Retirement Tax Planning - Income Optimization?

[googily]

Midpack, what does your modeling show in terms of conversions if you become single on the near future? Would you continue conversions?

 

[Midpack]

Midpack, what does your modeling show in terms of conversions if you become single on the near future? Would you continue conversions?

Good suggestion. I’ll run a couple scenarios with one of us becoming single with and without a Roth conversions.

 

[Perryinva]

Does the modeling advance the tax brackets by some adjustable amount, or is the assumption that all future dollars will be compensated for equally so everything is in todays dollars? I’m not sure if I am clear on this, so to word it another way, for example : if I have a fixed non COLA income of $100k forever, then my taxable IRA withdrawals will increase every year to COLA. BUT the tax brackets typically increases each year as well, so while my $100k after deductions may be the 22/25 bracket today, in 20 years it would be 15% as well as some portion of the IRA withdrawals.

I’m not even sure this makes much/any difference except in my mind I was thinking “If I do no conversions, and use my Roth early on so my taxable is only $100k, eventually I will run out of Roth, but by then if my tIRA (most or all) is only taxed at 15%, because the brackets have advanced, then it makes no difference and might even be better than converting today at 22(25)% because taxed at 15% in 25 years “

For instance, using the tax calculator on moneychimp, if I input $100k in tax year 2000, my tax is roughly $23k. If I input the inflation equal of $149k in tax year 2019, the tax is still roughly $23k. (I know, bracket percentages have changed as well as levels) Of course, the COLA equal of $23k in 2019 is $15.5k in 2000, so to my year 2000 self, I have paid almost a third less tax by doing nothing except letting the brackets change.

 

[Midpack]

Does the modeling advance the tax brackets by some adjustable amount, or is the assumption that all future dollars will be compensated for equally so everything is in todays dollars?

If you’re asking me, there are 5-6 tax options including 2017 inflation adjusted, TCJA then 2017 rates starting in 2026, rising rates, worst case and a couple others. I’ve been using TCJA>2017 even though I don’t think it’s realistic, rates will get worse. I just started studying the others last night. But as far as I can see, the user can’t makeup their own custom future tax scheme.

 

[pb4uski]

I think Perry is referring to the fact that tax brackets are adjusted annually for inflation and whether the program includes that and if so, if it is user defined or not.

 

[Perryinva]

Yes, exactly. From what I can tell, some may, & some don’t, since many are just portfolio growth models (like FIRECALC) and leave taxes up to oneself. It is a detail that is really only significant if you have a substantial percentage of your income from fixed, nonCOLA or self directed sources. If your income is entirely COLA income or inflation increased (like the 4% rule) portfolio derived, then it is a wash. In my case, already retired and ages 62 (for all practical purposes) & 67, with a lot of non COLA pensions, the withdrawals increases to compensate for inflation on the original withdrawals plus provide COLA for the non COLA (portion of) pensions.

FWIW, I too would model on assuming tax brackets increase in rates. I view current rates as a timely opportunity but not sustainable.

 

[fishfactory]

Midpack, you said "I modeled converting to 12%, 22%, 24% and 32%, each was progressively better than no conversions. But there was no additional in 32%...". Was converting to fill 32% bracket any worse than filling 24% or just no additional benefit ? I had an adviser recommend total conversion in one year no matter how high the tax bracket, as long as paying tax from non IRA account. I would love to be totally out from the tax overhang by converting past the 24% bracket, but right capital software modeling stops at the 24% bracket.

 

[Midpack]

Midpack, you said "I modeled converting to 12%, 22%, 24% and 32%, each was progressively better than no conversions. But there was no additional in 32%...". Was converting to fill 32% bracket any worse than filling 24% or just no additional benefit ? I had an adviser recommend total conversion in one year no matter how high the tax bracket, as long as paying tax from non IRA account. I would love to be totally out from the tax overhang by converting past the 24% bracket, but right capital software modeling stops at the 24% bracket.

I didn’t delve into exactly why but 32% was trivially worse than 24%. The software doesn’t seem to optimize, it just brute force fills to the top of the bracket each year until your fully converted. So it converted faster than necessary when I specified 32%. Not ideal? But you can somewhat optimize by trying each bracket given the years to 70, as I did. In practice if I proceed I’ll convert to complete at age 70, the equivalent of a few months slower than the software shows for 24%, the best brute force option for our situation.

 

[fishfactory]

I went back to i-orp keeping unlimited conversions as the setting. My current situation calls for filling the 24% bracket with conversions. If I increase non IRA asset levels it fills the 32% bracket. So you are likely correct that going into the 32% bracket doesn't hurt much as long as you are paying the tax from non IRA assets. Thank you for your help. Keep posting as you get new info ! It really helps.

