Your input on options for 2021 income

[Scuba]

Our goal is to max out the 22% bracket or maybe even the 24%. Currently our 2021 taxable income is very low because we are living from our taxable portfolio and generated enough cash last year to fund this year. We aren’t trying to manage income for ACA purposes. While part of me feels having a zero or very low tax year would be great, another part of me feels that we should pay taxes now at lower rates rather than continue to defer.

In thinking about ways to generate more income this year, we could:
- Cash out an employer provided annuity. This would result in generating only about 1/3 of income we could generate and remain in the 24% bracket. There are some surrender charges but there are also high fees so I’m ok with cashing it out. We would reinvest the proceeds.

- Do a Roth conversion. We don’t have any Roth IRA’s now. Traditional IRA’s make up about 1/3 of our financial assets. The rest are taxable brokerage accounts and a couple of employer-provided deferred compensation and annuity accounts. We have looked at Roth conversions before using i-Orp and other modeling tools and it has never been particularly advantageous for us. We have no children or heirs we want to leave big bucks to.

- Realize LTCG’s. Almost half of the value of our taxable accounts is unrealized gains. We don’t need to do a material rebalancing to get our asset allocation to our target, but we could realize some of our capital gains now and immediately repurchase the same investments, thereby resetting our basis and paying capital gains taxes at 2021 rates.

One other factor influencing us is that we are 61 and 62 now. Haven’t turned on any future income streams yet - my pension, either of our SS, nor are we withdrawing from any IRA’s. The pension, two SS’s, and eventual RMD’s will drive our income up quite a bit in future years.

Our CPA recommended the capital gains route because he feels capital gains tax rates are likely to increase more and potentially sooner than ordinary income rates. He feels that Roth’s would be good for our heirs but not so good for us.

Just wondering if anyone thinks we are missing something important? Or thinks we are crazy to pay tax now if we don’t have to?

 

[VanWinkle]

I think you are in a perfect position to do roth conversions, depending on the size of your tax deferred accounts. You are at the perfect age to take advantage of conversions with no SS or pensions started yet. Just my 2 cents worth. If I could go back to 61-62, I would do more Roth conversions than I completed.

 

[RunningBum]

Good planning. You want to optimize your finances over your remaining lifetime. Enjoying a 0 or low tax now and paying high rates later probably isn't the best move overall.

If you think your tax rate will be higher when RMDs start, then Roth conversions most likely make sense. You'll have SS later, and keep in mind that your SS income might not be at the full 85% taxation but RMDs would likely push it there.

My murky crystal ball tells me that cap gains rates may only go up for higher income people, though it's possible that they would be eliminated and be counted as regular income. Regular income tax rates are already scheduled to go back up in 2026 unless action is taken. So I see more likelihood that ordinary income rates will affect you than cap gain rates changes, but the latter could be more severe. But I'm just SGOTI so maybe you should listen to the pro you are paying. Really, there's probably not a big difference overall, and you can probably do a combination of the two. Or go big on LTCGs one year to enjoy the ~$80,000 space where you pay nothing, and do conversions the next year. Maybe that's worth having your CPA model for you.

 

[Scuba]

Good planning. You want to optimize your finances over your remaining lifetime. Enjoying a 0 or low tax now and paying high rates later probably isn't the best move overall.

If you think your tax rate will be higher when RMDs start, then Roth conversions most likely make sense. You'll have SS later, and keep in mind that your SS income might not be at the full 85% taxation but RMDs would likely push it there.

My murky crystal ball tells me that cap gains rates may only go up for higher income people, though it's possible that they would be eliminated and be counted as regular income. Regular income tax rates are already scheduled to go back up in 2026 unless action is taken. So I see more likelihood that ordinary income rates will affect you than cap gain rates changes, but the latter could be more severe. But I'm just SGOTI so maybe you should listen to the pro you are paying. Really, there's probably not a big difference overall, and you can probably do a combination of the two. Or go big on LTCGs one year to enjoy the ~$80,000 space where you pay nothing, and do conversions the next year. Maybe that's worth having your CPA model for you.

