Bridging The Gap From FI At 51 and 59 1/2

[oscar1]

Need advice on tax strategies for bridging the gap from 51 to 59 1/2. Have about 800k in IRAs. 150K in liquid taxable accounts. Current monthly expenses in the $4k range including health care, house, taxes, transportation. Want to retire early but not sure sure how to tax plan for the 51 to 59 1/2 gap? Any ideas?

 

[brewer12345]

Have you run your particulars through firecalc to make sure you have enough money? Taxes may be beside the point.

 

[siamond]

Also I'd suggest to use Turbotax. com, there is an easy yet fairly flexible online tax simulator tool, and you will likely discover that you'll pay very few taxes when early-retiring... That was so eye-opening for me when I tried it...

 

[bUU]

Also I'd suggest to use Turbotax. com, there is an easy yet fairly flexible online tax simulator tool, and you will likely discover that you'll pay very few taxes when early-retiring... That was so eye-opening for me when I tried it...

Which calculator are you referring to? I've been looking for some way to model our entire set of assets, factoring MRDs and shaping where we would cover our expenses, complete with tax impact of each, through the years of retirement. Did you find something like that one Turbotax.com?

 

[pb4uski]

Need advice on tax strategies for bridging the gap from 51 to 59 1/2. Have about 800k in IRAs. 150K in liquid taxable accounts. Current monthly expenses in the $4k range including health care, house, taxes, transportation. Want to retire early but not sure sure how to tax plan for the 51 to 59 1/2 gap? Any ideas?

For many ERs the common strategy would be to live off of taxable accounts and do tIRA to Roth IRA conversions sufficient to fill the 10% or 15% tax bracket.

With Obamacare, the game changes a bit in 2014 and the conversions will be limited to 400% FPL which is where the health insurance subsidies fall off the cliff.

Your WR at $48k a year is a bit on the high side for someone retiring at your age. How much in income taxes and health care are included in your $4k/month? As others have mentioned, one of the pleasant surprises of ER for many of us is much lower income taxes since we are in many cases living off of savings. Do you expect that you will be eligible for Obamacare HI subsidies? If either of those costs can be adjusted downward, your WR would become more comfortable.

If you're going to do a retirement plan, Quicken Lifetime Planner is a good place to start. It is an easy-to-use, intuitive tool that covers a lot of bases.

 

[scrabbler1]

Oscar, I basically agree with pb4uski but I can add a few things of my own.

When I was planning my ER back in 2007-2008, I split my ER plan into two parts. The first part, which is the part you are concerned about in your question, was getting from my ER age (45 for me at the time; I am 50 now) to age 59.5 which is when I begin to have better access to what I call my "reinforcements" such as unfettered access to my IRA, my frozen company pension, and Social Security.

Like you, I had about $800k overall in my tax-advantaged accounts and my taxable accounts with about 2/3 of it in the former. However, I knew that in order to be able to cover my expenses I needed to change that ratio significantly. I was able to do that by moving 1/3 of it from the tax-advantaged to the taxable, thereby pretty much reversing the ratio to 2/3 in taxable and 1/3 in tax-advantaged. I was able to do this at low income tax rates, too.

I realize that you may not be able to do that as I did but I am also aware of an option called a 72t one can use to withdraw money from an IRA and not get killed on the taxes. I am not familiar with the inner workings of this 72t option but I know others here are (possibly pb4uski?).

As pb4uski wrote, it is likely that your income taxes will be lower in ER than they were while you are working. For me that was surely the case. Besides having income taxed at the highest marginal rate being eliminated first, you may also end up having some or all of your long-term cap gains and qualified dividends taxed at 0%. Between that and my small muni bond fund income, I ended up having only 62% of my income subject to federal income taxes. Remember that you will not be paying any more FICA taxes or commutation expenses, two other nice savings from ER.

Another thing I did in my ER plan was to separate my income taxes into two parts - the "Basic" taxes and the "Excess" taxes. The Basic taxes are those I pay on the normal, predictable investment earnings such as monthly or quarterly dividends from my various taxable mutual funds. These are the ones I build into my ER budget. The Excess taxes are those I would pay on the more erratic and unpredictable investment earnings such as cap gain distributions, especially the rare short-term cap gains distributions which are treated like ordinary dividends. If I receive a lot of these, I know I will have the money to pay for them because it will come out of those earnings in one way or another. In 2010, for example, I had a huge spike in those erratic distributions so while I had a minor cash flow issue (I reinvested them) I knew they would not bust my budget.

I also agree with pb4uski that $48k in annual expenses seems a bit high. Is this for only one person, as you seem to imply, or for a couple? My annual expenses are around half of that (for one person). As pb4uski mentioned, being eligible for Obamacare subsidies will increase a lot if you can get that income lower.

