Taxes & Withdrawal Strategy

[tb001]

I've been focused on the expenses portion of our plan, but now starting to dig into the best strategy for minimizing taxes.

We recently did a 'check-up' with Vanguard where they laid out a 5 yr plan. It looks like they recommended automatically withdrawing 100% of our spending from our 401k and spending down this first. I'm wondering if this is just part of their standard plan or if there's a specific reason this is a better strategy.

Our largest spend is expected in the first few years of retirement, so taking out tax deferred dollars means a huge tax bill. By my calculations, not as huge as Vanguard is estimating, but still pretty big. Either way, it breaks my plan and takes us to a much lower success rate.

I've been trying to draw from taxable acts in the early years, when our spend is higher and we're in a higher tax band, then use projected RMDs in the later years. I think this has the effect of evening out withdrawals a bit and smoothing the tax burden.

Is it always the best strategy to empty our the tax deferred accts first? Want to be sure I'm not missing something...

(for context, we're 49 & 56. DH will start taking SS at 62, since we still have young kids at home. Projected spend after the kids finish high school is about 60% of todays spend, in part due to finished mortgage and in part due to kids being out of the house).

[SecondCor521]

Vanguard does not and will not give tax advice. They are an investment company, not a tax advisory company. So they did not make a recommendation as to where to withdraw from first.

There is rarely an "always the best strategy" when it comes to withdrawals and taxes. You may want to take a look at the advanced version of I-ORP and see what it says for your situation. Even if you don't follow the results from that website, it will give you food for thought.

[Rianne]

We also did a "check up" plan with VG. We moved a few funds around, got a simplified W/D-spending plan 3 years ago. All that has changed. We value input or recommendations but honestly, this forum has educated me much more than any strategy from an investment advisor.

The responses here will be very helpful and much more insightful than an hour with an advisor.

Our situation involves the ACA, so we have to keep our income <$60K. Cashing laddered CD's is one of our strategies. Having cash (in our situation) offsets the tax burden later. Taking portions from tax deferred, 401K and long term I-bonds and EE bonds smooths W/D tax burden. We have to consider pension and SS in 3 years, then it gets a little more complicated.

[Marc]

I am definitely in the take from the 401(k)/403(b) camp especially as I am deferring SS until 70. Tax brackets will probably rise over time plus at some point there will be just one of you paying taxes at the much higher single rate. I will also do Roth conversions up to the top of the 22% bracket (or IRMAA amount once I turn 63).

Marc

[tb001]

Quote:

Originally Posted by SecondCor521 Vanguard does not and will not give tax advice. They are an investment company, not a tax advisory company. So they did not make a recommendation as to where to withdraw from first. There is rarely an "always the best strategy" when it comes to withdrawals and taxes. You may want to take a look at the advanced version of I-ORP and see what it says for your situation. Even if you don't follow the results from that website, it will give you food for thought.

Thanks! They may not give tax advice, but they do add taxes in the plan, which if their taxes are correct, blows things up pretty fast!!

I've checked with i-orp and the recommended strategy there is more similar to what I had planned, though the tax liability numbers are still much higher than I get when I do it myself. With young kids, high property taxes and a mortgage, we end up having more deductions than average I think.

Rianne, I'm already finding that the advisor isn't that helpful. Actually the opposite, because he's now made DH worry we aren't on track! I've had to explain several things to him, including the SS at 62. That alone took up a significant part of our initial hour

Marc, good to hear the other perspective.

I think this is reinforcing my interest in meeting with an advisor who can help us walk through my plan and optimize it. I mainly wanted to make sure I wasn't missing something re pulling from tax deferred accts right away.

[LarryMelman]

Know. Your. Tax. Brackets. Plain and simple.

[tb001]

Quote:

Originally Posted by LarryMelman Know. Your. Tax. Brackets. Plain and simple.

Painfully high is the answer A good problem to have, but boy does it hurt come tax time!

Need to do some thinking about a CD ladder and whether the potential lower returns may offset taxes and minimize income enough to qualify for ACA. I'm guessing not, but we might be able to do an every other year strategy.

[Dtail]

Do you need to manage your income for ACA purposes? That could come into play with the taxable vs. TIRA/401k decision.

