IRA/SS Tax Question

[Rustic23]

I have a $30,000 pension with COLA. I also have in excess of $300,000 in IRAs, and enough in regular savings to live five or six years without drawing SS. Here is the questions. Do I draw down the IRAs and convert them to Roth IRAs keeping the annual withdrawal in the 15% bracket, or take the SS and let the IRA’s continue to grow till 70. If I do that, the withdrawal will be at the 25% rate. If I convert to Roth, I believe there is favorable tax treatment for estate purpose.

[New Thinking]

Not many people understand it, but your best bet is probably to take your IRA income first and delay Social Security..Here is why.Conventional wisdom has always said that you want to delay taking income from your tax-deferred investments as long as possible. Unfortunately, this wisdom is wrong for most people and you are right there due to your pension and possible IRA income...Yes, deferring taxes allows you to build your portfolio because you have the tax money at work for you..However, you are only building more assets that will be taxed later..What you want to do is limit your taxes. The reason that deferring your IRA until later hits you in the tax pocket is that it will cause the taxation of your SS benefits for the rest of your life and your spouse's life if you are married.

If you take your IRA income first and delay SS, you will pay ordinary income taxes only on your IRA money (and of course, your pension). When you reach a later age when you start SS, your IRA income has been replaced by higher SS income...Thus, your IRA income is gone (or some of it is) and is replaced by SS..IRA taxes are therefore gone and SS gets taxed much more favorably and, in your situation, is likely to escape a lot of taxation..This is because the formula that determines the taxation of SS (known as Combined Income or Provisional Income) only counts SS income at a 50% rate..and even then, it is the lesser of three tests...This is not intuitive, but it is true and you will read more about this in the future. You can look at doing Roth conversions also in the years that you have low taxable income..Of course, if you do this after age 70, you may cause some of your SS to become taxable.

When you say that Roth assets are more favorable than IRA assets as far as your estate, the advantage is that you have already paid the tax with the Roth..Your estate will value the assets the same way..$300,000 in IRA assets and $300,000 in Roth assets are both valued by the estate as $300,000. But, unless the laws change or you let these assets grow and they are a couple million when you die, estate taxes are not your issue..The real advantage with the Roth is that no taxes are due to be paid by your heirs..With an IRA, your heirs would owe ordinary income taxes when they take distributions (this is different than the estate tax)..Both the IRA and Roth IRA can be tapped over the expected lifetimes of your heirs..This is what is known as a "Stretch IRA" concept..You can see the value of the Roth here because their is compounding interest over many many decades which will never be taxed when taken as income.

Moving from fact to opinion..I don't think tax rates will ever be this low again during our lifetimes..The entitlement programs (SS, Medicare, Medicaid) are just too big and too difficult to drastically cut..We will have to raise taxes..I'd pay consider paying the piper and converting some of your IRA money to Roth now.

[uncledrz]

Rustic
I haven't been able to convert to roth's until this year (06) as I've gone to PT/semi retired and expect that I'll qualify. I've just started to look at the roth conversion issue and here's an article on it:

http://www.rothira.com/rothmyths.htm

and some calculators

http://www.calctools.com/RothConversion.htm
http://www.investsafe.com/developmen...hTransfer.html
http://www.fincalc.com/QUA_04.asp?id=12068

Looks like the conversion is favorable if tax rates are equal, but haven't really worked through it yet.

[New Thinking]

Uncle - Its not just an issue whether tax rates are equal..That is the mistake many make..You have to bring the taxation of SS into the equation. Those taxes will hit you for life..The calculators you reference probably do not bring that into the equation - but I haven't checked. Good luck in retirement.

[dory36]

I mentioned it in another thread -- see http://i-orp.com for a calculator that optimizes for taxes during retirement withdrawals.

"To run ORP you provide your tax-deferred and after-tax savings, your age, your spouse's age, and your planned annual savings until retirement. ORP will compute your cash flow during retirement from investment returns and drawing down your capital to a given estate level at the end of the plan. ORP's embedded linear programming optimizer maximizes the cash available, during retirement, based on inflation and compounding investment returns while meeting Internal Revenue Service requirements."

