Pre-Retirement Tax-Efficient Withdrawal Strategies

[bfrank12]

Hello I would like to ask opinion on getting a CFP/EA to review pre-retirement portfolio. Do you think this would be helpful?
It would be a one time fee-only service.

The purpose is to determine how to optimize withdrawal from the taxable and tax-deferred portfolio for tax efficiency. I have used the extended-ORP but am not sure that the reported strategy for withdrawal is really realistic or appropriate since the suggested w/drawal is $40,000 or more than I plan to withdraw per year.

Based on the calculator using Monte Carlo the worst case scenario would meet the projected required living expenses.
Should I withdraw from the tax deferred account at early retirement instead of only taxable account to minimized taxes at RMD?
If the tax bracket remains at 22% and higher throughout retirement is the ROTH conversion not an option? These are questions that I have not understand how to answer.

I feel comfortable with my pre-retirement portfolio, budget and asset allocation. I plan to quit full time job within the next year at 54 years and maybe work 1 day a week until my husband retire at 62 years
in 3 years or so. How does one work out mechanisms of tax-efficiency of the portfolio in retirement when it is in the future?

Thanks for any suggestions

 

[SecondCor521]

Welcome to the board! Congratulations on getting to where you are!

Personally I wouldn't and didn't bother. CFPs and EAs are generally not well versed in early retirement and tax efficiency related issues. Although if you can find someone who you think might be helpful, most here think a one time fee only arrangement is the best way to go - rather than an ongoing percentage-of-assets arrangement.

Roth conversions are an option. You pay federal and state income taxes now on whatever you convert, and the converted amounts can be withdrawn tax- and penalty-free five tax years later.

Since you're 54, you might also consider SEPP withdrawals. Generally, you have to withdraw according to a specific amount or formula, and withdrawals need to continue for five years or until age 59.5, whichever is longer. Withdrawals are taxed but no 10% penalty.

It's also possible that you could live well on just your husband's income and your part time work. With the reduced income, your taxes will drop somewhat, and you may have more time and energy to optimize and find savings and not stress-spend anymore (I ate a lot of Wendy's hamburgers in my last few years of work). That could lead to better health and less medications, even.

My suggestion to you is to continue to read threads here which talk about the subjects you're interested in, continue to ask specific questions with example numbers, and also read IRS publications. Learn how to build Excel models. You'll figure it out slowly but surely on your own, and you'll become a better expert on your money than almost all advisors.

Good luck!

 

[pb4uski]

.... Should I withdraw from the tax deferred account at early retirement instead of only taxable account to minimized taxes at RMD? ...

In short, yes as long as you can do it without the 10% early withdrawal penalty.

For many of us, there is a short period of time from when we stop working until when any pensions or SS start that are prime time to do withdrawals (if penalty-free) and/or Roth conversions from tax-deferred accounts.

Question is what is your tax bracket now? What will it be once you retire but DH is still working? What will it be once you both retire but before pensions and SS start? What will it be after pensions and SS start?

You can ballpark the answers based on you 2018 tax return and adjustments to eliminate earned income as you each retire and add any pensions or SS (85% at most) as they come online.

In our case, our tax bracket immediately after I retired was 0% as the standard deduction exceeded our interest and dividend income... so those years were prime time to do Roth conversions... over the last 6 years we've done about $54k a year and paid about $4.4k a year in tax... 8% vs 28% or more when that income was deferred vs 22% or more once my pension and SS start.... we convert to the top of the 0% capital gains tax bracket (which is $200 lower than the top of the 12% tax bracket). For 2019 that means total income of $103,150.

The one mistake that I made over the first 5 years was living off of taxable funds.... in retrospect I would have left those alone to grow and to possibly be eligible for a stepped up basis... the capital gains on sales for spending money significantly inhibited the amount that I could do in low tax-cost Roth conversions.

 

[SnowballCamper]

Hello I would like to ask opinion on getting a CFP/EA to review pre-retirement portfolio. Do you think this would be helpful?
It would be a one time fee-only service.

I think time studying ORP (and its documentation & linked articles) is better than sitting with an advisor. If I had further questions and decided to seek a CFP, I'd be sure to specify that I have ORP results to discuss and interpret.

The purpose is to determine how to optimize withdrawal from the taxable and tax-deferred portfolio for tax efficiency.

I think that when we want to be tax efficient, we want to pay taxes so that we have the most money after taxes, computed for our remaining life's spending. This is what ORP does. Contrast this with seeking how to pay the least tax. To pay the least tax, have zero taxable income. But most of us don't want to live at that level.

To work around the fact that we don't plan to spend the maximum, specify a plan surplus in the extended tab. You'll have to adjust the value a few times to get the output to match what you plan to spend.
EDIT: We don't want the "maximum annual disposal income" to match what we plan to spend. We want to match the Monte Carlo output to our expected spending and to the % success that we can live with.

If the tax bracket remains at 22% and higher throughout retirement is the ROTH conversion not an option? These are questions that I have not understand how to answer.