Thanks. My concern is that capital gains rates may quickly either go up to 25% or even to ordinary income rates. I understand your point that unless laws are changed, ordinary income rates will increase in 2026. I just think at the rate the government is spending, rate increases for both CG and OI are likely. CG’s seem to be perceived by the masses as something only wealthy people get, so it’s politically easier to bump up CG rates. But I don’t have a crystal ball either.

It’s hard for me to pay more taxes now when most of my adult life I’ve believed “defer, defer, defer,” but I do appreciate the wisdom of smoothing out income over time and also believe tax rates on both capital gains and ordinary income will be higher later in life.

I am having a hard time getting excited about a Roth conversion. It feels like our taxable brokerage account already provides tax diversification. Maybe we should model this again in i-Orp and see if results are different. A few years ago, their model did not indicate a significant benefit from Roth conversions for us.

 

[pb4uski]

What is the driving force behind the goal to max out the 22% tax bracket and perhaps even 24%?

While I'm a big fan of Roth conversions, if it is pay 22% now to avoid 24% later there isn't much bang for the buck.

I think that in your situation I would lean towards capital gains harvesting.

You might also look at filling the 12% bracket with Roth conversions and then add capital gains harvesting on top of the Roth conversions.

 

[ERD50]

Another consideration for heirs (if you care): If (semi-big if) they don't take away the step up in cost basis on stocks, you might want to leave any high gain stocks alone, so they pass to heirs w/o gains.

That assumes you don't need to tap them in your lifetime, which is likely the case if they aren't a huge % of your portfolio, you have a relatively conservative WR, and the future isn't in the worst of the worst of the historic profiles.

That's a lot of ifs, but I think they have a pretty high probability of working to favor holding stocks.

I don't want to veer into the politics other than to explain the impacts here, but even though there is pressure from the "tax the rich" faction to eliminate the step-up in cost basis, it would affect an awful lot of people (small business and farmers). And I'd guess that a majority of Congress doesn't want to alienate that group of small business and farmers, so I think the step-up is fairly safe, at least at the lower levels.

Not a recommendation, just some food for thought. I'm torn myself, but am opting for Roth conversions and preserving my cap gains, but I can't say I feel strongly about it.

-ERD50

 

[Montecfo]

Hi Scuba,

I think you are thinking of this correctly. Since you already have decided to cash out the annuity, it seems like good timing.

Roth conversions could improve your balance sheet ( if tax rates realized are below expected) but you may in fact pay more tax during your lifetime by using them. Without heirship as a particular goal, perhaps this is not important.

Some capital gain harvesting may seem more beneficial psychically if you feel you have too much cash locked into high gain positions. I'm dubious of a significant change to basis rules but who knows? It sounds to me like you should do what feels most comfortable.

If you plan meaningful charitable giving, transferring high gain positions to favored charities or a donor advised fund is a way to meet those objectives, avoid tax on unrealized gains, and generate current tax deductions. If you pair that with some Roth conversions your tax benefit could be higher than would otherwise be true.

It sounds like you have a lot of flexibility. Not sure there is a wrong answer here.

 

[Time2]

Good planning. You want to optimize your finances over your remaining lifetime. Enjoying a 0 or low tax now and paying high rates later probably isn't the best move overall.

Just to complicate that thinking, If I used my cap gains (keeping under $80k) and paid $0 tax for say the next 10 years, Rather than going into the 22% bracket and paying $28,000 each year, I would have an additional $280,000 (that I didn't pay in taxes) plus growth during those 10 years. That is a large offset that continues to grow for several more years until you used it all up paying taxes.
I surely don't have any answers, I'm very confused. Our first year retired I went max capital gains keeping in the $0 tax bracket, The second year I did $75,000 of Roth conversions staying in the 12% tax bracket, This year I'm thinking about maxing out the 22% bracket doing Roth conversions. I'm pretty sure that by the time we are collecting two SS checks and have RMDs, our forced income will be over $150k and maybe closer to $180k. Assumes no great stock market slump.