 

[oscar1]

Scrabbler1, How were you able to move 1/3 of the nest egg from tax-advantaged to taxable? And just a logistics question. I'm assuming you put up the ER flag around the holidays and start the moving of money around after Jan 1st when you are actually in a zero income tax bracket assuming work does not suck you back in and you end up making a pile of money the very first year you retire. Or am I missing something there?

 

[pb4uski]

I actually do the opposite - I do virtually nothing until late December. In early December, I prepare my tax return so I have a really good idea of my tax situation and how much in cap gains or tIRA conversions I can do. I update it in late December once I know what my qualified dividends and capital gains distributions are for the year. Then I pull the trigger. Last year, I did some significant stock transactions on Dec 31 to take advantage of 0% capital gains rate and reset my cost basis.

 

[brewer12345]

Scrabbler1, How were you able to move 1/3 of the nest egg from tax-advantaged to taxable? And just a logistics question. I'm assuming you put up the ER flag around the holidays and start the moving of money around after Jan 1st when you are actually in a zero income tax bracket assuming work does not suck you back in and you end up making a pile of money the very first year you retire. Or am I missing something there?

The game is usually converting money from taxable IRA to Roth, waiting 5 years and then taking out the amount of your principal tax free. You would need taxable or other funds to last you through the first 5 years, after that you could just take out each year's Roth conversion principal for living expenses. I deally you would wait until after you quit to start the conversions to stay in a low tax bracket.

 

[scrabbler1]

Scrabbler1, How were you able to move 1/3 of the nest egg from tax-advantaged to taxable? And just a logistics question. I'm assuming you put up the ER flag around the holidays and start the moving of money around after Jan 1st when you are actually in a zero income tax bracket assuming work does not suck you back in and you end up making a pile of money the very first year you retire. Or am I missing something there?

The big blob of money I moved came from cashing out about $300k in company stock. I used NUA (Net Unrealized Appreciation) to liquidate the stock so I would pay federal income taxes at only the long-term cap gains rate (15%) which was most of the stock's value. The presence of this huge cap gain did trigger the AMT on the rest of my rather small income. I ended up paying about 25% overall which included state income taxes and AMT taxes, a lot better than cashing out the 401k and losing half of the account.

I announced my resignation in late September and took the cash in early November, a week after my last day which was October 31st. I paid enough estimated taxes in late December and early January to avoid any penalties, then paid the rest of it in April (2009).

 

[oscar1]

Ok. We're getting to the good stuff now. This is fascinating and I can't hardly wait for the next reply!

I get the Roth conversion but you are right, convert it while you are retired and use the reduced tax bracket to your advantage. But you still have to wait 5 years to start tapping that source. Meaning I would need to figure out how to stretch $150k taxable accounts for that period (doable with some minimal added income on the side). So, my 51 to 59.5 gap is now reduced to 51-56. Would anyone have experience with 72t? Does that have to be in effect from 51 to 59.5 or can you just use it for 51-56? And what are the tax implications of 72t?

 

[brewer12345]

Everything you wanted to now about 72T, but were afraid to ask:

72t on the Net | SEPP, 72t, and /72q Distributions

 

[brewer12345]

IMO, the big downside of 72t is that once you start it, you are locked in for at least 5 years and there is a minimum age through which yoy must take it (55 or 59, can't remember). So you lose flexibility big time by commiting to a 72t. The Roth bridge seems a lot more attractive because you can always just stop taking the principal out of the Roth if your circumstances change.

 

[pb4uski]

I'm not all that familiar with the details of the 72t but it may provide some relief but IIRC the amounts that can be withdrawn are fairly minor and would not be sufficient to fund your $48k a year of living expenses.

One workaround might be if you have a paid off house to refinance and obtain some taxable money and then use the 72t money and some of the taxable money to make your mortgage payments until you are 59.5 at which you could access your IRA without penalty. While this is a less than ideal solution and involves some risk, if you can get the numbers to work it might be better than working.

Or if you have other assets it moight be possible to sell them or borrow against them to provide the liquidity you need for those years.

 

[CyclingInvestor]

I was in a similar situation when I retired in 2006 at 48 (with 90% of my assets in IRAs),
and am using 72t withdrawals to live on. I use the simplest of the 3 methods (annual recalc), which provides for about a 3% withdrawal the year you turn 51 (and slowly increases afterward). Once started 72t withdrawals must be maintained for at least 5 years, and until the year you reach the age of 59.5.

 

[oscar1]

If you start on 72t distributions, what happens when 59.5 arrives? Once you have unfettered access to your IRA funds at 59.5, can you reduce your withdrawal rate to provide more longevity to your overall nest egg?