 

[Midpack]

I had my 1 hour "expert help" session with Income Strategy this morning, best $125 I've ever spent on financial services. It was extremely helpful. I had unlocked some of the tools, but there were others I hadn't found yet - now I am really armed. You can vary almost anything you can think of, including several set future tax rate changes PLUS the rate of change of each as well. I am NOT going to go through every one of the settings, many/all will be self explanatory, but see pic attached below for an idea. And there are other toggles and settings elsewhere, including how you can set how your AA evolves over the course of your retirement in five phases (I hadn't caught that) down to individual holdings vs general asset classes. It handles spending exceptions, income exceptions, pensions, annuities, risk tolerances and it does Soc Sec optimization. It's quite a piece of software, but it takes a while to understand and you have to be a little savvy.

The software allows you to control inflation adjustment very independently, tax inflation, spending inflation, Medicare inflation, SS annual increases, etc.

Every question I asked was well answered, the advisor has done help sessions with "thousands of clients."

To my surprise, the advisor talked about the emotional side of planning as well. For example, he pointed out - though I could maximize our portfolio total value and reduce our taxes considerably by converting to 24% - the difference in portfolio total value in converting to 22% was pretty small, less than 1%, even though taxes alone would be reduced quite a bit. He fully understood why a retiree might want pass on converting everything in 5 years at a much higher tax rate than ever before or after and 'settle' for a slightly less aggressive conversion rate. And in fact the software had already recommended converting to 22% even though portfolio total value was a little higher at 24% - just to smooth out taxes a little. So this is not just software that just blindly spits out the numeric best, though it shows that too you along with more than a dozen other strategies. And the user can build their own unique strategies as well (like I did). Yes, all the data/reports are underlying the software, but the advisor offered more than just a truckload of numbers.

So I am thrilled with my experience with Income Strategy, and the value provided - but I am NOT necessarily recommending it's right for others, that's for each individual to decide. For as little as $20/mo, you can get one hell of a value if you're moderately savvy enough to figure it out. To be honest, I'm probably middle of the road for ER.org - more sophisticated than some here, but (much) less than others (I can name many). If you're a complete novice looking for answers, you'll be lost with the software alone, and I would not recommend it unless you pay for [-]several[/-] many hand holding sessions at $125/hour.

He was impressed with how well prepared I was, that's thanks in part to the insights many of you provided here - IRMAA, widow taxes, etc. He told me we'd gotten much further in this first session than he usually gets with most clients.

 

[fishfactory]

Midpack, thank you for taking the time to give such a detailed response on the 1 hour session you had. The more I read the more I feel it best to fill the 24% bracket at a minimum. I believe fed tax rates have nowhere to go but up after 2025, and I like preventing the widow's tax trap if something were to happen to me. I say this with the usual caveat that each person's situation is different, and I am speculating on future tax rates.

 

[Midpack]

Midpack, thank you for taking the time to give such a detailed response on the 1 hour session you had. The more I read the more I feel it best to fill the 24% bracket at a minimum. I believe fed tax rates have nowhere to go but up after 2025, and I like preventing the widow's tax trap if something were to happen to me. I say this with the usual caveat that each person's situation is different, and I am speculating on future tax rates.

I may not have explained it well, but while 24% is the numeric optimum for me, I will probably convert to 22%. Though total lifetime taxes are significantly lower, they're just too high to stomach while I am converting, and the portfolio total value (the overriding objective) difference is almost trivial. YMMV

FWIW now that I know how to inflate future tax rates, I may run some scenarios with much higher future rates to see the sensitivity and double check myself.

And the widow's tax trap is bad, but not as bad as I thought - we looked at that directly today.

 

[fishfactory]

Understood. In my case, I am trying to get out from under the tax burden as soon as possible while still optimizing as much as possible. The 24% bracket is very wide, allowing for many dollars of conversion at only 2% additional tax. I definitely want to take full advantage of this. I understand that each person has different priorities. I am prioritizing minimizing possible future higher tax rates and avoiding widow tax trap.

 

[Gumby]

Thank you for this thread, Midpack. My plan has always been to Roth convert to the top of the 22% bracket. We'll probably stick with that plan, but you (and others) have provided much more food for thought before that becomes our final answer.

 

[CardsFan]

Thanks for asking. I wasn't sure (and my earlier guess was wrong) so I went back and added Roth conversions to 22% (vs 24%). To my surprise the lifetime savings were only 9% vs 31%, and the "breakeven" age was about the same. Doesn't make our decision any easier. It appears we either convert aggressively or not at all, not quite what I was guessing - but I have my consult later this week, so we'll see if I'm missing something. If nothing else, it appears I've gotten more than our money's worth on our $20 one month subscription. Who knows, I may continue it for more than a month, or even try their $50 premier version.

And like RunningBum, the tax situation we leave heirs isn't a top priority for us, though it's probably a very legit consideration for many households.