[73ss454]

Good posts guys,

Let me ask this, once the IRA's are switched to Roth does it pay to take SS at 62? Or is it the same as Newthinking stated with the taxes?

What if any are the differences?

[Nords]

Quote:

Originally Posted by Rustic23 Do I draw down the IRAs and convert them to Roth IRAs keeping the annual withdrawal in the 15% bracket, or take the SS and let the IRA’s continue to grow till 70. If I do that, the withdrawal will be at the 25% rate. If I convert to Roth, I believe there is favorable tax treatment for estate purpose.

There sure is a favorable tax treatment. We're two years into Roth conversions that'll take 6-8 years.

You can do a combination of your ideas. You could draw on your IRAs for expenses if necessary (either penalty-free after age 59½ or via 72(t) if younger) while converting the rest of your IRAs to a Roth.

As for the conversion, I'd be astounded if future taxes are lower than today's brackets. Of course that speculation may not be rewarded if some other tax scheme blindsides us.

Another consideration, as you & others have pointed out, is SS. The RMDs for a conventional IRA can quickly raise your income high enough to tax your SS. So although a conversion calculator might not show the SS impact, you can raise your retirement tax bracket by having to take the RMDs.

A third issue is determining the RMDs. I'm watching my FIL, aided by his son the CPA, trying to understand the RMD for an IRA that's composed of pre-tax 401(k) employee contributions, 401(k) employer matches, after-tax 401(k) employee contributions, a lump-sum buyout, deductible IRA contributions, & non-deductible IRA contributions. It's getting done and it's correct, but let's just say that there's been considerable emotional & mental anguish over the calculations and "those ba$tards at the IRS & Congress". (Son the CPA is getting the mental part, we're getting the emotional part.) Conversion allows you to take out what you need, if anything, instead of RMD.

Finally, the Roth conversion allows you to sneak in more tax-free assets by paying the conversion taxes from other funds (if available). If you convert $100K of a conventional IRA that has a $50K basis, and pay the taxes from your taxable funds, then your Roth IRA starts its life with a $100K basis (instead of $50K). This is a great way to defer both the income and the associated taxes indefinitely.

If you haven't already, take a look at either of Ed Slott's books-- at least one of them is probably in your local library-- and his discussion board.

[cute fuzzy bunny]

Roth conversions are a good idea...unless a flat tax/national sales tax/vat is put in place before you start withdrawing.

We're going to split the difference. We're not contributing to my IRA/401k rollover anymore, we're still contributing to my wifes 403b, and we're maxing roths. I think I'll avoid converting any of the pretax plans to Roths. Once the wifes 403b rolls into six figures (about 5-6 years) we'll probably cut her hours to the minimum to continue health care and just max the roths.

At the time we're both fully retired, we'll have just about the same amount in our IRAs and Roths. We'll look at the tax situation then and withdraw accordingly from one bucket or the other.

[uncledrz]

Quote:

Originally Posted by New Thinking Uncle - Its not just an issue whether tax rates are equal..That is the mistake many make..You have to bring the taxation of SS into the equation.* Those taxes will hit you for life..The calculators you reference probably do not bring that into the equation - but I haven't checked.* Good luck in retirement.

Thanks New. Will consider Soc Sec Taxation when evaluating the conversion, as well as costs of the conversion, method of conversion, basis issues, etc. As far as I can tell, the calculators do not consider the Soc Sec Taxation Issues, but I really haven't delved into them in detail yet.

[mickeyd]

Rustic,

Many excellent answers here, you should be able to arrive on a good resolution with this info alone!

Here's another idea. Can you live on the $30k Cola pension alone? If you can, you can delay all of these withdrawalls and keep your stash untouched as long as possible. The longer that you can put off dipping into your money and starting SS the bettr off that you will be in the long run.

Remember, once that you turn on the tap, it is damn tough to turn it off. Even if you can delay touching your stash a year or so, you will benefit greatly in the long run.