Is this a good strategy

[nun]

I'm planning for ER

I estimate I'll need $30k/year from my after-tax investments, IRA and Roth accounts to live as the house is paid for.
My plan is to live off my after-tax investments until I've drawn them down to about 2 years worth of living expenses.
SS will start around the time that happens, then I'll start taking distributions from the IRA, always keeping in the 15% tax bracket, and leave the Roth for big one time expenses like buying a new car etc.

Is this a sensible way to plan?

I found this technical article on IRA withdrawals and it gives various tax strategies for
allocating funds between IRAs and Roths.

http://www.rothira.com/leibman.htm

I'm not keen on the idea of using a line of credit
to pay the taxes on the rollover to the Roth, even if it is the best financially in the end,
but after all these calculations am I correct in thinking that if the couple only needed
say $30k per year and were therfore in a substantially lower tax bracket, it would make
sense to leave the money in an IRA rather than doing rollovers into a Roth?

 

[brewer12345]

I would do it a bit differently. I would probably draw out $$$ from the traditional IRA up to the top of the 15% bracket. If you can draw more than you need to live on, use it to do roth conversions. Leave the taxable stuff alone if you don't need to tap it. Why?

- The 15% bracket may not be around forever, so take advantage of it.
- Traditional IRAs suck as estate planning vehicles compared to Roths and taxable stuff, so spend them down.
- If you don't make use of the 15% bracket throughout your life, the IRA balance builds, meaning that you will eventually be taking larger sums out at higher tax rates in the future. In an extreme case, you start having to take large RMDs at high marginal rates.

 

[Rustic23]

I have been pondering a similar question. I also thought about drawing down the IRA faster by delaying SS till 70. Seems like the 8% it gains after 66, and the add on COLA it would make since to delay taking SS.

 

[REWahoo]

I have been pondering a similar question. I also thought about drawing down the IRA faster by delaying SS till 70. Seems like the 8% it gains after 66, and the add on COLA it would make since to delay taking SS.

Rustic, we've had lots of discussion on the forum about this very topic. You might want to do a search for "delay SS". The 'financial advice' press has been full of advice on this very subject, including Scott Burns who had columns both pro and con on delaying.

While the numbers do favor you waiting until 70, my personal bias is toward taking SS as early as possible. I suspect I will enjoy x SS dollars at 62 more than I will x+ SS dollars at 70, assuming I live that long (one of my brothers died at age 70). Plus you never know what changes could be made to SS benefits in the next 11 years (I'm 59).

So, I'm gonna take it as soon as I can get it and hope I live long enough to wish I had waited.

 

[maddythebeagle]

If you can take money out of the traditional ira/401k, seems like a good idea to do some every year rather than wait. Your first 10-15k will be taken care of by your standard deduction/exemptions, then you have the 10% bracket if you want to take out some more. Then the 15% bracket. Manage yourself into the 15% bracket so that your dividend and capital gains taxes on your "taxable stash" is the lowest, also.

 

[nun]

I would do it a bit differently. I would probably draw out $$$ from the traditional IRA up to the top of the 15% bracket. If you can draw more than you need to live on, use it to do roth conversions. Leave the taxable stuff alone if you don't need to tap it. Why?

- The 15% bracket may not be around forever, so take advantage of it.
- Traditional IRAs suck as estate planning vehicles compared to Roths and taxable stuff, so spend them down.
- If you don't make use of the 15% bracket throughout your life, the IRA balance builds, meaning that you will eventually be taking larger sums out at higher tax rates in the future. In an extreme case, you start having to take large RMDs at high marginal rates.

Thanks, so using your advice here's my new plan

I'll live off the after tax $$$ until I'm 59 1/2, then, once I can get at the IRAs without 10% penalty, I'll take $$$ from the TIRA making sure to stay in the 15% tax brackett. Should I then also start doing Roth conversions, paying the tax from my after tax investments, so that by the time I get to 70 1/2 the minimum distributions from the TIRA are below some educated guess at what the future 15% tax bracket would be?

 

[brewer12345]

Thanks, so using your advice here's my new plan

I'll live off the after tax $$$ until I'm 59 1/2, then, once I can get at the IRAs without 10% penalty, I'll take $$$ from the TIRA making sure to stay in the 15% tax brackett. Should I then also start doing Roth conversions, paying the tax from my after tax investments, so that by the time I get to 70 1/2 the minimum distributions from the TIRA are below some educated guess at what the future 15% tax bracket would be?

One possible wrinkle: depending on your age and the size of your IRA, you might consider doing a 72T dealie to pull stuff out of the IRA boefore 59 1/2. Why? If your IRA is so large that you will end up with big RMDs (and big tax bills) by waiting to pull from it until age 59 1/2, you might be better off 72Ting it. You'd have to do some spreadsheet work to figure it out though.

