Have Any Of You Tried to Figure Out Your Tax Equilibrium Rate?

[Midpack]

I know this is an imperfect exercise, and I have to assume future tax rates - but I am willing to live with that. At 70 yo, I know when I turn 73 and then DW turns 73, there won't be anyway we can change our tax picture ever again. Just trying to optimize remaining Roth conversions if possible, considering Fed taxes, state taxes, IRMAA and RMDs. "The optimal balancing point really is a balancing point between the two – seeking out an equilibrium rate that accelerates enough income to fill up lower tax brackets today, but still defers enough income to fill up the tax brackets in the future as well."

Odds are I will go through a lengthy process, only to find there was a simple answer - but I enjoy the work and I have time, so why not. At least when I've done exercises like this in the past, when I am done I really understand the answer giving me the confidence to act.

Finding Your Tax Equilibrium Rate When Liquidating Retirement Accounts

The best way to plan around taxes in retirement is not to defer too much income, nor too little, but to seek out and find the equilibrium rate that balances them out,

www.kitces.com

No one wants to pay any more in taxes than they have to, and Judge Learned Hand is famous for stating that, “Anyone may arrange his affairs so that his taxes shall be as low as possible.” Which, in practice, usually entails engaging in tax strategies that minimize (or at least defer) taxes as long as possible. Except the caveat is that when it comes to tax deferral, there really is such thing as being “too good” at doing so, given the progressive nature of income tax brackets (with higher tax rates on higher income levels). For instance, the tax-deferred retirement account that grows so large that, when Required Minimum Distributions begin, the retiree is thrust into a tax bracket higher than he/she ever faced during the accumulation years (or earlier retirement years) in the first place.

Accordingly, the reality is that sometimes the best way to arrange affairs to minimize taxes is actually not to defer them, and instead accelerate the income. With the caveat that if too much income is accelerated, the individual may simply drive themselves into higher tax brackets today, finishing with less wealth than they would have if they simply relied on good old-fashioned tax deferral instead!

Thus, the optimal balancing point really is a balancing point between the two – seeking out an equilibrium rate that accelerates enough income to fill up lower tax brackets today, but still defers enough income to fill up the tax brackets in the future as well. Or what are actually two tax rate equilibria – one for ordinary income (and its 7 tax brackets), and a second for long-term capital gains and qualified dividends (which have their own 4 tax brackets, and stack their income on top of ordinary income).

 

[SnowballCamper]

It seems like I-orp did this (albeit imperfectly with regard to NIIT and IRMAA). One of the reasons I started SEPP was to equalize taxes over the future years.

 

[sengsational]

@SnowballCamper I did i-orp, but haven't found a replacement, and been going by the seat of my pants. Thinking about it here: No RMD Problem to Solve?

Thanks for posting the link @Midpack. I, like you, have the time and don't mind the fiddling.

 

[audreyh1]

Not worrying about it. It’s a complex situation with many factors including the occasional one-off event, not just RMDs. Not trying to equalize. We’ll manage.

 

[USGrant1962]

I do that by stepping through Gumby's annual important trigger income levels post to come up with a sweet spot / equilibrium income level.

Some important "trigger" income levels for 2025

CORRECTED TO POST #_____ Similar to what I did for the last five years, here is a list of important “trigger” income levels for 2025. Numbers are actual AGI/MAGI (i.e. - before standard or itemized deductions) unless indicated as Taxable Income by an asterisk * which means you can add $30,000...

www.early-retirement.org

I'm targeting levelizing my taxable income with future RMDs. Because a large fraction of my stash is in tax deferred I'll probably always be in the 22% income / 15% LTCG brackets (or higher). So my plan is to withdraw or convert tax deferred to approximately fill the 22% bracket while keeping AGI below NIIT, Add'l Medicare tax, and soon IRMAA Level 2.

This strategy needs to be evaluated every year as various brackets and trigger income levels are increased by inflation (or not) and tax laws change.

So I looked at the article after I wrote this, and this paragraph is what I am starting to do:

For more affluent individuals, “just” staying in the 22% or 24% brackets and avoiding the sizable jump to the 32% tax bracket that kicks in at $157,500 for individuals and $315,000 for married couples filing jointly may be optimal. Notably, this also typically aligns with staying in the 15% long-term capital gains rate and trying to avoid the 3.8% Medicare surtax on capital gains that kicks in at $200,000 of AGI (for individuals, or $250,000 for married couples), recognizing that it may be harder for those couples to avoid in the future given that the 3.8% Medicare surtax threshold is not indexed for inflation.

