went on for several pages, even ending up as a spreadsheet on another part of the site. Best part was this sage advice (IMHO) from one of the posters regarding complexity:

"After long thought, and years of reading posts here, and just thinking about the well known fact from psychology that humans are very poorly wired to intuitively understand probability and make rational decisions in the face of uncertainty, I think people, otherwise very smart people, have an extremely hard time really at a gut level dealing with the level of uncertainty in investing and retirement planning that exists despite all our hard work to make it otherwise. Thus we agonize over hyper-precise rebalancing schemes, worry about precisely how to set an asset allocation, despite huge amounts of evidence that no one can estimate future returns with any accuracy we read and many (including our resident experts both those that post regularly and not so regularly) insist that to invest well we much make such predictions. And why we have such fascination with various safe withdrawal rate schemes.

I'm sympathetic. It took me a long time, and much modeling and calculating, not just in things like the above withdrawal rates, but more importantly in studying the sensitivity of results to changes in assumptions to get to where I am today. I would suggest that if anyone likes precise calculations, much can be learned by looking at the changes in results due to sensitivity to errors in assumptions. As a hint, just as compound growth in your portfolio over decades is a great thing, the compound growth in errors over decades is just as powerful.

One could certainly at age 30 calculate to the nearest dollar what they plan to spend at age 60. And people could get together to discuss different methods of how to do this calculation to the nearest dollar. But would it be very useful compared to a back of the envelop estimate? Would it even be useful at all?"

Lately I have been asking myself, do I really want to optimize every last dollar of my PF? If I pay some more to the tax man due to RMD's/SS txs (while enjoying a robust retirement) shouldn't I be spending my time on the things that make retirement/life worthwhile? Counting every last nickel in the PF isn't one of them. Just some thoughts I've been pondering lately...

 

[NW-Bound]

Lately I have been asking myself, do I really want to optimize every last dollar of my PF?...

And you really cannot. Tax law changes and variations in future return mean one's spreadsheet may be all out-of-whack 10 or 15 years from now. We would have to make too many assumptions.

I will still do Roth conversions of course as I do not see any drawback, but I do not attempt to quantify that tax advantage this far from that RMD date.

 

[Ed_The_Gypsy]

Another gotcha:

If I understand correctly, distributions from a Roth at any time in your life (this I gotta confirm) will include a 10% penalty if taken less than 5 years after the money was put in. The count starts as of January 1 of the year following the contribution. So, Year 1 = contribution/conversion. Years 2-6, have to sit on it. Year 7 = first opportunity to withdraw without penalty.

This is complicating my strategy, but does not break it.

Another reason to START EARLY! Learn from my mistakes.

 

[kaneohe]

Another gotcha:

If I understand correctly, distributions from a Roth at any time in your life (this I gotta confirm) will include a 10% penalty if taken less than 5 years after the money was put in. The count starts as of January 1 of the year following the contribution. So, Year 1 = contribution/conversion. Years 2-6, have to sit on it. Year 7 = first opportunity to withdraw without penalty.

This is complicating my strategy, but does not break it.

Another reason to START EARLY! Learn from my mistakes.

no 5 yr clock on withdrawing contributions....can take out anytime.
5 yr clocks on conversions unless stopped by 5 yr clock on original Roth and age 59.5.
I believe your year counting overcounts the required yrs.

Google on the fairmark.com site "roth withdrawal table kawill" to find a relevant thread and be sure to look at the latest post in the threads since there were some changes along the way.

 

[Ed_The_Gypsy]

Thanks, kaneohe,

The 5-year clock on conversions is a problem for me. I have to check on the 59.5 issue.

Thanks for the link.

 

[NW-Bound]

The "no clock" after 59.5 is true. I raised this question a short time ago, and Animorph pointed this out to me. See: http://www.early-retirement.org/forums/f28/aa-during-3-years-high-spending-69532.html#post1388039.

What this means is that Roth conversion should be used as an income-averaging method to reduce tax liabilities. Even in years when one does not need IRA withdrawal, he should draw some and transfer to his Roth account, to "bank" his lower tax bracket for later years.

I will be doing this every year, even though I am only 57 and still living off my after-tax account. Most of dividend-paying stocks are in my tax-deferred, while my after-tax accounts are meant for cap-gain stocks, which I can control the selling to keep within the 15% tax bracket for a couple.

 

[Ed_The_Gypsy]

kaneohe,

Fairmark doesn't seem to specifically address my situation. I am still digging around their web site, though.

