Beginner's withdrawal strategy question

[DanP]

Hi folks,

Adjusting to my gliding into ER, and the realities of starting a withdrawal strategy next January are almost here (had enough cash to get me through 2017).

Noticed that i-ORP would have withdrawing from tax deferred right from the start. I am in my early 50s and have plenty in after-tax accounts to not have to touch differed ones for a very long time.

Am I missing something basic? Always thought one should use up regular assets first and leave the tax advantaged accounts grow for as long as possible.

For extra clarity I am talking about withdrawing from a T-IRA, not Roth.

Thanks in advance!

 

[LOL!]

You didn't give us enough info to help you.

We convert tax-deferred money to Roth IRAs while spending dividends from our joint taxable investments. Sometimes we sell some of those joint taxable investments, too, but we are in the 0% LTCG tax bracket.

You wrote about after-tax accounts without clarifying if they were joint taxable and/or Roth accounts. Yes, you can withdraw from Roth accounts without penalties.

Why i-ORP would have you withdraw from a tax-deferred account before age 59.5 is a mystery if one would have to pay a penalty to do so. Perhaps user error?

 

[DanP]

Thanks for the reply LOL. We have 3 types of accounts: joint taxable, T-IRAs and R-IRAs.

i-ORP labels T-IRAs as "Tax Deferred", and those are the ones that show as withdrawing in year 1, using the IRS 72(t) exception.

It does not touch the Roth until the very end so that part is right.

I don't understand the logic, and could be a user error but not sure where to look. Below is an excerpt from the "Withdrawal Report" section:

...
Age RMD TaxDef AfterTax RothIRA Income
052 0 75 152 0 0
053 0 75 160 0 0
054 0 75 169 0 0
055 0 75 179 0 0
...

 

[LOL!]

i-ORP had a trivial feature (don't know if it is still there), but it would withdraw first the account that you said had the lowest return. The way around this was to give every account type the same expected return (say 6% or 7%).

 

[capjak]

Also I believe if you limit the amount of withdrawal. For example, max withdrawal at 120,000 pre year.

It used to do some wild things when you do this. Therefore when I use it I do not limit the max withdrawal and let Iorp optimize the highest withdrawal amount.

 

[marinauser]

To me, whether to withdraw from tax deferred accounts also depends on your other income each year, the marginal tax rate, AMT impact, and the amount of deferred assets. If you have large deferred accounts where your RMD could amount to say $200 or $300,000, that will be a big hit on taxes. If your current income is at a low marginal rate, you may want to take some out of the deferred at that lower rate up to the amount that would cause AMT to kick in. If you income is high and there will be no tax savings, then, it may not be worth it. So if you can withdraw say $50,000 now at a low marginal tax rate with no AMT, then i would probably do that. You can just roll it into your after tax account.

 

[ace8]

Am I missing something basic?

Think of the next goal after providing income as minimizing taxes.

You did not give us many numbers to use.

Generally speaking, you want to minimize tax (and maximize tax credits) by roughly equalizing taxable income over your lifetime.

What you do not want to do is to create an income spike causing a tax spike at a higher than usual rate:
- Having a large tIRA RMD
- Having a large Capital Gain tax by selling highly appreciated assets

You can shift tax burden between years
- Roth conversion
- deciding when to sell your appreciated assets
- 72t tIRA distributions (or regular distros for older folks)

 

[Sunset]

Without numbers it's hard to comment or at least easy to comment but the quality of the comment is low.

If I had a large IRA and was worried about the tax torpedo at age 70.5 (which is when your RMD + SS puts you in a high tax bracket). I would withdraw some from IRA as early as I could either to spend, or convert to ROTH.
Be sure to check out proper way to do 72t so you have flexibility as it is not flexible.

 

[pb4uski]

i-orp would have me withdrawing much more than I am comfortable doing.... I'm not saying that they are wrong, just that I'm not convinced enough to withdraw and pay taxes so early.

I withdraw from taxable, tax-deferred and tax-free, in that order.

 

[ace8]

Here is a Kitces article suggesting a blended strategy including partial Roth conversions is likely best.

 

[DanP]

Thanks for the insight folks. I do think that ORP is doing this for tax benefits, not sure that I understand them though.

At this stage I will continue planning on the more common Taxable/Deferred/Free order.

Again, appreciate the insight - always learning here. At least I have another 3 months to figure it out, time to get reading.

 

[DanP]

Here is a Kitces article suggesting a blended strategy including partial Roth conversions is likely best.

Interesting, thanks!

 

[Gotadimple]

Jim Welch, the i-Orp developer had a statement on his site at one time about using the dollar amounts for withdrawal. I can't find it now, but, will paraphrase: use the pattern of withdrawals for your own situation, rather than the actual amounts.

- Rita

 

[teejayevans]

I would take as much out of your tax deferred as you can without exceeding your target tax bracket (15% for most).

 

[pb4uski]

Here is a Kitces article suggesting a blended strategy including partial Roth conversions is likely best.

