My current plan and two alternatives that might be better

[SecondCor521]

Hi all.

I'm 52, FIREd about 5 years. Single (probably permanently). Three kids: DS26 (graduated/first job), DS21 (college sophomore), and DD19 (college sophomore).

I have a traditional IRA, Roth IRA, and taxable account in roughly a 6:2:1 ratio. My taxable account is about half basis and half gains.

My main goals are to maintain my financial security, pay for my kids' college degrees, maintain flexibility, maintain simplicity, minimize taxes, and donate to charity, in that order.

I have a relatively low cost of living. I live off of my NPI (non-portfolio income - a catchall term of mine for any income not generated by my portfolio, such as side gigs, gifts, tax refunds, and other things like that) which I supplement with occasional sales from taxable.

For the sake of discussion, and not my real numbers, assume I have a lifestyle of $40K and it's $30K NPI and $10K taxable sales (so $5K LTCG and $5K basis).

I also do Roth conversions each year up to a target AGI, which last year sopped up all my non-refundable credits but didn't go beyond that because my federal plus state plus ACA subsidy loss plus EFC loss for two college kids put me at about a 52% marginal rate.

With my current Roth conversion plan, I expect to be paying about 28% at age 75 between FIT and IRMAA surcharges.

This is all working just fine. Assuming historical spending patterns, I should have enough in my taxable and Roth conversion ladder to easily make it to 59.5. Kids' college currently is funded out of their separate college accounts and looks to be overfunded at the moment.

But I have two other plans that might be better. I'd like your opinions on whether they are definitely better or definitely worse, or perhaps deserve more examination.

1. Stop selling taxable. This would enable more Roth conversions and leave taxable for step up. But it would require me to fund that $10K of expenses from my Roth. So I'd need to figure out if this method is sustainable until 59.5. I think it probably is. Assuming it is, I'd need to figure out if the benefits outweigh the loss of tax-free compounding in my Roth on the amounts I would need to take to support my living expenses.

2. Do a baseline SEPP. I could carve off a small chunk of my traditional IRA and do an SEPP for that $10K of expenses for the next seven years or so (instead of using taxable). I would still do Roth conversions from the larger remaining chunk of my traditional IRA to continue hitting my target AGI. The benefit here would be drawing down my traditional IRA further (which is probably a good idea) and preserving taxable (also good), but with some added complexity (having to carve off a second IRA) and lack of flexibility (locked into SEPPs for seven years).

As I write this, I'm already inclined to prefer the second option over the first, and the second option over what I'm already doing, but probably waiting another year or two in order to reduce the loss of flexibility and hopefully have more clarity on where my younger two are in terms of finishing college.

OTOH, since minimizing taxes is a lower stated goal of mine than flexibility and simplicity, maybe I should just forget about the whole thing. I have enough.

Thoughts? Smart? Dumb? Too much hassle?

 

[tulak]

I didn’t see this post until now, or would have responded sooner.

This might be too much of a hassle. You’re asking questions that can only be answered if you model these options. As such, I can only give general thoughts on my approach to minimizing taxes.

I have two long-term goals: maximize Roth and minimize tax deferred accounts balances as much as possible.

Based on this, I don’t like option 1. I never pay taxes in a Roth and it’s the best account for beneficiaries. I’m sure you’ve had your Roths for more than 5 years, so no tax issues for non-spousal beneficiaries. My goal is to not touch the Roth until tax deferred accounts are gone and quite possibly, never (my heirs will be happy).

Option 2 is interesting. It would help reduce amounts in tax deferred accounts. The problem might be the amount is too low to make a difference, especially if you’re already doing Roth conversions (you’re at the max for your tax bracket). This is where I would be curious to know if you can reduce the balance enough to make tax savings at RMDs worthwhile. That requires you model the scenario with your numbers and see how it pencils out. Another benefit to this approach is a reduced inherited IRA for your beneficiaries, which can help them when they have to take distributions over ten years.

My ideal scenario would be to completely drain tax deferred accounts before RMDs. I’m skeptical that’s possible (for me), but I haven’t modeled it yet. I also want my beneficiaries to inherit Roth, taxable, IRAs, in that order. So my goal is to drain the accounts in reverse order.

If you end up modeling this, please update the thread with your results.

I’m still contributing, but one of my goals is to model my distributions in retirement to get a rough idea of how to handle withdrawals tax efficiently. It could be that a SEPP is part of that plan and I’m curious to know if it helps in your situation.

 

[38Chevy454]

I like option 2 from the ease of understanding view, but the SEPP will offset the amount you can do Roth conversions on (assuming using the same tax bracket limits). So in the end it uses up the pretax balance either way, paying taxes as you withdraw or paying taxes when you convert. The loss is the Roth compounding over the 7 years. But the gain is the taxable going up. I would rather have more Roth going up vs taxable going up.