 

[nun]

One possible wrinkle: depending on your age and the size of your IRA, you might consider doing a 72T dealie to pull stuff out of the IRA boefore 59 1/2. Why? If your IRA is so large that you will end up with big RMDs (and big tax bills) by waiting to pull from it until age 59 1/2, you might be better off 72Ting it. You'd have to do some spreadsheet work to figure it out though.

Is the 72T the substantially equal distribution thingy?

Is rolling over money from IRA to Roth (any paying the tax from after tax $$$) to make sure the min distributions will keep me in the 15% tax bracket a sensible thing to do?

 

[brewer12345]

Is the 72T the substantially equal distribution thingy?

Is rolling over money from IRA to Roth (any paying the tax from after tax $$$) to make sure the min distributions will keep me in the 15% tax bracket a sensible thing to do?

Yep 72T = SEPP.

Is it "the sensible thing" to do? I dunno. This is all just a calculated bet that includes expectations about what the tax code will look like years in the future. However, its probably not a bad idea to take advantage of low current tax rates to the extent you can do so.

 

[Rustic23]

REwahoo,
Basic problem is size of IRA to convert and other income. I can delay SS and other retirement income untill I am 70. I will be able to convert most of the IRA at 15% however some would have to be converted at 25% each year. If I don't delay SS and other pension income, I incur a rather large sum taxed at 25%.

 

[REWahoo]

If I don't delay SS and other pension income, I incur a rather large sum taxed at 25%.

Everyone's situation is different and you do need to examine all your options and do what makes sense for your circumstances. Someone commented on another thread that he never dreamed he was going to opt for early retirement and end up becoming a tax accountant. (Not that there is anything wrong with that. All you tax accountants out there, we sincerely appreciate your advice on this forum... )

 

[obryanjf]

As I think I read above, to keep in the 15% bracket

Wages+Interest+ Dividends+Capital Gains+IRA will roughly = AGI - Std Deduction - Personal Exemptions = Taxable income

So you want Taxable Income to be 30k + Std Deduction(10k) + Personal Exemptions(3k) = AGI

My point is the AGI can be about 43k given the current variables to stay within the 15% bracket. Of course your std deduction may not be std and your exemptions may be different than mine.

In my case I plan to do a similar strategy and 72t $30,000 from an IRA + Int+Div+CG+small Trust. The rest on my budget will come from taxable accts.

job

 

[nun]

As I think I read above, to keep in the 15% bracket

Wages+Interest+ Dividends+Capital Gains+IRA will roughly = AGI - Std Deduction - Personal Exemptions = Taxable income

So you want Taxable Income to be 30k + Std Deduction(10k) + Personal Exemptions(3k) = AGI

My point is the AGI can be about 43k given the current variables to stay within the 15% bracket. Of course your std deduction may not be std and your exemptions may be different than mine.

In my case I plan to do a similar strategy and 72t $30,000 from an IRA + Int+Div+CG+small Trust. The rest on my budget will come from taxable accts.

job

The $30k is my total living expenses, so I'll just take that and any more that I can from the IRA, up to the 15% limit, I'll rollover into the Roth.

 

[ESRBob]

Nun,
Just to chime in -- (Brewer's got even more detailed advice) but I think you're on the right track. Make a few spreadsheets and run a few scenarios for your unique cases but I am of the opinion that taking Roth conversions early, (now if you can) up to the limit of your 15% bracket, makes sound long term financial sense in the face of uncertain taxes in the future. (I have trouble believing taxes will come down in the face of all the debt and deficit, but hey, ya never know!)

The point is that big Required Minimum Distributions (RMDs) added to Social Security payments can push even modestly well-off retirees into higher marginal brackets.

And, sort of like backgammon, I like to know I've moved a certain number of my pieces 'home' into the Roth, beyond the grip of the taxman (we assume/hope).

Should you go into debt to convert the Roth? Worth considering if you have cashflow for a few more years.

Also, don't worry about getting the numbers wrong and converting too much of your IRA to a Roth in any given year: I just finished re-characterizing my Roth Conversion and it took all of 5 minutes filling in and mailing a simple form from Vanguard.

 

[Martha]

For 2006, the married filing jointly 15% tax bracket tops out at $61,300. With a standard deduction of $10,000 plus personal exemptions for $3200 each, the 15% bracket is pretty generous.

 

[nun]

Nun,
Just to chime in -- (Brewer's got even more detailed advice) but I think you're on the right track. Make a few spreadsheets and run a few scenarios for your unique cases but I am of the opinion that taking Roth conversions early, (now if you can) up to the limit of your 15% bracket, makes sound long term financial sense in the face of uncertain taxes in the future. (I have trouble believing taxes will come down in the face of all the debt and deficit, but hey, ya never know!)

