Questions about I-ORP

[user5027]

Maybe it is just me but I would not consider that tax avoidance. My neighbor buys cars more frequently than I do. I see now he is avoiding taxes.

I took hnzw to mean he would have more estate money in the end from his taxable account with the conversion strategy.

 

[hnzw_rui]

How does doing roth conversions avoid taxes on a taxable account?

What pb4uski said. You don't pay taxes if all your money is in Roth. Most of estate money will be in Roth, too.

If you do aggressive Roth conversions (thereby minimizing or eliminating RMDs from tax-deferred accounts), that money is forever tax-free (assuming they don't amend tax laws).

If, however, you reach a point where RMDs are higher than spending, you can only invest excess RMDs in a taxable account. Which is fine if you're in the 15% bracket and paying 0% LTCG. Not so much if you're at the 25% bracket or higher. Then there's also state income tax to consider.

 

[fishboat]

However, purely on the math front, spreading out Roth conversions over several years at lower tax brackets is more beneficial than one giant conversion pushing you to higher tax brackets. Of course, that's assuming you don't have a taxable account (with LTCG) from which to pay taxes and assuming your RMDs will never be higher than your spending ergo making paying the higher taxes at the beginning unnecessary. No doubt the i-ORP model takes these factors into account and minimizes taxes at retirement while maximizing spending. That said, it doesn't appear to try to minimize taxes pre-retirement. Unfortunately, it doesn't quite handle more complicated state taxation rules, either.

Great thread not only from an ORP-understanding perspective, but from a strategy in general. (I'm fast approaching an unexpected early retirement..in terms of months..and I'm on a steep learning curve on how best to approach it. ORP is one tool I've used..)

Would the (paid version, not Basic) ESPlanner software address the case described above? I know it'll handle the comparable state taxes aspect, but how about the conditions/constraints in the first couple sentences?

 

[sengsational]

Would the (paid version, not Basic) ESPlanner software address the case described above? I know it'll handle the comparable state taxes aspect, but how about the conditions/constraints in the first couple sentences?

If ESPlanner still offers the money-back guarantee, you could try it. It takes some study time, though. I tried it, but it didn't fit my situation because it would not pull penalty-free from my 401k at age 55. I don't think it did Roth conversions either (maybe?). And it didn't have the Obamacare cliff. Roth conversions don't make that big of a deal, but it's something. And it's easy for me to have a plan that lets me stay under the cliff, but if the software doesn't know about the cliff, that's giving up a lot.

When it comes to planning software like this, I'd say you need one that does two things...comes up with a reasonably optimized plan for the entire duration, and secondly, one that gives you a solid plan for what to do this year that fits-in with the long-term plan. Those are separate because one is actionable now, and for the other one, you must just be convinced (have faith) that the future plan is "realistic enough". Next year, you'll run another plan from what reality is at that point. And the year after that. Maybe you'll use the same planning software, maybe that software will have new features, or maybe some other software will begin guiding you.


http://www.early-retirement.org/forums/f28/too-many-scenarios-help-77288.html#post1594066

http://www.early-retirement.org/forums/f28/esplanner-paid-pc-software-cost-66668-2.html#post1321451

 

[lawman3966]

Merlin3942 -

Roth IRA Distribution Table

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-Yes (Taxable Portion)
Conversions: Tax-No ;Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

Clearly, I'm a little new to conversion. But, I don't understand the distinction between the taxable portion and the non-taxable portion in the above table.

It appears that all of the funds concerned are currently sitting in a TIRA awaiting conversion (or withdrawal), and that all such funds are taxable upon either withdrawal or conversion. So, to clarify the question: what do the terms taxable and non-taxable mean in this context?

 

[Whisper66]

Here's my understanding

The table is a Roth IRA Distribution (see title). The assets in the Roth come from (1) direct contributions (2) Conversions from tIRA funds that have not been taxed yet and therefore are called "taxable" (3) Conversions from tIRA funds that were taxed before they went into the tIRA....such as can occur in a 401k rollover to tIRA and therefore are now called "nontaxable" and (4) Roth asset earnings.

For (3 - nontaxable), you've already paid taxes before the assets entered the Roth account and are not required to pay taxes or penalty on early withdrawal. That would be consistent with no penalty on direct contributions since taxes have already been paid there as well.

I believe this is correct but hopefully others will confirm.

 

[kaneohe]

Here's my understanding

The table is a Roth IRA Distribution (see title). The assets in the Roth come from (1) direct contributions (2) Conversions from tIRA funds that have not been taxed yet and therefore are called "taxable" (3) Conversions from tIRA funds that were taxed before they went into the tIRA....such as can occur in a 401k rollover to tIRA and therefore are now called "nontaxable" and (4) Roth asset earnings.