 

[RunningBum]

Just to complicate that thinking, If I used my cap gains (keeping under $80k) and paid $0 tax for say the next 10 years, Rather than going into the 22% bracket and paying $28,000 each year, I would have an additional $280,000 (that I didn't pay in taxes) plus growth during those 10 years. That is a large offset that continues to grow for several more years until you used it all up paying taxes.

No, this has been disproved time and time again. You'll pay those taxes later, and taxes on the growth.

 

[pb4uski]

No, this has been disproved time and time again. You'll pay those taxes later, and taxes on the growth.

Yes, see https://www.early-retirement.org/forums/f28/is-roth-conversion-worth-it-110776-2.html#post2659354

It doesn't matter... you are falling into a common trap/popular misconception.

Say you have $10,000 in an tIRA and $2,000 in taxable accounts and your tax rate is 20% and your investments grow at 7% annually.

One choice is to Roth convert where you end up with $10,000 in a Roth and the taxable account is used to pay the $2,000 tax bill. After 10 years at 7% the $10,000 Roth has grown to be a $19,672 Roth that can be spent.

Alternatively, you don't convert. Over the 10 years, the $10,000 tIRA grows to $19,672. Meanwhile, the $2,000 taxable account grows to $3,449 (growth is less because each year's 7% get's taxed at 20% so the after-tax growth is 5.6%). If you withdraw the $19,672 tIRA to spend, pay the 20%/$3,934 in tax, at the end you only have $19,187 to spend ($19,672+$3,449-$3,934).

You actually come out ahead with the Roth because you avoid tax on the taxable account earnings... so where is this alleged growth that you are so concerned about?

Let's say that there isn't tax on the taxable account earnings, so over the 10 years it grows to be $3,934.... after you withdraw the $19,762 tIRA and pay the 20%/$3,934 in tax you have $19,672 left to spend... the exact same as the Roth.

So the Roth comes out better for the tax avoided on the taxable account growth if you don't convert.

And... this all assumes that the future tax rate is the same as today's tax rate... if today's tax rate is lower then you come out even further ahead... run the numbers for yourself and see.

So this simple example proves that you come out ahead even if the tax rate is the same then its pretty easy to see that if the tax rate is lower today that you come out further ahead... no complex models needed!
---------------------------------------------------------------------------------------------------
$19,672 = $10,000*(1+7%)^10
$3,934 = $2,000*(1+7%)^10
$3,449 = $2,000*(1+7%*(1-20%))^10

 

[Time2]

No, this has been disproved time and time again. You'll pay those taxes later, and taxes on the growth.

I'm not convinced, but open to be convinced. First, I'm pretty sure that assumes you will spend all your money down to zero. I expect when I get SS and RMDs, I will never touch my taxable account, it will go to my heirs.

 

[ERD50]

I'm not convinced, but open to be convinced. First, I'm pretty sure that assumes you will spend all your money down to zero. I expect when I get SS and RMDs, I will never touch my taxable account, it will go to my heirs.

Did you see pb4uski's post just before yours? You may have cross posted, but he explains it quite clearly.

But yes, your heir's tax rate, and possibility to have them inherit stepped-up stocks/funds will affect all this.

-ERD50

 

[Sunset]

OP - Largely I'd go with the harvesting of LTCG.

While you don't have heirs for the ROTH conversion (which is not why we do it). Other advantages are after a few years of conversions, having a LOT of money available on a whim. Handy if you decide to buy another house or enter a CCRC , or put it all on red

However, harvesting LTCGs for years will probably leave you a large selection of stocks/etf's to sell with only a small tax hit, if extra money is needed .

 

[Scuba]

I see why Roth’s make a lot of sense for people in two situations:
- People who have the majority of their financial assets in tIRA’s.
- People who have heirs they want to benefit from the Roth’s.

In our case, the majority of the assets we will live on are in our taxable brokerage account and what I’ll call intermediate term assets in former employer-provided deferred compensation and annuity accounts. The tIRA’s are about a third of our assets, so to the extent we need flexibility, we can tap into the other two thirds to fund our needs.