 

[SecondCor521]

I tried for a bit, but the complexity and uncertainty made getting the answer between difficult and impossible.

What I have settled for is an approximate answer based on the "large rocks" - my FIRE stash and it's growth, tax brackets and rates, SS, IRMAA, Roth conversions, RMDs and QCDs.

Basically I project the maximum tax rate I expect to pay between now and 85. I do Roth conversions yearly up to close to that maximum tax rate. I then iterate and update my spreadsheets and plans yearly as things change, so I'm sort of lazily trying to get closer to that equilibrium rate.

After doing this for a few years and looking at the spreadsheet, it seems to me that I can't tell if my equilibrium rate is 21.3784219%, but I can tell that it's around 2x% plus or minus about 3 percentage points.

Since I have more than enough, and my kids will have more than enough, and they don't plan to have kids, I've relaxed a lot about trying to get the exactly correct answer because it really doesn't matter any more. The approximate answer is more than good enough for us.

ETA: It does help that there is usually some obviously good AGI target related to some trigger level that I can aim for. In past years, my tax rate below the AGI target was 1x% and above the AGI target it was 4x%. I use the Case Study Spreadsheet to figure this out each December.

 

[N02L84ER]

We have been not taking any unnecessary income while on an ACA plan because additional taxable income amounts to an 18% to 23% additional "tax". Once we are both on Medicare, we plan to take additional income and/or do Roth conversions up to the top of the second tax bracket. Once we are both receiving SS, we plan to cut back on Roth conversions to stay within the second tax bracket. Once we are required to take RMDs, we will probably stop all Roth conversions. We expect to stay in the second tax bracket until one of us becomes a single tax filer. The survivor will probably move up a tax bracket but probably not for a long period of time.
TL/DR we are levelizing income once we are both on Medicare.

 

[Surewhitey]

I do miss I-orp. At least I have a general understanding of making efficient tax moves by it's short term use.

We've been talking about Roth conversions lately but we are in the 24% tax bracket as we are still in accumulation mode. I'd like to start the minute DW hangs up her hat and especially for her age 65-73 at least to the 22 or 24% rate. We have ~40% in post tax, so we have options.

 

[Jerry1]

I just did something I think is this or similar to it. Me and DW are on SS and with that and my pension, we’re at about $100K (gross). I entered my information in TT and added extra ordinary income in order to model out doing Roth conversions. No matter what I did, I was taxed at around 22%. Every dollar added to the amount of SS that would be taxed so any ability to take advantage of the 12% bracket that I’m technically in was thwarted. I’m 64 and DW is 68 and I was hoping there was still some time left to minimize RMD’s, but while there’s time, there’s no headroom. Never heard it called equilibrium but I guess that’s where I’m at. Now I just need to figure out if I want to place a bet on what my tax rate will be when I hit RMD’s and convert anyway.

 

[sengsational]

Wasn't there a Boglehead sheet that modeled this? I used it a very long time ago, and it seemed overly complicated compared to i-orp, and I couldn't get the two to output anything very close to each other, so I tossed the spreadsheet aside. The Kitces article gives one the concepts, but far from a cookbook. And it's old (2019), so uses old tax law (RMD at 70).

 

[Midpack]

After playing around with the idea this afternoon, I think just developing charts like the ones attached using my own projections and assumptions should give me a good sense of my tax equilibrium at a glance. I’ve maintained income projections 20+ years out starting a few years ago, putting them in chart form will probably work better for me - just how my brain works. I’ll just area graph interest income, Roth conversions, Soc Sec (85%), RMDs (less QCDs) and dividends on top (not taxed as ordinary income) and add the tax bracket threshold lines overlayed. I’ll vary Roth conversions to smooth, since I can’t control the other incomes sources - but DW’s Soc Sec and RMDs are a few years away. I’ll also factor in IRMAA and NIIT. I feel better…I think.

 

[pjigar]

I have an adhoc spreadsheet to decide equilibrium point. You may get some ideas from this. It tries to project future values of everything. It has two sheets with simple and more advanced versions.