 

[LazyErik]

Hi Oscar1,
Hey my DW and I are also trying to come up with a plan to bridge the gap from 45-59.5. We also require about 4k a month in income, just like you. This might not be your exact situation, but we are going to use dividends from our general (non tax advantaged) stock accounts and cash. We are currently in the cash accumulation stage for the next 6 years (or so). We plan on taking cash from our savings if for any expenses not covered by dividends.
We ran this plan past our tax adviser. The dividends are such an amount that we will never break the 15% tax bracket. This makes them tax free as long as the are qualified. I think our overall tax bill was projected to be less than $500 a year if we use this plan. (This is only if tax laws stay the same. . . oh sure that will happen *rolls eyes*).
Our back up if things go badly is to pull from the Roth accounts (the principal, not the gain). If things really go bad, we would do a 72t on our 401k, 403b, etc. I would rather go back to work than do a 72t, but you never know things happen.
The real downside right now to this plan is that we accumulate this cash that is earning no money (negative in light of inflation). I would much rather have it in some nice dividend earning stocks like those in our trading accounts. We are trying to come to terms with a good balance of cash/stocks that gets us to where we need to go, but still allows us to sleep at night.

 

[Brett_Cameron]

. . .

With Obamacare, the game changes a bit in 2014 and the conversions will be limited to 400% FPL which is where the health insurance subsidies fall off the cliff.

PB4USKI,
Are you saying there is a dollar limit being imposed on conversions in 2014 or are you saying that the upper limit that one would want to convert is the 400% FPL to avoid loss of subsidy?

 

[oscar1]

Hi Oscar1,
If things really go bad, we would do a 72t on our 401k, 403b, etc. I would rather go back to work than do a 72t, but you never know things happen.

Why would you rather go back to work then do the 72t? Is it because you fear you'll deplete your tax-advantaged accounts too quickly under the 72t distribution rules?

 

[bo_knows]

Why would you rather go back to work then do the 72t? Is it because you fear you'll deplete your tax-advantaged accounts too quickly under the 72t distribution rules?

As of today's rates, isn't that nigh impossible?

 

[pb4uski]

PB4USKI,
Are you saying there is a dollar limit being imposed on conversions in 2014 or are you saying that the upper limit that one would want to convert is the 400% FPL to avoid loss of subsidy?

There is no limit being imposed on conversions. Poor wording on my part - sorry.

What I am saying is as a practical matter if you do conversions that bring your O-MAGI above 400% FPL that the economic cost of that conversion is exorbitant due to the loss of the subsidy.

For example, if I made a mistake and converted too much so I was $10k over 400% FPL the loss of the subsidy would likely exceed the $10k that I converted (so the economic cost would be the economic equivalent of a marginal 'tax" rate of over 100%!).

 

[Brett_Cameron]

There is no limit being imposed on conversions. Poor wording on my part - sorry.

What I am saying is as a practical matter if you do conversions that bring your O-MAGI above 400% FPL that the economic cost of that conversion is exorbitant due to the loss of the subsidy.

For example, if I made a mistake and converted too much so I was $10k over 400% FPL the loss of the subsidy would likely exceed the $10k that I converted (so the economic cost would be the economic equivalent of a marginal 'tax" rate of over 100%!).

Thanks! My plan is to do some conversions in the future.

 

[photoguy]

For people doing the roth, how do you decide how much to convert in year given the 5 year lag? The lower of 400% of the FPL (for ACA) or the top of the 15% tax bracket? Your budgeted ER expense?

 

[scrabbler1]

There is no limit being imposed on conversions. Poor wording on my part - sorry.

What I am saying is as a practical matter if you do conversions that bring your O-MAGI above 400% FPL that the economic cost of that conversion is exorbitant due to the loss of the subsidy.

For example, if I made a mistake and converted too much so I was $10k over 400% FPL the loss of the subsidy would likely exceed the $10k that I converted (so the economic cost would be the economic equivalent of a marginal 'tax" rate of over 100%!).

A flip side of this is something I have in reserve - I have an unrealized LT capital loss I can turn into a realized loss via tax loss harvesting in case my investment income will be a little too high to qualify for the ACA subsidies. Most years I have a few thousand dollars in LTCG distributions so I can potentially negate those plus as much as another $3,000 if needed to lower my MAGI. I would have to be careful to avoid wash sales to preserve the loss.

 

[clifp]

If you start on 72t distributions, what happens when 59.5 arrives? Once you have unfettered access to your IRA funds at 59.5, can you reduce your withdrawal rate to provide more longevity to your overall nest egg?

If you are more than 59.5 AND you have been withdrawing for at least 5 years from the 72(t), THEN you can cancel it. At which point you can withdraw as much or as little from your IRA penalty free, although you have to pay tax :-( on a traditional IRA.