I have read all the posts, but am responding to this one specifically.

So, in your case, after age 85 (break even point), you will pay an extra 3% per year in taxes, on average, to get to the 31% higher tax payment with no conversions.

Now, I know tax rates can, and will, change. And yes, they will probably go up, unless they don't. But I can't get excited about saving 3% per year after I turn 85. H@ll, I"ll be grateful I lived that long.

The factors of the widow's tax and inheritance concern me more.

From the small number of scenarios I have run (not in your software, but in others), the widow's tax is real, but only a small portion of the IRA would be in the 32% (or higher) bracket.

Inheritance, on the other hand, could cause me to convert more, if something like the SECURE act passes

 

[CardsFan]

Edit to add: BTW thanks for the info you have shared. It is very helpful.

 

[RunningBum]

But I can't get excited about saving 3% per year after I turn 85. H@ll, I"ll be grateful I lived that long.

I see this kind of statement now and then on this board, and I never understand that attitude. I understand you'll be grateful if you live past 85. But won't you be even more grateful if you make it past 85, AND took easy steps in your finances now to live a little more comfortably later?

 

[Montecfo]

I see this kind of statement now and then on this board, and I never understand that attitude. I understand you'll be grateful if you live past 85. But won't you be even more grateful if you make it past 85, AND took easy steps in your finances now to live a little more comfortably later?

If you think of the taxes voluntarily paid early as an investment, it will make more sense I think.

Stated differently, would you buy the investment called "taxes paid in advance" or TPIA that will take most or all of your remaining life to generate a return, if at all? ?Or would you find other investments to be more lucrative?

I am not trying to convince you one way or the other, (I do not fully know the answer for me) I just think the long time horizon involved does materially impact the decision.

 

[Montecfo]

Midpack,

Thanks for all the detail. It is nice to know there is such a powerful tool out there. I may have to take a crack at it!

 

[RunningBum]

If you think of the taxes voluntarily paid early as an investment, it will make more sense I think.

Stated differently, would you buy the investment called "taxes paid in advance" or TPIA that will take most or all of your remaining life to generate a return, if at all? ?Or would you find other investments to be more lucrative?

I am not trying to convince you one way or the other, (I do not fully know the answer for me) I just think the long time horizon involved does materially impact the decision.

Now we back to debating whether the conversion breakeven point is a meaningful thing, and I don't want to go there again.

 

[Midpack]

I've been well below the 22% bracket since I retired.

For those getting something from my journey and still here, who are also reluctant to pay higher taxes now vs later, this chart showing Federal tax brackets might help ***. If we don't do some conversions, we're going to be in the 22% bracket for almost the rest of our years. I'd rather pay marginal income into 22% for 5-6 years, than most of the 28 years after. Yes, it's a "good problem." FWIW

I apologize for the quality of the chart, hard to squeeze into one.

*** It assumes when TCJA expires in 2026 we revert to 2017 tax rates - not that I expect that will happen, I expect taxes will go (much) higher in my lifetime.

 

[ChrisC]

Good food for thought. We've been converting since 2013 going deep into the 24% bracket the last few years -- IRMAAs be damned for at least my wife who pays Part B premiums. Our plans were to continue this for my wife and empty her tIRA/457 completely into her Roth IRA for the next 3 years before she goes into RMD land. Without any conversions, we'll always be in the 22% bracket (from pensions alone) and once my wife dips into SS at 70, we'll always be in the 24% bracket. Once my wife is done with her conversions, I'll begin the process of converting my 401k and TSP into my Roth (that I was able to fund with a rollover from the Federal/OPM Voluntary Contribution Program).

Our plans have always been to maximize our Roths for legacy purposes. We continue to bite the Federal and State tax burden with these conversions, and will probably still do that even post RMDs. We need a gut check on this and will probably consult with a CFP to see if this continues to make sense for us.

 

[harley]

Wow! What a meaningful chart! Thanks. I was already planning on doing this, but that really drives it home.

 

[CardsFan]

I see this kind of statement now and then on this board, and I never understand that attitude. I understand you'll be grateful if you live past 85. But won't you be even more grateful if you make it past 85, AND took easy steps in your finances now to live a little more comfortably later?

I know you don't want to discuss the break-even point, but for OP, with no concern about heirs, isn't it the ONLY thing to look at?

In our case, since we do not come close to spending our FireCalc SWR, and we DO have an heir we would like to leave it to, as I stated in the post you quoted, both the widow's tax and inheritance taxes COULD drive us to make more aggressive conversions. But it is not compelling.

 

[Midpack]

I know you don't want to discuss the break-even point, but for OP, with no concern about heirs, isn't it the ONLY thing to look at?

It was just an offhand observation. Not terribly meaningful and never intended to start in a discussion. FWIW