For us, if we do Roth conversions instead of recognizing capital gains, we will pay a higher current tax rate (22-24% rather than 15-20%) and while we will get a benefit many years down the road, assuming we live that long, we forego the opportunity to increase the basis of our taxable account holdings and pay capital gains rates while they’re low. For whatever it’s worth, Fidelity’s modeling said that our total assets would be lower than they are today with a Roth conversion until 2037, when I’ll be 77 and DH will be 79. If that is true, it’s only in our 80’s and beyond that we would benefit from Roth conversions.

Most people on this forum are such strong advocates of Roth conversions that I am questioning myself and our CPA as to whether we are missing something big here. But every time we’ve modeled it, whether i-Orp or Fidelity or our former FA, Roth conversions didn’t look hugely advantageous for us. I think this is largely because we don’t have heirs and we had too many other sources of income so doing a conversion would have put us into too high of a tax bracket. That isn’t the case this year so maybe we have a unique opportunity in 2021.

 

[Out-to-Lunch]

For whatever it’s worth, Fidelity’s modeling said that our total assets would be lower than they are today with a Roth conversion until 2037, when I’ll be 77 and DH will be 79.

Curious: Is that "total assets" or "spendable assets"? In other words , are they counting a dollar in tax-deferred the same as a dollar in Roth?

If that is true, it’s only in our 80’s and beyond that we would benefit from Roth conversions.

Perhaps that is assuming you are still MFJ in your 80's.

 

[Scuba]

Curious: Is that "total assets" or "spendable assets"? In other words , are they counting a dollar in tax-deferred the same as a dollar in Roth?







Perhaps that is assuming you are still MFJ in your 80's.

Good question re total assets vs spendable assets. I will check on that. Yes, they’re modeling that we will both live to 95 to be conservative.

 

[Montecfo]

I see why Roth’s make a lot of sense for people in two situations:
- People who have the majority of their financial assets in tIRA’s.
- People who have heirs they want to benefit from the Roth’s.

In our case, the majority of the assets we will live on are in our taxable brokerage account and what I’ll call intermediate term assets in former employer-provided deferred compensation and annuity accounts. The tIRA’s are about a third of our assets, so to the extent we need flexibility, we can tap into the other two thirds to fund our needs.

For us, if we do Roth conversions instead of recognizing capital gains, we will pay a higher current tax rate (22-24% rather than 15-20%) and while we will get a benefit many years down the road, assuming we live that long, we forego the opportunity to increase the basis of our taxable account holdings and pay capital gains rates while they’re low. For whatever it’s worth, Fidelity’s modeling said that our total assets would be lower than they are today with a Roth conversion until 2037, when I’ll be 77 and DH will be 79. If that is true, it’s only in our 80’s and beyond that we would benefit from Roth conversions.

Most people on this forum are such strong advocates of Roth conversions that I am questioning myself and our CPA as to whether we are missing something big here. But every time we’ve modeled it, whether i-Orp or Fidelity or our former FA, Roth conversions didn’t look hugely advantageous for us. I think this is largely because we don’t have heirs and we had too many other sources of income so doing a conversion would have put us into too high of a tax bracket. That isn’t the case this year so maybe we have a unique opportunity in 2021.

The folks that advocate most strongly for Roth conversions do so viewing things from a balance sheet perspective. In contrast it will take a long time to achieve a cash flow benefit from Roth conversions because the benefit is realized in lower future RMDs i.e. over the rest of your life, or even later. The argument for Roth conversions usually includes a desire to leave after tax funds to heirs. Since for most of us that day will come decades after the conversions, whether funds will truly be saved and how much it matters depends heavily on the assumptions used.

Cutting the other way is the idea that rates will go up in 2026 absent a law change and surviving spouses will pay tax at much higher single rates at some point in the future.