[pb4uski]

We expect to be in the 22% tax bracket once SS and RMDs start... before tIRA withdrawals or Roth conversions our marginal tax bracket is currently 0% as the standard deduction exceeds our interest, dividends and my small pension.... so we do a combination of tIRA withdrawals for what we need for spendlng and Roth conversions up to the top of the 12% tax bracket.

Prior to 2019, we were spending from taxable and doing Roth conversions to the top of the 12% tax bracket... over the last 6 years we've converted over $320k and paid about 8% of the amount converted in federal tax since some is sheltered by deductions, some is at 10% and some is at 12%.

We plan to redomesticate to a no income tax state in 2020... at which point I may step up tIRA withdrawals and Roth conversions to the top of the 22% tax bracket.

I'm trying not to touch our taxable savings that are in equities because they are highly appreciated (50% or so) and when we pass they will get a stepped up basis to our heirs so that appreciation will be tax-free.

[tb001]

Quote:

Originally Posted by Dtail Do you need to manage your income for ACA purposes? That could come into play with the taxable vs. TIRA/401k decision.

Unfortunately I don't think we'll be able to, given expenses and cost basis. I've thought about doing an every other year strategy, but not sure the savings on ACA makes sense and I worry about complicating things too much. A lot of moving parts and we have some investment income that is somewhat unpredictable, so we could easily end up over by accident.

[RunningBum]

Quote:

Originally Posted by tb001 Is it always the best strategy to empty our the tax deferred accts first? Want to be sure I'm not missing something...

There's no such thing as "always the best strategy" in most financial situations, and this is certainly one with too many variables.

Generally I would say it would probably be good to use your taxable account, while converting as much as makes sense from your tax deferred to a Roth. If you want an ACA subsidy you have to take that into consideration. If you think you will be passing some assets to your heirs, you might leave highly appreciated stock in a taxable account since they will get a step up basis, if those rules hold.

I think Marc has a good point that tax brackets will probably rise, and your personal rate will rise when there's just one of you, so one way or the other I like to drain tax deferred at a reasonable tax rate, which is probably the rate you expect to pay once you start collecting SS and face RMDs.

My advice, if you are capable with spreadsheets, is to model your situation from now until age 90 (pick a number) and try to minimize taxes over time, which usually means trying to smooth them out as best you can.

[tb001]

Quote:

Originally Posted by pb4uski We expect to be in the 22% tax bracket once SS and RMDs start... before tIRA withdrawals or Roth conversions our marginal tax bracket is currently 0% as the standard deduction exceeds our interest, dividends and my small pension.... so we do a combination of tIRA withdrawals for what we need for spendlng and Roth conversions up to the top of the 12% tax bracket. Prior to 2019, we were spending from taxable and doing Roth conversions to the top of the 12% tax bracket... over the last 6 years we've converted over $320k and paid about 8% of the amount converted in federal tax since some is sheltered by deductions, some is at 10% and some is at 12%. We plan to redomesticate to a no income tax state in 2020... at which point I may step up tIRA withdrawals and Roth conversions to the top of the 22% tax bracket. I'm trying not to touch our taxable savings that are in equities because they are highly appreciated (50% or so) and when we pass they will get a stepped up basis to our heirs so that appreciation will be tax-free.

A lot of good info here. I *knew* there was a reason I asked Sometimes you don't know what you don't know... Hadn't even considered the inheiritance piece.

We're in a very high tax state and have thought about downsizing/relocating to a lower col area when kids are gone, so that plays into things as well. Would like our plan to cover us as if all stays static, but realistically, I can't imagine wanting to stay in a large home when kids are gone!

[GrayHare]

If you have ordinary investments from which to also draw, from the 401k I would pull only enough to get me to the top of the 0% (or 12%) bracket.

[pb4uski]

Quote:

Originally Posted by tb001 .. Hadn't even considered the inheiritance piece....

I hadn't either until last year... also, the capital gains generated on sales to generate spending money was reducing the amount of low-tax Roth conversions that I could do by a significant sum... since tIRA withdrawals reduce tax-deferred money it will reduce our RMDs.

We'll likely still be in the 22% tax bracket...but not as deep into the 22% tax bracket.

[EarlyBirdly]

" I'm already finding that the advisor isn't that helpful. Actually the opposite, because he's now made DH worry we aren't on track! "


Well then, he does his job well doesn't he ? Sow the seeds of doubt and wait for the returns.