I plan to convert all of my tIRA to a Roth. (I started a small Roth long ago.) My original plan was to convert over 4 or 5 years, before reaching 70.5 and MRDs kick in, taking enough each year to live on and pay the taxes (worst case) and converting the rest.

At the end of the conversion process, I would start to withdraw from the Roth. I am already over 59.5 and taxes would already be paid on the Roth contribution/conversion. However, 5 years from the first conversion would not have elapsed yet.

5 yr clocks on conversions unless stopped by 5 yr clock on original Roth and age 59.5.

The original Roth is old, but small.

Conversions would be substantial but recent. Does this override the start date on the original Roth and the fact that I am over 59.5?

Still not clear enough.

 

[Ed_The_Gypsy]

A qualified distribution is any payment or distribution from your Roth IRA that meets the following requirements.

1. It is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your benefit, AND

2. The payment or distribution is:
a. Made on or after the date you reach age 59½,

NW-Bound, this looks like it applies to my case. It appears that I can't withdraw anything without the 10% penalty from the first conversion until after 5 years, regardless.

 

[Ed_The_Gypsy]

Please correct me if I am wrong.

 

[Ed_The_Gypsy]

Checking Animorph's comments and references now. The IRS seems to contradict itself.

It seems that such a withdrawal would not be a Qualified Distribution, but it may not be subject to the 10% penalty. Are you following this?

 

[haha]

NW-Bound, this looks like it applies to my case. It appears that I can't withdraw anything without the 10% penalty from the first conversion until after 5 years, regardless.

I think this is correct, at least as I understand what you are saying. To deal with this, I opened a $500 Roth for me and one for my then wife when they first became available. I don't even remember when this was, but it was > 5 years ago.

Ha

 

[Ed_The_Gypsy]

Ha, I am going to go with the 5-year limitation for the time being unless and until I can confirm that the 59.5 exemption will apply.

The mind boggles.

 

[Ed_The_Gypsy]

How about this?

Other early distributions. Unless one of the exceptions listed below applies, you must pay the 10% additional tax on the taxable part of any distributions that are not qualified distributions.

Exceptions. You may not have to pay the 10% additional tax in the following situations. You have reached age 59½.

I am still trying to figure out what part of a distribution from a Roth is taxable.

And..."may" not have to pay....?



It looks like anything but 100% caution 'may' be too risky.

 

[Ed_The_Gypsy]

Fairmark had this entry in a little table:

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Distributions Are Qualified

No Taxes
No Penalties

So, it looks like I would be OK. From all accounts, opening even a small a Roth many years ago makes the distributions I am interested in Qualified and >59.5 protects me from the 10% penalty.

I am still anxious about this interpretation, however.

Not in a hurry, fortunately.

Cheers,

Gypsy

 

[Ed_The_Gypsy]

Back again.

Ed Slott's forum gives the same positive information, almost specific to my situation:

https://www.irahelp.com/forum-post/18094-withdrawal-conversion-within-5-years

It is not logical, but oh, well.

Thanks all for very helpful inputs and patience.

Merry Christmas!

 

[Animorph]

If you (or someone) has a copy of Turbo Tax, you might try entering in the info for withdrawal of a rollover conversion after 59.5 but before 5 years after the conversion.

I will keep separate Roth IRA's for each Roth conversion year, and should have 5 years delay before withdrawals.

Certainly we could use better clarity from the IRS.

 

[kaneohe]

Back again.

Ed Slott's forum gives the same positive information, almost specific to my situation:

https://www.irahelp.com/forum-post/18094-withdrawal-conversion-within-5-years

It is not logical, but oh, well.

Thanks all for very helpful inputs and patience.

Merry Christmas!

Ed, sorry I couldn't give you the direct link to that Fairmark table. Had to clean house for the grandkid's arrival. Looks like you found the table by kawill. Not trying to make life difficult for you but if you think you found the right answer by finding 2 different confirmations online......... the table at fairmark was developed by kawill w/ significant input by and then an eventual blessing by Alan S. who knows a whole lot. I didn't look at your Ed Slott link but be aware that the Alanxxxxxxx (he changes the name from time to time) who is a primary poster there is the same Alan S. at fairmark.com so your confirmations may not be independent ones That said, the IRS words are difficult to interpret at times and I am banking my life on the kawill table and Alan S.'s rep. I've even proposed that IRS adopt the table in their Pub. 590 because it takes the thinking and ambiguity out of this whole process............so the choice is now yours......to worry since the inputs aren't totally independent or to accept..........