Bridging the gap between 65 and 70

[LoveOGG]

When we start taking SS and a pension at age 70 this will cover about 70% of our spending needs and our RMD will easily cover the rest. However getting from age 65 (retirement) to age 70 how do you decide which type of of assets to use?
I know not to touch our Roths and ideally our taxable account should go first. But assuming an average market (let's say 6-7% return for the year) or less, should we take from our bond index funds? And if it is a very good return year (9-15% returns) should we use our equity funds?

Or do we just look at using most of our bond funds for those few years since our SS and pension income will help balance out the remainder of equity and some mixed asset allocation funds in our portfolio?

 

[pb4uski]

What most people do is to withdraw from one or the other during the year and then just rebalance to their target asset allocation (AA) periodically, usually at least once a year.

Another approach is to periodically compare your actual AA to your target AA and then use the categories that you are overweight in for withdrawals... so if your target AA is 60/40 and you are currently 65/35 then withdraw from stocks... or the inverse.

 

[ivinsfan]

Have you run any tax modeling..you will be starting 3 income streams in your early 70s how does that look tax wise.

 

[LoveOGG]

Yes I have. Odds are we will be in the 25% bracket, we are in the 22% bracket now. I talked to our accountant who actually is not a fan of Roth conversions. Basically since we would be losing the growth in our taxable account if we use that money to pay for the conversion. We have an emergency fund (and this year was a great reminder why we have it, even though we didn't need to touch it) but I want that money to be worth 2 years of expenses when we retire (not there yet).

Some calculators I have run says yes we will come out ahead, but I don't' think it's so much that I want to give up our EF savings to do so.

 

[pb4uski]

.... I talked to our accountant who actually is not a fan of Roth conversions. Basically since we would be losing the growth in our taxable account if we use that money to pay for the conversion. ...

Your accountant is misinformed, but in their defense, that rationale is a popular misconception.

Not only will you save 3% difference between 25% later and 22% now, but assuming that you are paying the taxes from taxable accounts you'll also save 22% on the the growth of the taxable account that is lost to taxes every year between when you do the Roth conversion and when you do the tIRA withdrawal.

You also mitigate the risk of tax rates going up, which is likely and the risk of being in a much higher tax bracket if one of you passes early.

Let's take an example of a $25k Roth conversion at 22% tax today vs a withdrawal of the same $25k in 10 years at 25%... and let's assume that the money grows at 6%/year and that the taxes are paid from taxable accounts so you have $5,500 of taxable account money to pay the taxes.

If you convert, the $5,500 taxable account money is gone since it was used to pay taxes but you have $25k in the Roth which grows to $44,771 in 10 years that can be used for spending.

OTOH, if you don't convert the $25k in the tIRA will also grow to $44,771 in 10 years, at which point you will owe $11,193 in tax at 25%. Meanwhile, because the 6% income on the $5,500 of taxable account money is taxed at 22% each year, it only grows at 4.68%... and in 10 years the $5,500 has grown to $8,690. So after you withdraw the tIRA money and pay the tax you only have $42,268 left for spending.

The $2,503 in savings is comprised of $1,343 of tax savings on the 23%/25% tax rate difference and $1,160 of tax savings on avoiding the 22% tax on the growth of the money for taxes in the taxable account.

Would you rather have $44,771 or $42,268?​

Now if one doesn't have taxable account money to pay the tax and the taxes are paid from the tIRA by being withheld from the Roth conversion, then the advantage is only the $1,343 of tax savings on the 23%/25% tax rate difference.

 

[finnski1]

Very sound analysis from pb4uski, pay heed!

 

[ivinsfan]

Yes I have. Odds are we will be in the 25% bracket, we are in the 22% bracket now. I talked to our accountant who actually is not a fan of Roth conversions. Basically since we would be losing the growth in our taxable account if we use that money to pay for the conversion. We have an emergency fund (and this year was a great reminder why we have it, even though we didn't need to touch it) but I want that money to be worth 2 years of expenses when we retire (not there yet).

Some calculators I have run says yes we will come out ahead, but I don't' think it's so much that I want to give up our EF savings to do so.

Unless you care to share some numbers or % of how this shakes out compared with your rough expenses cant really give much guidance It's everything together such as the fact after you hit 70 you will both be paying big Medicare surcharges.

On the so called emergency fund you dont mention if you working or retired. Generally in retirement the EF isn't such a big deal.

 

[LoveOGG]

Thank you everyone for the follow up advice. Our EF is large enough that I decided that I should take the conversion money from there. (Besides that money is earning about 0.75% right now (and will probably do so for the next couple years). So I think that will also make the conversion more appealing.