The iORP output tells you how you should do withdrawals to be most tax efficient for the input parameters. I know it's isn't super easy to interpret, so you have to read through the documentation a bit.

How does one work out mechanisms of tax-efficiency of the portfolio in retirement when it is in the future?

Ahh, that is the real question. What will the future tax code be? We have to take it a year at a time. Other members have pointed out that ORP isn't accurate at income levels lower than most, or those higher than most, due to other tax rules at the extremes (the NIIT for investment income over $250,000 or so, etc.)

My beef with the output is that it has me pay a lot (to me) of tax early on for conversions. To get the advantage, I have to live something like 15-20 more years for the conversion to pay off (as I recall).

So having run the numbers for myself, I'll probably just do a conversion to bring me to the top of whatever tax bracket I'll be in for the year anyway. This way I split the risk of dying early (paying too much tax through conversions) and dying late (not paying enough tax early, and missing on some income late in life).

I hope this helps...

 

[RunningBum]

...

For many of us, there is a short period of time from when we stop working until when any pensions or SS start that are prime time to do withdrawals (if penalty-free) and/or Roth conversions from tax-deferred accounts.

...

The one mistake that I made over the first 5 years was living off of taxable funds.... in retrospect I would have left those alone to grow and to possibly be eligible for a stepped up basis... the capital gains on sales for spending money significantly inhibited the amount that I could do in low tax-cost Roth conversions.

That's one of the factors that makes it so complicated to answer, but I question whether a CFP/EA will really grasp it in a short review of your situation.

At a glance it seems like a no brainer to spend from taxable, and convert tax deferred to a Roth, because a Roth is the best place to have money. But, if you have big gains, and are likely to leave behind some money, it could very well be better to leave the taxable alone, and withdraw from tax deferred as needed.

There are other complexities, like whether you are going for an ACA subsidy. Every dollar you take out of tax deferred for living expenses count towards your MAGI. But if you sell shares from a taxable account, the basis does not count towards MAGI--only the capital gains in income.

Try to figure out all of the factors like this. See if you can model it in a spreadsheet, probably with the help of doing experimental tax returns for various models. Some people aren't convinced that paying taxes now for Roth conversions is a good idea, but modeling it will help see if it does save you money in the long term.

Most likely these decisions aren't make-or-break for your financial success, but making the correct ones can leave with you more money for extras or heirs. For example, letting space in the 12% tax bracket now only to pay 22% or higher once MRDs and SS kicks in means you are paying 10% or more on some of your money. Why not do some planning and keep it for yourself?

The frustrating thing is that tax law changes or big ups or downs in the market can turn the "correct" decision into a less optimal one. I figure to make the most informed decision I can on reasonable projections, and live with any consequences.

 

[donheff]

The problem with hiring someone to advise you is that they will simply ask you to gather data such as those pb4uski mentioned. By the time you gather the data you will be in a position to do the estimates yourself. Just drop your income streams into a tax program and run various scenarios of withdrawals entering guesstimates on capital gains from taxable account withdrawals and straight income from IRA withdrawals. It may be confusing to estimate those figures but you have to do it - planners or accountants can't generate the data themselves they will need the info from you.

 

[CRLLS]

IMO, one problem with hiring a CFP is that the risk of getting one that puts "their spin" on what to do is high. I fear that I may go in and get a canned answer to exactly what I ask and not get questioned in areas that I am not even thinking of and should. Like any other service provider, I would want to interview a min of 3 CFP's to see how they compare and select the one for Now who is going to pay for that, spend the time, or share a bit of our finances with 3 or more different CFPs?

I believe that asking a question on this site may get you responses that are more insightful than a CFA may give in an initial sitting. Sure, you won't get just one pat answer here, but what is life without a little variety?

I did hire a FP for creating an overall retirement financial plan looking out 30+ years and considering taxes and Roth conversions. During this, he filled in some "average expenses" where he though mine were a bit off. This was good. On the other hand, I asked him questions about situations that he had not considered before, all due to what I have learned here. He basically used a fancy program that was available to professionals. From that, I built my own spreadsheet that can be managed by me in the future. YMMV.

 

[Niuatoputapu]

Hi bfrank12, welcome to the group!

In response to your following question,

If the tax bracket remains at 22% and higher throughout retirement is the ROTH conversion not an option?

Most of our (wife and me) wealth sits pre-tax, Roth, and home value - thus we don't have much option to spend after-tax balances or capital gain proceeds. That coupled with ongoing mortgage payments and two kids away in college forces us to currently reside in the middle of the 22% marginal bracket.

Despite being in the 22% bracket, my worksheet projections show it is advantageous to convert tIRA balances to Roth accounts up to the lowest Medicare IRMAA threshold, which is MAGI of $170,000 for married couples. (You have a few years before you need to worry about IRMAA).

Converting at 22% marginal rate is advantageous if one predicts one's future marginal rate to be 25% (when current law expires). But, a larger advantage is calculated when you do survivor spouse scenarios. What tax bracket will be forced upon a surviving spouse? Good market returns, tax-law expiration, plus RMDs could easily throw a surviving spouse into higher brackets, even a 35% marginal rate. So we convert in the 22% bracket.