As an acquaintance once said to me, " Wow..I would hate to have to make a living that way."

Drug Dealers and Prostitutes have more integrity as far as I'm concerned.... At least they are honest and upfront about their motivations, products, and pricing.

[tb001]

Quote:

Originally Posted by RunningBum There's no such thing as "always the best strategy" in most financial situations, and this is certainly one with too many variables. Generally I would say it would probably be good to use your taxable account, while converting as much as makes sense from your tax deferred to a Roth. If you want an ACA subsidy you have to take that into consideration. If you think you will be passing some assets to your heirs, you might leave highly appreciated stock in a taxable account since they will get a step up basis, if those rules hold. I think Marc has a good point that tax brackets will probably rise, and your personal rate will rise when there's just one of you, so one way or the other I like to drain tax deferred at a reasonable tax rate, which is probably the rate you expect to pay once you start collecting SS and face RMDs. My advice, if you are capable with spreadsheets, is to model your situation from now until age 90 (pick a number) and try to minimize taxes over time, which usually means trying to smooth them out as best you can.

This is helpful--that's essentially what I've done, just out of a need for simplicity. I created a spreadsheet that has taxes calculated for each 'phase' of spend/major tax change, with different withdrawal %s, and in later years have calculated for both S and MFJ to see the impact. While the brackets do rise, the $ amount stays fairly flat due to decreased spending.

The big numbers I'm seeing in i-orp and vanguard have me doubting my methodology! I think I need to run a tax scenario using the i-orp withdrawals and none of our deductions just as a double check on my calculations.

[tb001]

Quote:

Originally Posted by EarlyBirdly " I'm already finding that the advisor isn't that helpful. Actually the opposite, because he's now made DH worry we aren't on track! " Well then, he does his job well doesn't he ? Sow the seeds of doubt and wait for the returns. As an acquaintance once said to me, " Wow..I would hate to have to make a living that way." Drug Dealers and Prostitutes have more integrity as far as I'm concerned.... At least they are honest and upfront about their motivations, products, and pricing.

Thankfully this is the free service provided by Vanguard and not a % based FA, but in general I agree with you! The good news is that I can get to his % success rate if I completely screw up our tax situation, so at least I think I understand how my 95% success went to his 66%, but geez, that's a big difference!


ETA that I'm remembering our rep also told us to choose our cost basis strategy carefully, as that can have a big effect on the degree of flexibility later. We really need a good CPA!

[Gotadimple]

To the OP, I would just add, that withdrawing from your 401K (if you qualify and there is no penalty) is probably a good strategy to use to avoid a tax torpedo. That's the one that comes when you take social security and have to start taking RMD from the 401k. Reducing the tax-deferred account (401K/traditional IRA) to the extent you can before RMDs kick in will also help reduce the tax hit.

-Rita

[Al18]

I'm withdrawing some of my expenses from 401K, some from CD's and sold some stock from my after tax brokerage. 20% federal tax is automatically withheld from the 401K and I have some withheld for state taxes. No tax is withheld from stock sales or CD's. I don't pay estimated tax, and expect a small refund next year.


I see no need to empty the 401K account. Once I'm over 59 1/2, I will transfer the 401K to an IRA - where I can choose my withholding.

[Cobra9777]

We are 58 and 59, with two small pensions, taxable dividends, and some rental income that cover most non-discretionary spending. We sell equities in the taxable account to cover the rest.

We convert to the top of the 12% bracket, but those aren't huge amounts due to other taxable income. But we have many years to work on this, having started at 52. So far, I have resisted converting into the 22% bracket, but that might change.

At 70 when SS/RMDs start, we'll likely be in the 22% bracket. My goal, at that point, is to have roughly equal buckets of taxable, tax-free, and tax-deferred, which should provide some flexibility tax-wise. Pensions, SS, and dividends should cover most expenses by then, depending on how inflation goes (one pension is non-COLA, the other has a partial COLA).

We're not too concerned about legacy considerations at this point. I tend to be more concerned about possible LTC, inflation, longevity, and prolonged downturns. Our equities in taxable are only about 20% appreciated currently. A lot of this came late in my Megacorp career and for a few years thereafter as a result of employee stock option exercises.