RMD Scenarios

docs.google.com

 

[bada bing]

I use Right Capital, a financial planning software package used by CFP's. I bought individual access by a one time fee a few years ago, the log in under my name through the CFP's subscription. I don't have a name for how you could currently get access, but I know there are some financial planners that will do it. It is by far the best for doing this type of future tax modelling that I've seen.

I do Roth conversions up to the top of the 22% bracket. I'm trying to minimize the amount in the 24% (or whatever it becomes) once RMDs start. There isn't a reasonable way for me to escape being in the 24% bracket once RMDs start. A really hot market for the next 7 years would push me permanently over the top of the 24% when RMDs begin.

It's too late for me now, but for anyone younger, be careful of building a tax deferred balance too large, too soon. I should have been doing Roth for the earlier years and a bit into the later years while working. If you save tax deferred too much, too early, natural portfolio growth will carry you right into a higher bracket and undo all your Roth/deferred tax arbitrage plans.

 

[GrayHare]

Not the best Kitces content IMO because it never directly describes either what defines the tax equilibrium rate, or specifically how to calculate it. Best I can tell is one's tax rate reaches equilibrium if that rate is the same both before and after retirement. If that's what Kitces means, I'd have thought he'd write that.

 

[CardsFan]

Not the best Kitces content IMO because it never directly describes either what defines the tax equilibrium rate, or specifically how to calculate it. Best I can tell is one's tax rate reaches equilibrium if that rate is the same both before and after retirement. If that's what Kitces means, I'd have thought he'd write that.

Well, it is almost 6 years old.

 

[GrayHare]

Well, it is almost 6 years old.

Was that before he turned pro? Serious question because I do not know Kitces.

 

[Exchme]

I like the comprehensive models as so many things affect Roth Conversions that it's best to see them all interact in the model. Comprehensive tools do take some effort to learn and set up by their very nature. I've used the two below extensively and trust their answers.

There is a free spreadsheet at the boglehead.org wiki called the Retiree Portfolio Model. It's good on the tax front but a bit confusing if you you have anything complicated and Roth Conversions are very manual, you have to guess a number, root around the program for the likely limits and test those.

I switched to Pralana, which is a paid web app at pralanaretirementcalculator.com (there is an Excel spreadsheet version too, but that's being phased out after next year). Pralana has an an excellent tax package and includes a Roth Conversion optimizer. The Roth Optimizer tests ordinary tax brackets in each year to come up with a plan. I can do a little better than the optimizer by making manual tune-ups, selecting IRMAA tier limits or staying below the LTCG phase-in (or if we were younger, an ACA FPL multiple). To get the most value out of the program you should also select a tax rate for the residual IRA balance in the estate since your heirs will have to pay that. Pralana is the only consumer grade tool I've seen that also tracks your capital taxes when you sell assets. Unless you are flush with cash flow, that's important in Roth Conversions as conversions pull down your taxable account and force you to sell more assets, incurring more lifetime capital gains taxes than doing no conversions.

Those are the only two tools I know of in the market that will allow you to preferentially hold your bonds in tax deferred and your stocks elsewhere. Most tools may allow you to input holding different allocations in different accounts, but don't do the math to allow proper Roth Conversion studies. That will mess you up by recommending huge Roth Conversions. When you tell most tools that you have lots of bonds in tax deferred, they project a low return for tax deferred and a high return for Roth. So they seek better overall returns by doing huge Roth Conversions to get your money out of the "low return" IRA and get it into the "high return" Roth. But of course the investment return didn't change when you made the conversion, the limited programs are just skewing your overall asset allocation toward more stocks and that effect is bigger than the advantage of Roth Conversions, so you get dangerous nonsense for answers. (For the folks pining over i-orp, this shortcoming was the reason so many people complained about it recommending huge conversions).

 

[audreyh1]

Was that before he turned pro? Serious question because I do not know Kitces.

No, he’s been pro for decades.

 

[walkinwood]

I switched to Pralana, which is a paid web app at pralanaretirementcalculator.com (there is an Excel spreadsheet version too, but that's being phased out after next year). Pralana has an an excellent tax package and includes a Roth Conversion optimizer. The Roth Optimizer tests ordinary tax brackets in each year to come up with a plan. I can do a little better than the optimizer by making manual tune-ups, selecting IRMAA tier limits or staying below the LTCG phase-in (or if we were younger, an ACA FPL multiple). To get the most value out of the program you should also select a tax rate for the residual IRA balance in the estate since your heirs will have to pay that. Pralana is the only consumer grade tool I've seen that also tracks your capital taxes when you sell assets. Unless you are flush with cash flow, that's important in Roth Conversions as conversions pull down your taxable account and force you to sell more assets, incurring more lifetime capital gains taxes than doing no conversions.