That said, an additional kicker is most talk about means testing of Social Security benefits revolves around the same IRMAA limits as Medicare. (Since that testing already exists, use it also for SS). Therefore, my plan is to smooth my MAGI, with Roth conversions today and lower RMDs in the future, so it stays under $170,000, inflation adjusted. The $103,150 limit for the 12% bracket is great, but since we can't get that low, we strive to stay under the $170,000 level and will do Roth conversions up to that point.

One size does not fit all, but the above works for us. Looking forward to easily manageable RMDs.

 

[bfrank12]

Thank you for your thoughts and questions as these questions are very helpful. I have draw these conclusions after reading the suggestions. Please correct me if they are not correct.

1) If I retire before age 55 then I will not qualify to w/draw from 401K without paying 10% penalty.

2) The SEPP requires IRS guidelines calculate payment over entire life of me and beneficiary. With sufficient income in taxable account this option is not as flexible.

3) "short period of time from when we stop working until when any pensions or SS start that are prime time to do withdrawals (if penalty-free) and/or Roth conversions from tax-deferred accounts."

* We can w/draw from IRA penalty free at 59&1/2 so at age 62yr this is an option. Because the assett are mainly in 401K this option is limited.

Benefit to ROTH conversion depends on differences of tax brackets during time of conversion and at RMD age. It does not appears to be beneficial?

a) Current tax bracket: 24%
b) Tax bracket when reduced hours & spouse work: 22%
c) Tax bracket when both retire but not w/draw SS. Probably 22%


4) "Question is what is your tax bracket now? What will it be once you retire but DH is still working? What will it be once you both retire but before pensions and SS start? What will it be after pensions and SS start?"


Please clarify how this is calculated:
Tax bracket: 12% 19,401-78,950
22% 78,950-168,400
24% 168,401-321,450

We will have pension & capital gains/dividends when spouse is 62 & before collecting SS at 70.

Do you add capital gain & dividends income to your wages & pension to calculate income amount for tax bracket ?

But qualified dividends and long term capital gains are taxed at 15% instead of your total income tax bracket?

4) In ORP I edited as suggested. "DIT: We don't want the "maximum annual disposal income" to match what we plan to spend."

* I did not realized ORP reported disposable income and discretionary income. The report shows taking tax deferred & taxable account at spouse 62. It also showed Disposable income at 94% current income?. We would not take out this much.

* When I edited & add the Plan Surplus the w/drawal plan changed to only taking out the taxable account from 62-70yrs. However the remaining asset balance is in the tax-deferred account using this w/drawal strategy.

The ESP planner is now not free. I think that it does require more understanding on my part to have confidence to retire early.


Thank again.

 

[big-papa]

Hello I would like to ask opinion on getting a CFP/EA to review pre-retirement portfolio. Do you think this would be helpful?
It would be a one time fee-only service.

The purpose is to determine how to optimize withdrawal from the taxable and tax-deferred portfolio for tax efficiency. I have used the extended-ORP but am not sure that the reported strategy for withdrawal is really realistic or appropriate since the suggested w/drawal is $40,000 or more than I plan to withdraw per year.

Based on the calculator using Monte Carlo the worst case scenario would meet the projected required living expenses.
Should I withdraw from the tax deferred account at early retirement instead of only taxable account to minimized taxes at RMD?
If the tax bracket remains at 22% and higher throughout retirement is the ROTH conversion not an option? These are questions that I have not understand how to answer.

I feel comfortable with my pre-retirement portfolio, budget and asset allocation. I plan to quit full time job within the next year at 54 years and maybe work 1 day a week until my husband retire at 62 years
in 3 years or so. How does one work out mechanisms of tax-efficiency of the portfolio in retirement when it is in the future?

Thanks for any suggestions

Besides I-ORP, if you're spreadsheet-savvy you can also try the retiree portfolio model, available over on Bogleheads. It even has a way to compare its results with I-ORP.

 

[HI Bill]

2) The SEPP requires IRS guidelines calculate payment over entire life of me and beneficiary. With sufficient income in taxable account this option is not as flexible.

If you are turning 55 in the year you retire, you MAY be able to take tax-deferred distributions, penalty-free (but not tax-free) from your 401(k) if your employer allows it. If so, there's no need for the SEPP. SEPP is fairly limited in that there are only three means of determining how much you can withdraw each year. However, you can apply it to some of your tax-deferred accounts, or all. Also:

IRS rule 72(t)(2)(A)(iv): Take penalty-free withdrawals from IRA prior to age 59 ½ by making ‘substantially equal periodic payments’ (SEPP) based on one of 3 methods as long as payments continue at least 5 years, or until 59.5, whichever is later.​

You're not locked into the SEPP withdrawals forever, just per the requirements above; if you're starting at age 54.5 or earlier, you can discontinue them at age 59.5. Then, you can take out more than the RMD to lower your tax-hit when you start pensions and SS, and have lower RMDs at 70.