The point is that big Required Minimum Distributions (RMDs) added to Social Security payments can push even modestly well-off retirees into higher marginal brackets.

And, sort of like backgammon, I like to know I've moved a certain number of my pieces 'home' into the Roth, beyond the grip of the taxman (we assume/hope).

Should you go into debt to convert the Roth? Worth considering if you have cashflow for a few more years.

Also, don't worry about getting the numbers wrong and converting too much of your IRA to a Roth in any given year: I just finished re-characterizing my Roth Conversion and it took all of 5 minutes filling in and mailing a simple form from Vanguard.

I ran a few simulations with the following parameters and assumptions and this is what I found

Age 45
expenses until 60 years old covered from after tax investments
Tax bracket 15%
Starting IRA balance 300k
ROTH balance 20k
After tax balance 100k
3% inflation
6% investment return

Senario 1
No rollovers to ROTH
Start taking 35k/year from IRA at 60 years old until 88 inflating by 3% per year

Senario 2
Rollover from IRA to ROTH at amount up to the top of the 15% income bracket each year
pay the tax from after tax funds
Take 35k/year from IRA at 60 years and inflate by 3% per year.
Once IRA is zeroed out take money from the ROTH at same rate until 88 years old

I'm still checking my maths, but initially it seems that if you do the rollover you end up with more total income
over the years, but with a smaller final net worth than if you leave the money in the IRA.

If you add the total income to the final value of the accounts you come out slightly ahead with the Roth rollover,
but it really doesn't make a whole lot of difference.

 

[jdw_fire]

I ran a few simulations with the following parameters and assumptions and this is what I found

Age 45
expenses until 60 years old covered from after tax investments
Tax bracket 15%
Starting IRA balance 300k
ROTH balance 20k
After tax balance 100k
3% inflation
6% investment return

Senario 1
No rollovers to ROTH
Start taking 35k/year from IRA at 60 years old until 88 inflating by 3% per year

Senario 2
Rollover from IRA to ROTH at amount up to the top of the 15% income bracket each year
pay the tax from after tax funds
Take 35k/year from IRA at 60 years and inflate by 3% per year.
Once IRA is zeroed out take money from the ROTH at same rate until 88 years old

I'm still checking my maths, but initially it seems that if you do the rollover you end up with more total income
over the years, but with a smaller final net worth than if you leave the money in the IRA.

If you add the total income to the final value of the accounts you come out slightly ahead with the Roth rollover,
but it really doesn't make a whole lot of difference.

I'm confused, how do you get 15 years of $30k/year for expenses out of a $100k after tax balance?

 

[Nords]

If you add the total income to the final value of the accounts you come out slightly ahead with the Roth rollover, but it really doesn't make a whole lot of difference.

Yep.  The keys are being in a higher (or at least same) tax bracket in retirmeent and paying conversion taxes with funds outside the IRA.

If the simulation isn't complicated enough yet, see how the rise in your AGI from your conventional IRA withdrawals would affect the taxation of your Social Security income.  That's another advantage of a Roth-- those withdrawals don't count against your AGI.  If you pay less tax on your SS then a Roth is a better deal.

To make it still even more complicated, re-do the scenario with various delays in the date that you start SS payments.  Are we having fun yet?

A non-financial advantage to a Roth conversion is that you only have to contend with Form 8606 for a few years instead of having to calculate RMDs for the rest of your life.

 

[nun]

I'm confused, how do you get 15 years of $30k/year for expenses out of a $100k after tax balance?

Sorry, I'm assuming that the 30k/year comes from part time wages. I wasn't really considering
how to fund the 15 years until 60, just the effects of the IRA /ROTH ratios

 

[nun]

Yep. The keys are being in a higher (or at least same) tax bracket in retirmeent and paying conversion taxes with funds outside the IRA.

If the simulation isn't complicated enough yet, see how the rise in your AGI from your conventional IRA withdrawals would affect the taxation of your Social Security income. That's another advantage of a Roth-- those withdrawals don't count against your AGI. If you pay less tax on your SS then a Roth is a better deal.

To make it still even more complicated, re-do the scenario with various delays in the date that you start SS payments. Are we having fun yet?

A non-financial advantage to a Roth conversion is that you only have to contend with Form 8606 for a few years instead of having to calculate RMDs for the rest of your life.

Yes you can have way too much fun with spreadsheets, but I'm not sure the differences I'm seeing are really worth
the effort or worry.

Here's another complication I have, I'll be doing all this from the UK. One wrinkle might be that the ROTH will be better for me because it has the same tax exempt status in the UK as the US, but I'll be in the 20% tax bracket in the UK as opposed to the 15% in the US.