I started using the excel version of this program earlier this year. There is enough flexibility in the ROTH conversion inputs that you can either ask the program to optimize it for you, and then futz around year to year to see if you can do better or just tell it what you plan to do each year.

There's no way to know if what you do will be optimal till after the fact, but the cost, imho, is nominal especially if playing what-if gives you some joy or peace of mind. I plan to continue the subscription & update the program with my portfolio values each jan and re-evaluate our annual budget & ROTH conversion strategy.

 

[SevenUp]

...especially if playing what-if gives you some joy or peace of mind.

Good point. The question of complexity vs. simplicity in tax prediction is similar to "should I pay down my mortgage or invest?" For both questions, what allows "sleeping well at night" may vary from person to person.

Personally, secondcor521's approximate answer seems best. Some will think that too complicated, and some will think that too simple. Depends on what lets you sleep well at night....

 

[Koolau]

I'm not spending a lot of time w*rking on the issue. I am trying to watch out for IRMAA. Sooner or later - if I should live so long and the markets don't crash - I'm gonna get bit by one or more of the "gotchas" based on total income. Nature of the beast I suppose and just one more 1st world problem.

To the young'uns, now is the time to be thinking about this stuff!

 

[Midpack]

I have an adhoc spreadsheet to decide equilibrium point. You may get some ideas from this. It tries to project future values of everything. It has two sheets with simple and more advanced versions.

RMD Scenarios

docs.google.com

Outstanding work, thanks for sharing!

 

[Midpack]

Wasn't there a Boglehead sheet that modeled this? I used it a very long time ago, and it seemed overly complicated compared to i-orp, and I couldn't get the two to output anything very close to each other, so I tossed the spreadsheet aside. The Kitces article gives one the concepts, but far from a cookbook. And it's old (2019), so uses old tax law (RMD at 70).

I think there was a Bogleheads spreadsheet, I followed its development for a while. It was complicated, and some of the calcs weren’t transparent (partly black box), so I didn’t trust the results - even though the author was probably a LOT smarted than me.

I also thought the Kitces article was a good starting place, and I’m running with that. I have my balances and incomes sources projected out for the next 30 years already, putting that in graph form like Kitces has will be helpful - I shoulda thought of that years ago.

I’ll find the approximate equilibrium, and probably continue to convert a little more now (while staying under the 2X IRMAA threshold) because I assume tax rates will have to go up sometime before I go poof. If I’m wrong, so be it, wouldn’t be the first or last time. I’d rather try to plan as best I can, versus just throwing up my hands.

Lots of good thoughts and insights in posts above as usual, thanks all.

 

[pjigar]

I have an adhoc spreadsheet to decide equilibrium point. You may get some ideas from this. It tries to project future values of everything. It has two sheets with simple and more advanced versions.

RMD Scenarios

docs.google.com

By the way, our equilibrium point is somewhere between 22% and 24% bracket. Like someone said, trying to project an exact equilibrium point is not possible due to several factors. Especially for people like me who are still earning, too many unknowns in the future. So having "some" idea about equilibrium rate is good enough. For me personally, the calculations showed that we will be squarely in the same or higher tax bracket at RMD so we switched all our contributions to Roth/Brokerage accounts since last 3 years. That alone would keep us from jumping in to crazy brackets at RMD. The picture becomes much clear as you near RMD but then again, you can't do much at that point. So having a fuzzy picture from far is far more valuable in this case (pun intended).

 

[mrfeh]

Wasn't there a Boglehead sheet that modeled this? I used it a very long time ago, and it seemed overly complicated compared to i-orp, and I couldn't get the two to output anything very close to each other, so I tossed the spreadsheet aside. The Kitces article gives one the concepts, but far from a cookbook. And it's old (2019), so uses old tax law (RMD at 70).

Retiree Portfolio Model - Bogleheads

www.bogleheads.org

I played with it a bit a couple years ago, and found it too complicated. If one is ready to invest a lot of time, I assume it would be useful.

I signed up for Pralana online last month. Need to spend more time with it before I can review it.

Pralana Online Released - Impressions - Bogleheads.org