I think the case for Roth conversions generally is there, especially at the lower rate brackets. But the case is weaker if leaving after tax funds to heirs is not a priority. And if you think of pre-paying tax as an "investment" the payback period is uncomfortably long, in my view.

Actual results will vary, and other views welcome.

 

[tb001]

Timely post for us as we’re struggling with the same questions. I’m a little confused though. Why wouldn’t we just take the $ out of the IRA and live on it, drawing down less from the taxable account?

Our IRAs are all currently in bonds and are about 15% of our assets.

iORP has been of limited utility because our withdrawal is variable and front loaded over time.

When I’ve tried to model our various scenarios (not including Roth conversions), it seems to make sense from a tax perspective for us to drawdown IRAs as much as possible first, to avoid the rmds.

 

[Scuba]

Timely post for us as we’re struggling with the same questions. I’m a little confused though. Why wouldn’t we just take the $ out of the IRA and live on it, drawing down less from the taxable account?

Our IRAs are all currently in bonds and are about 15% of our assets.

iORP has been of limited utility because our withdrawal is variable and front loaded over time.

When I’ve tried to model our various scenarios (not including Roth conversions), it seems to make sense from a tax perspective for us to drawdown IRAs as much as possible first, to avoid the rmds.

I don’t know the details of your situation, but for us, we have substantial funds in an after tax brokerage account, so we prefer to use this to fund our cash flow needs right now. Down the road, we’ll tap into IRA’s as well as take pension and SS income, but right now we have more options if we keep our ordinary income as low as we can. YMMV

 

[Scuba]

The folks that advocate most strongly for Roth conversions do so viewing things from a balance sheet perspective. In contrast it will take a long time to achieve a cash flow benefit from Roth conversions because the benefit is realized in lower future RMDs i.e. over the rest of your life, or even later. The argument for Roth conversions usually includes a desire to leave after tax funds to heirs. Since for most of us that day will come decades after the conversions, whether funds will truly be saved and how much it matters depends heavily on the assumptions used.

Cutting the other way is the idea that rates will go up in 2026 absent a law change and surviving spouses will pay tax at much higher single rates at some point in the future.

I think the case for Roth conversions generally is there, especially at the lower rate brackets. But the case is weaker if leaving after tax funds to heirs is not a priority. And if you think of pre-paying tax as an "investment" the payback period is uncomfortably long, in my view.

Actual results will vary, and other views welcome.

Thank you. I’m going to have to re-model our situation in i-Orp as well as maybe my own spreadsheet. It’s hard to know what the right decision is for us but maybe updated modeling will help. I am not sure I trust the Fidelity e-Money results as I’m finding it’s not as transparent as I’d like in terms of reports I can analyze.

 

[tb001]

I don’t know the details of your situation, but for us, we have substantial funds in an after tax brokerage account, so we prefer to use this to fund our cash flow needs right now. Down the road, we’ll tap into IRA’s as well as take pension and SS income, but right now we have more options if we keep our ordinary income as low as we can. YMMV

We’re in the same boat. ~10% of funds in IRAs. When I model it out, even with the IRAs in bonds, the tax consequences of not pulling from them early are significant. The RMDs are deadly by the time we get to our 70s.

 

[Scuba]

We’re in the same boat. ~10% of funds in IRAs. When I model it out, even with the IRAs in bonds, the tax consequences of not pulling from them early are significant. The RMDs are deadly by the time we get to our 70s.

So are you doing Roth conversions?

 

[DrRoy]

Roth Conv.

 

[Time2]

We’re in the same boat. ~10% of funds in IRAs. When I model it out, even with the IRAs in bonds, the tax consequences of not pulling from them early are significant. The RMDs are deadly by the time we get to our 70s.

I have a friend that is 76, every year he complains about how much the tax
is on his RMDs. His solace is, "at least the government lets me keep 75% of my money."

 

[tb001]

So are you doing Roth conversions?

Not sure yet. We’re still trying to figure out the best option. If we have to take the money out and pay taxes on it, I’m not sure why we wouldn’t just use it for living expenses. I think I’m missing the magic of the Roth conversions…