For (3 - nontaxable), you've already paid taxes before the assets entered the Roth account and are not required to pay taxes or penalty on early withdrawal. That would be consistent with no penalty on direct contributions since taxes have already been paid there as well.


I believe this is correct but hopefully others will confirm.

Whisper66.........you have the basic idea but I am not sure I understand your example for 3) : 401K rollover to TIRA..........in my mind, you don't pay a tax for that rollover since typically the 401K is a pre-tax contribution and you wouldn't pay a tax to put that in a TIRA.

A taxable conversion is exactly what you said......... a pre-tax (or deductible) TIRA contribution is converted to Roth. You pay taxes on that conversion .....thus the name : taxable conversion.

A non-taxable conversion results when you convert a post-tax (non-deductible) TIRA contribution to Roth. You don't pay taxes on that conversion.....thus the name: non-taxable conversion. If you MAGI is too high, you cannot deduct your TIRA contribution.......this is how you get post-tax (non-deductible) TIRA contributions.

If you have both deductible and non-deductible components in the TIRA, the Roth conversion will consist of components of both (so called pro-rata) so you will have a taxable and a non-taxable component to the conversion. The Roth
withdrawal rules say that the taxable part comes out before the non-taxable so they can penalize you.

 

[hnzw_rui]

One thing I'm curious about, there's a Desired Spending Level parameter when looking at results but for the life of me, I can't find it when filling out the form.

 

[pb4uski]

I think i-orp calculates it. You can adjust it up or down by chaning the estate you want to leave at the end of the projection period.

 

[hnzw_rui]

I think i-orp calculates it. You can adjust it up or down by chaning the estate you want to leave at the end of the projection period.

That's just the thing. You can only adjust spending level by doing a trial and error on estate value but on the results page, there's a specific parameter for Desired Spending Level which I think would be helpful if you need to set a floor for expenses for basic living.

 

[Whisper66]

hnzw_rui - I asked the author (James Welch) recently about that "Desired Spending" on the results page. His response was that ...."it is in there as reminder for me to finish that option someday......"

 

[Whisper66]

Responding to Kaneohe comment....Whisper66.........you have the basic idea but I am not sure I understand your example for 3) : 401K rollover to TIRA..........in my mind, you don't pay a tax for that rollover since typically the 401K is a pre-tax contribution and you wouldn't pay a tax to put that in a TIRA.

You are correct that no tax will be paid on the rollover. The example was maybe not clear. In my personal 401k, the majority of money is indeed pre-tax contribution but there still is a chunk of contribution that was a post-tax contribution. That later chunk was the part I was intending to use as an example. If I roll it into a tIRA, there will be no tax on that rollover. Nor will there be taxes if I convert that part to a rIRA. And if I withdraw it from the rIRA, there will be no tax nor penalty. I think this is all correct but maybe a bad example for others that may not have that situation.

 

[hnzw_rui]

hnzw_rui - I asked the author (James Welch) recently about that "Desired Spending" on the results page. His response was that ...."it is in there as reminder for me to finish that option someday......"

Thanks! Would be nice if we can get that option.

 

[sengsational]

hnzw_rui - I asked the author (James Welch) recently about that "Desired Spending" on the results page. His response was that ...."it is in there as reminder for me to finish that option someday......"

It goes against what i-orp is all about! The whole purpose is for it to optimize your actions so you can end with whatever ending balance you want, and spend the rest! I'd rather he spend his time modeling the ACA into the tax calculations. We already have a "cliff avoidance" , which is awesome.

 

[orplanner]

It goes against what i-orp is all about! The whole purpose is for it to optimize your actions so you can end with whatever ending balance you want, and spend the rest! I'd rather he spend his time modeling the ACA into the tax calculations. We already have a "cliff avoidance" , which is awesome.

What do you have in mind?

 

[hnzw_rui]

It goes against what i-orp is all about! The whole purpose is for it to optimize your actions so you can end with whatever ending balance you want, and spend the rest! I'd rather he spend his time modeling the ACA into the tax calculations. We already have a "cliff avoidance" , which is awesome.

My goal is more to set a spending floor. Imho, some of the other spending models reduces the annual spending in later years way too much.

 

[sengsational]

What do you have in mind?