I was considering converting my SEP account next year. (We will both turn 60 next year) Right now it is about worth $136,000. (None of it is pre-tax contribution money).
We are in the 22% bracket now, and I think we will be in the 25% bracket in the future when the revert the tax rates in 2026.

 

[ivinsfan]

Your EF is in after tax accounts?

 

[LoveOGG]

It's just in our credit union supplemental savings account.

 

[Out-to-Lunch]

I was considering converting my SEP account next year. (We will both turn 60 next year) Right now it is about worth $136,000. (None of it is pre-tax contribution money).

Terms regarding taxation status can be slippery. Can you confirm whether or not you already paid the taxes on the SEP $136k?

I.e., will you have to pay taxes on the $136k when you convert?

 

[LoveOGG]

I don't believe I have paid any taxes on it. I looked at my brokerage acct where it is held and it look like I put in $72,000 to start with in March of 2015. I must of transferred it over from my original brokerage acct where I started it. All I can see our deposits , dividends and capital gains listed.

When I run it through some calculators I think the Roth conversion will run around $35,000 to convert it all.

 

[Out-to-Lunch]

I don't believe I have paid any taxes on it. I looked at my brokerage acct where it is held and it look like I put in $72,000 to start with in March of 2015. I must of transferred it over from my original brokerage acct where I started it. All I can see our deposits , dividends and capital gains listed.

When I run it through some calculators I think the Roth conversion will run around $35,000 to convert it all.

Okay, good. Thanks for clarifying. I think most of us would have said "ALL of it is pretax contribution money," not "none" of it is. Hence my confusion.

I agree with @pb4. Roth conversions, while paying taxes from taxable, is a way to effectively move money from taxable into a Roth, which benefits you. And, unless your tax rates will go down in the future, does no harm.

 

[LoveOGG]

I think when the tax code reverts in 2026 the base for the 25% bracket is around $80,000 (married filed jointly). Our RMD at that point alone should be around $65,000-$80,000, so doing this conversion now will help lower that total as well as adding in our SS benefits and a pension. I can't see how we would avoid not being in that tax range.

 

[Out-to-Lunch]

I think when the tax code reverts in 2026 the base for the 25% bracket is around $80,000 (married filed jointly). Our RMD at that point alone should be around $65,000-$80,000, so doing this conversion now will help lower that total as well as adding in our SS benefits and a pension. I can't see how we would avoid not being in that tax range.

Yes, I agree. Good!

Also, I have to always mention the unpleasant fact that there is no guarantee you will be taking your RMDs while MFJ. Single tax rates are, of course, much higher.

 

[LoveOGG]

Is our yearly taxable bracket based our total income including the cost of the Roth conversion(Gross total)? Or is our next year's tax bracket based on total income (plus the conversion) after all our deductions (Net total)?
I don't want to get pushed into a higher bracket due to the conversion, though I know I can do it over a two year span if needed.

 

[walkinwood]

Get a copy of turbotax and enter your best estimates of your income, cap gains etc in there. Then you can model the effects of a ROTH conversion. There is so much interconnection between different aspects of taxation that it is easy to miss something in your calculations.


Depending on your income/cap gains this year, a portion of your ROTH conversion could be at 0%, 12% - that does not seem to be the case once you get SS & pensions.


Good luck - and remember these are good problems to have

 

[Out-to-Lunch]

Good advice from @walkinwood. But the simplest way to think about it is that any money you convert counts just the same as if you had that much more income for the year.

So, in your language, I think that is the "net total" case.

 

[pb4uski]

Is our yearly taxable bracket based our total income including the cost of the Roth conversion(Gross total)? Or is our next year's tax bracket based on total income (plus the conversion) after all our deductions (Net total)?
I don't want to get pushed into a higher bracket due to the conversion, though I know I can do it over a two year span if needed.

Taxes (and tax brackets) are based on tax return taxable income which would include pensions, SS, capital gains, Roth conversions less deductions.

A handy tax calculator is https://www.dinkytown.net/java/1040-tax-calculator.html

 

[TheWizard]

I bridged a seven year gap from age 63 to age 70 (this year).
I devised a pension/annuity to cover the bulk of my expenses at age 63 and then withdrew an additional $3000/month from tax-deferred 403(b) in lieu of SS.
I soon realized I didn't need that entire $3000/month in my checking account so I changed $1500/month to be a Roth conversion.

Also, I left my 403(b) account fully invested over that seven year period; no savings account or MM account holding X months of expenses.
My monthly withdrawal from my 403(b) was done "pro rata" which left my AA unchanged, about 55% stock funds.

I did aim to keep around $10k in my checking account to deal with lumpy expenses. Excess income beyond that got invested in my taxable account...