 

[nun]

FYI, Here is a quote form the www.i-orp.com webpage that is in agreement with what I've found from my spreadsheets. Basically the only reason to do a rollover to a ROTH after ER, assuming your tax rate is a costant in retirement, is to give you more control over your funds and to avoid issues with large min distributions.

www.i-opr.com summarizes this like this:

"Analytically, there is little difference between a regular IRA and a Roth IRA, all other things being equal:

V = b(1+r^y) (1-t) is the distribution value of a regular IRA at year y, earning at rate r, starting with before-tax balance b and paying tax rate t.

R = (1-T)b(1+r^y) is the value of a Roth IRA at year y, earning at rate r, starting with before-tax balance b and paying tax rate T at the time of the contribution.

There are 3 cases:

If t = T then V = R and whole thing is a wash. This case occurs when the distribution tax rate (t) is the same as the pre retirement personal income tax rate (T).

If t < T then V > R the Tax-deferred Account provides more retirement funds than does the Roth IRA. This case occurs when income tax rate during retirement (t) is less than during the working years (T). This is the normal retirement situation.

If t > T then V<R and the Roth IRA is a better deal. This case occurs when the distribution tax rate (t) is larger than the tax rate before retirement (T). This is the situation for very young wage earners, graduate students, and the like. Roth IRA savings during this period in a persons working life can have a big payoff."

 

[Nords]

FYI, Here is a quote form the www.i-orp.com webpage that is in agreement with what I've found from my spreadsheets. Basically the only reason to do a rollover to a ROTH after ER, assuming your tax rate is a costant in retirement,  is to give you more control over your funds and to avoid issues with large min distributions.

Well, if someone can whip out a more complicated formula that agrees with our spreadsheets then we must be right.

Tax brackets are just one part of the issue. I think the "math" completely glosses over the issues of Social Security taxation and making an effective additional Roth contribution during the conversion by paying the taxes with funds outside of the IRA. The reason that i-orp.com doesn't bring them up is because it's darn hard to turn into a spreadsheet sound-bite.

That math doesn't even begin to consider the issues of starting a deductible traditional IRA in your teens & 20s (low-income years for most) and then converting it to a Roth before age 70½ ... for example after retirement but before drawing SS. It also doesn't offer any speculation on the direction of tax rates, which are arguably as low as they're gonna get for the next few deficitcades.

It's not a simple issue, and there are not simple answers.

 

[nun]

Well, if someone can whip out a more complicated formula that agrees with our spreadsheets then we must be right.

Tax brackets are just one part of the issue. I think the "math" completely glosses over the issues of Social Security taxation and making an effective additional Roth contribution during the conversion by paying the taxes with funds outside of the IRA. The reason that i-orp.com doesn't bring them up is because it's darn hard to turn into a spreadsheet sound-bite.

That math doesn't even begin to consider the issues of starting a deductible traditional IRA in your teens & 20s (low-income years for most) and then converting it to a Roth before age 70½ ... for example after retirement but before drawing SS. It also doesn't offer any speculation on the direction of tax rates, which are arguably as low as they're gonna get for the next few deficitcades.

It's not a simple issue, and there are not simple answers.

I agree that there is more to consider than the simple calcs as all the caveats and particular circumstances will change the results. One thing though if you pay the tax on the rollovers from other after tax funds the ROTH rollover does win if the tax rate is the same going in as coming out

As my situation will be that I'll drop from the net 25% tax to 15% tax bracket at ER I'll just do ROTH conversions that take me up to the 15% income limit and pay the tax from my after tax account. I should end up a bit ahead financially, but way ahead in financial flexibility by the time I'm 60.

 

[ESRBob]

Nun,
I think your last post hits the nail on the head. The use of taxable funds to pay the tax on the Roth conversions, done up to the limits of your 15% bracket in ER, makes the Roth come out way ahead, especially when you factor in possible RMDs and the overall sense that we are unlikely to pay for baby boomers' retirements with lower taxes in the future!

 

[scrinch]

Nun and ERBob--
Paying the (15%) taxes with after-tax funds is equivalent to contributing an additional 15% (of the rollover amount) to your Roth IRA. So no wonder this scenario comes out ahead in the end! You're able to roll $100K (eventually) from your TIRA, which is subject to taxes upon withdrawal, directly into your Roth IRA, which is not subject to taxes. Really, though, what you have done is taken an after-tax $15K and indirectly add it to the Roth IRA to make up for the taxed portion.

I've been making RMD's from an IRA I inherited from my dad for the last several years. It's not so tough. You make a spreadsheet one time for the annual % withdrawal for the next XX years and then just paste in your year-end balance each January 1. Or have Vanguard/Fidelity calculate it for you. The difficult part for me is paying the 30+% tax on the RMD that I don't need anyway.