Does avoiding the ACA subsidy tax cliff really save much? That's the question that I think is important to have answered. Currently, a cliff-on vs. cliff-off i-orp run isn't quite apples to apples because a cliff-on run has a significant reduction in taxes for model years below age 65 that is not credited in the model. For me, $11K for 9 years. For people who will work to age 65 or those who can't qualify for the ACA, this feature would be of no value. But for those of us with years of ACA in our future, it would allow us to see if we really should bother with cliff avoidance.

From an implementation standpoint, the idea would be to have another input: "Annual ACA Premium Tax Credit" (PTC). This would be used if the cliff avoidance option was selected. This field would be defined as the number of thousands of dollars annually that the family would get in tax credits associated with having purchased health insurance from one of the exchanges. Or more succinctly, the number of thousands expected on line 24 of IRS form 8962. That value, indexed by inflation, would reduce the federal income tax for model row ages less than 65 (the ACA doesn't apply to Medicare users of 65 and older). It's a straight reduction in taxes, even allowing taxes to "go negative", meaning the government pays the taxpayer.

Now, the edge cases. These, I think, can be managed or ignored.

What happens when one member of the couple turns 65, goes on Medicare and the other is still using ACA? I suspect that the PTC could be halved and things would work out about right. An alternative would be to have a PTC input value for each spouse. That would be more complicated for the end-user to complete the two fields for most couples, since with the typical a joint policy, the number is not broken out by spouse. The only time it would make a big difference, I think, is if there was one person who was much more expensive to insure than the other (a lot older and/or a smoker). But I'd say halving it would be 95% of the way there, and not to bother with and input for each spouse.

Another edge case would be hot to handle a family size change. The PTC goes down as the kids leave the nest. I'd say this case can be ignored without compromising much; the expected PTC can be set to the forecast for the PTC value of whatever the majority of years will be, or some kind of average determined by the user.

I'm not sure how other i-orp users feel about it, but I think it would be cool to put a tidy dollar figure on what the PTC is worth by comparing one run with, and one run without doing the ACA dance.

 

[H2ODude]

This whole thread, or rather the subject of optimizing tira conversions to Roth gives me a headache. Iorp tells me to pay some really big tax bills for the next 6 years doing conversions; sort of backed up by the FIDO RIP calculator that has my tax bills quadrupling when I hit 70. Sorta frozen in the headlights right now; know I'm going to do something but it's likely not to be full Iorp. I have no question that from this point forward, asset allocation (well, at least within reason) and investment selection will have less of an impact on spendable income/estate remains than will tax strategy. It's a long way from the income earning days when all I cared about was sheltering as much money from taxes as I could. That built us an incredible "nest egg" but unfortunately it's now being held hostage by the tax man!

 

[2017ish]

This whole thread, or rather the subject of optimizing tira conversions to Roth gives me a headache. Iorp tells me to pay some really big tax bills for the next 6 years doing conversions; sort of backed up by the FIDO RIP calculator that has my tax bills quadrupling when I hit 70. Sorta frozen in the headlights right now; know I'm going to do something but it's likely not to be full Iorp. I have no question that from this point forward, asset allocation (well, at least within reason) and investment selection will have less of an impact on spendable income/estate remains than will tax strategy. It's a long way from the income earning days when all I cared about was sheltering as much money from taxes as I could. That built us an incredible "nest egg" but unfortunately it's now being held hostage by the tax man!

We are seeing this train coming down the tracks as well, even as we continue to push as much money into tax deferred accounts as the law permits. Not going to be fun once we start drawing down and converting, but the odds of us ever seeing our present marginal rate in retirement are vanishingly small. Hopefully, the same is true for you.

 

[jabbahop]

I see the same problem but not sure I want to pay a bunch of taxes 10 years early (60 vs 70). What if I sell to start the conversions and pay taxes @ a market high?


Sent from my iPad using Tapatalk

 

[samclem]

Iorp tells me to pay some really big tax bills for the next 6 years doing conversions; sort of backed up by the FIDO RIP calculator that has my tax bills quadrupling when I hit 70.

I'll be doing lots of Roth conversions (up to the top of the 15% bracket, anyway) to minimize the "tax torpedo" caused by RMDs and SS. But I'm not going far beyond that. The projections that have me paying >tons< of taxes at age 85+ generally assume high portfolio growth rates. If that happens, then I'll be happy and our portfolio will have done its job--gotten us to the "finish line" with a comfortable amount of spending money. Right now I'm most concerned about the 30 years from now until age 85, and making sure my portfolio lasts/grows. So, a dollar kept in my portfolio, hard at work and available as a cushion in the possible rough stretches over the next three decades is worth a lot more to me than one I later have to pay to the taxman after I'm comfortably in the home stretch. IOW, I'm eager to improve my chances of success, not to maximize my final portfolio value.