Kitces indicates:

However, the optimal approach is actually to preserve the tax-preferenced value of retirement accounts and to fill the tax brackets early on, by funding retirement spending from taxable investment accounts but doing systematic partial Roth conversions of the pre-tax IRA to fill tax brackets in the early years.

This is exactly what I have done since 2013.... we live off of taxable account dividends and sales proceeds and fill up the 15% tax bracket with Roth conversions... I usually overconvert and recharacterize any excess as I finalize preparing my tax return.

 

[ace8]

This is exactly what I have done since 2013

That is great. I had trouble getting that understanding from your earlier comment

I withdraw from taxable, tax-deferred and tax-free, in that order.

Perhaps it was the wording in the OP that was implying he was funding spending in retirement. The better question is 'how do I minimize taxes'. Then you 'verify that you have access to money needed for spending'.

 

[pb4uski]

That is great. I had trouble getting that understanding from your earlier comment



Perhaps it was the wording in the OP that was implying he was funding spending in retirement. The better question is 'how do I minimize taxes'. Then you 'verify that you have access to money needed for spending'.

I guess that I need to clarify. Our long-term plan is to withdraw from taxable, tax-deferred and tax-free, in that order. We are still in the early years of the plan (year 6 this year) so we are living on taxable funds.

However, we still have lots of headroom in the 15% tax bracket so we do Roth conversions to fill up the 15% tax bracket (and paying any taxes due with taxable funds). From 2013-2017, we'll convert almost $300k and pay ~7.5% in federal taxes... much lower than the 28%+ that we avoided when we deferred that income or the 25% that we expect to pay if we had waited until my pension and our SS start.

 

[Perryinva]

Let me see if I understand this. From 2013 thru 2017 you have been living off of div or LTCG sales from after tax investments (which are 0%taxed up to the 15% bracket) and savings, and converting almost 75k/yr from tax deferred to Roth, and paying the tax for that out of after tax savings as well? So essentially all of your income is from Roth conversions to max the 15% bracket? Saving you over $50k in taxes. That is spectacular planning. Wow. I wish I was able to defer my pension for a few years to increase the amount and live off savings to do conversions. We are required to take it the month following retirement, unless we decline the medical benefit, which is huge.

By the time I realized I would be in the same tax bracket in retirement that I am in now (25%) I had already saved too much tax deferred, some probably even at a lower rate. Luckily I can save after tax in my 401k and roll it once a year in to a Roth, and max out my HSA for the last few years, which helps a lot, but overall poor tax planning (due to ignorance) on my part.

 

[pb4uski]

You got it. Living off taxable account dividends, savings (taxable account cash portion of retirement portfolio). When I rebalance and replenish taxable account cash I sell equities in the taxable account and then buy or sell equities in tax-deferred accounts to get back to my target AA.

So the big pieces of our income is taxable account dividends, LTCG and Roth conversions.

I did defer my pension until this year so I could do more Roth conversions... but it got to the point where the annual increase in my pension started to flatten out so I decided to take it.... so my 2017 Roth conversions will be reduced from what it otherwise would have been by my 2017 pension benefits.

We'll keep doing Roth conversions, albeit at a slightly lower level, until we start SS at our FRA in 4-5 years. Once SS starts we'll likely be back in the 25% tax bracket so the golden opportunity will end.

 

[Perryinva]

I’m not complaining, really, having too much income to have to pay taxes all the time is one of the better problems to have, of course. I keep working to increase my pension which compounds the issue, but even if I quit today our combined pensions don’t leave enough room to make any difference, and the taxes I would save are far less than the pension increases. So based on my current tax situation, working 2 more years gives me the number that I feel comfortable at in order to delay filing to FRA plus one year. That also gives me more leeway should I decide or have to file earlier.

 

[DanP]

OP here - so just to make sure on conventional wisdom:

Use up taxable first, then deferred*, last Roth

(* Unless there are some exotic tax scenarios)

As I enter 2018 without a W2 for the first time as an adult, but (possibly) still some consulting income, couple of questions:

* If I continue my part time consulting then I may qualify for direct Roth contributions, but only maybe because income may be too high. BUT, no-brainer that if I qualify for Roth contributions I should right?

* Regardless of potential earned income, we (wife and I) should still fund our T-IRAs even if that is from withdrawals from taxable accounts right?

 

[Perryinva]

Yes on the Roth, but unsure why you would fund tIRA with after tax in retirement when you are at your lowest or final tax rate? Whats the point?

 

[DanP]

Yes on the Roth, but unsure why you would fund tIRA with after tax in retirement when you are at your lowest or final tax rate? Whats the point?

Well, my part time consulting is still bringing in 6 figures, that plus my taxable accounts keep me out of the lower tax rates.

But not sure that I will continue consulting for much longer.

Still, even without the extra income, as a general rule wouldn't one want to defer taxes for as long as possible and keep the money invested? Any T-IRA contributions would not be touched for 10+ years.