 

[orplanner]

This whole thread, or rather the subject of optimizing tira conversions to Roth gives me a headache. Iorp tells me to pay some really big tax bills for the next 6 years doing conversions; sort of backed up by the FIDO RIP calculator that has my tax bills quadrupling when I hit 70. Sorta frozen in the headlights right now; know I'm going to do something but it's likely not to be full Iorp. I have no question that from this point forward, asset allocation (well, at least within reason) and investment selection will have less of an impact on spendable income/estate remains than will tax strategy. It's a long way from the income earning days when all I cared about was sheltering as much money from taxes as I could. That built us an incredible "nest egg" but unfortunately it's now being held hostage by the tax man!

Before you jump under the bus, caution dictates that you should compare ORP runs with conversions and without conversions. There is a growing body of evidence that conversions don't make any difference in annual spending but they do shift taxes from the end of the plan to the front; i.e. prepaying your taxes. Both models will pay the same amount of taxes, just at different ages. If your plan shows anything different than my conjecture I would sure like to know about it. Please send me a Model Id.

There are several justifications for doing conversions but economics ain't one of them.

 

[orplanner]

...
I'm not sure how other i-orp users feel about it, but I think it would be cool to put a tidy dollar figure on what the PTC is worth by comparing one run with, and one run without doing the ACA dance.

This is an intriguing idea. Anything that affects initial income, particularly as it relates to Federal Taxes should to be considered.

I do have one point that I could stand some elaboration on. Is PTC actually income? Is it credit for out of pocket expenses? PTC reduces Federal Taxes but what about the computations?

I need to be clear on this stuff before I diddle the software. As a non tax expert I need all the help I can get.

 

[sengsational]

This is an intriguing idea. Anything that affects initial income, particularly as it relates to Federal Taxes should to be considered.

I do have one point that I could stand some elaboration on. Is PTC actually income? Is it credit for out of pocket expenses? PTC reduces Federal Taxes but what about the computations?

I need to be clear on this stuff before I diddle the software. As a non tax expert I need all the help I can get.

It's not income. It is a credit to reduce the sting of health insurance monthly premium payments. It just comes in as a credit on the second page of the 1040. The first page results in the MAGI. Then taxes are computed based on that, and that's a number that you have already in the model...thats the taxes computed 'before credits'. So you already have that value as an expense. The PTC reduces that expense. If the PTC is less than the before credits tax, it should be easy to manage that. But since the PTC can exceed what the before credits tax is, you have to allow what remains of the PTC to be non-taxable income. In other words, if my income generates $3k in before credits income tax, and my PTC is $5k, the model would need to set taxes to zero, and chunk $2k into after tax, but not count it as income. Its like the 2k helped pay my bills. Alternatively, I suppose that the model could hang onto the negative amount, keeping it in the tax bucket and apply it to future taxes. But then taxes would be another "account" with a balance, and all that. It seems easier to do an non taxable add to the after tax. Or, since thats probably very uncommon for the kind of person that uses the model, you could just set taxes to zero, and in the help, say, if you have zero taxes, and are running with the PTC "on", you may not have the full advantage of the PTC.

 

[Options]

I'll be doing lots of Roth conversions (up to the top of the 15% bracket, anyway) to minimize the "tax torpedo" caused by RMDs and SS. But I'm not going far beyond that. The projections that have me paying >tons< of taxes at age 85+ generally assume high portfolio growth rates. If that happens, then I'll be happy and our portfolio will have done its job--gotten us to the "finish line" with a comfortable amount of spending money. Right now I'm most concerned about the 30 years from now until age 85, and making sure my portfolio lasts/grows. So, a dollar kept in my portfolio, hard at work and available as a cushion in the possible rough stretches over the next three decades is worth a lot more to me than one I later have to pay to the taxman after I'm comfortably in the home stretch. IOW, I'm eager to improve my chances of success, not to maximize my final portfolio value.

[Emphasis added]

All of this. And text in bold is the extent of my strategy as well.

I've been frugal (but comfortable, and spending lots more in retirement now) for so many years that all calculators say I'll have a bunch of $ left over at plan end, even in the most dire scenarios. So I'm not going to worry about a few $ lost to taxes because I didn't spend months figuring out how to absolutely dodge the tax bullet. 2 out of 3 dollars are in after tax or Roth anyway, so squeezing that last nickel out won't make much difference. I'd rather go dancing, which I'm about to do.