Since you already have the college covered, your decisions are really short and longer term tax reduction. I think using taxable up now is better to allow more Roth conversions. Taxable being (I assume) long term cap gains has favorable tax rate. Taxable also has tax due each year on the dividends and other distributions, whether you like it or not. So might as well spend that money since tax will be due on it. Any extra money needed after that can be the selling long term cap gains. So I guess you could call my version option 3, which is a little like your current process.

 

[RunningBum]

I'm not totally clear on what you're proposing, but #1 sounds like withdrawing from your Roth so you can convert more to your Roth. That doesn't seem worthwhile to me. Money going into that pocket and money coming right back out. I'm going to only dip into my HSA and then Roth if I need extra in a special situation, and don't have room to take more income by selling taxable shares.

If you think you can get all of your tIRA converted, I'd keep using the taxable account, so that the tIRA all gets into a Roth. If not, it seems like a tossup between using taxable money or using a SEPP. I'd go with the simplicity, which is probably to keep doing what you've been doing.

 

[chassis]

I like #2 with the SEPP.

It’s both an increase in flexibility, due to cash liberation from the tIRA, and it has a degree of inflexibility because of the time/age commitment.

I think this helps your high priority goals of college funding and flexibility.

I assume because you have FIREd that your portfolio and guaranteed income sustain you at a macro level, until your demise. Is this a fair assumption?

 

[W2R]

This is all working just fine. Assuming historical spending patterns, I should have enough in my taxable and Roth conversion ladder to easily make it to 59.5. Kids' college currently is funded out of their separate college accounts and looks to be overfunded at the moment.

If it works, don't fix it? You seem to be doing just fine.

 

[SecondCor521]

Replies:

@tulak, you're right, I should model it out. Roughly speaking, though, you're right: The amount really won't be that big in the grand scheme of things. I think it would be about $10K a year delta, times maybe 5 to 7 years, so about $50K to $70K delta. Really not that much. And yes, I am already doing Roth conversions up to my target AGI. I think I'll be doing more Roth conversions in two years or so when my "FAFSA tax" goes away.

@38Chevy454 - yes, the SEPP will affect how much I can do in Roth conversions. But I think of it more as swapping the SEPP for the taxable withdrawals, so it's $10K of SEPP instead of $5K of AGI from a $10K taxable LTCG. So my Roth conversions would have to drop $5K, but the $10K of SEPP means that's still a $5K gain in traditional IRA reduction (which is probably my primary tax-related goal now). Which may mean that the benefit I mentioned in the previous paragraph to @tulak is only $25K to $35K. Hmm, doesn't really seem worth the hassle at that level. And yes, all of my taxable is LTCG at about 50% basis 50% gain. My taxable is in VTSAX, and I take and spend the dividends already.

@RB, yes, part of my additional alternatives could be considered Roth rinsing. But I'm under 59.5, so the valuable part is that I avoid the 10% early withdrawal penalty on any Roth withdrawals because all of my Roth withdrawals would either be contributions or conversions that have met the 5 year rule.

There is no way I can get my traditional IRA all converted - if my projections are right and my investments perform the way I expect, I'll be RMD'ing in the 2x% tax bracket in my 70's and maybe the 3x% bracket in my mid-80's even after my Roth conversions for the next 20ish years.

@chassis, yes, I'm fine regardless. I generally am going along at about a 1% net WR.

@W2R, thanks. That's pretty much the argument for the status quo. Although part of me thinks that if I can give my kids another $10K each or whatever that it's worth the hassle. In the grand scheme of things again, probably won't make that much of a difference to them percentage-wise.

Thanks all! Any additional thoughts welcome.

 

[tulak]

Are you converting up to the 24% bracket now?

It might be worth paying a little more tax now if you expect to be in a higher bracket in your 70s/80s.

That’s the only additional idea I have: pay a smaller amount of tax now instead of a larger amount of tax later. But not sure how this pencils out.

 

[SecondCor521]

^ Sort of.

With two kids in college and having an ACA plan, I look at my tax bracket as federal income tax plus state income tax plus ACA subsidy loss plus FAFSA EFC increase when evaluating how much Roth conversions to do each year.

While my federal income tax bracket is relatively low (paid off home, paid off car, boring life, college payments from 529s generally means low cash flow requirements which means I can maintain a low taxable income), the additional ACA and FAFSA effects means my real total marginal rate is about 52% even if my federal income tax bracket is much lower.

As the FAFSA effect drops off, I'll be able to do more Roth conversions, and when I switch off ACA (at 65) I can do even more. (Of course at that stage it could easily be a matter of too little too late.)

But I've bought into the notion that it really comes down to total marginal rate now vs. total marginal rate later, and in my 70's I'll just have federal income tax plus state income tax plus IRMAA, which at this point look like that will be about 35% at age 75. So each year I'll convert up until my next dollar gets taxed at 35% or so, and I'll rerun the analysis each year with updated info from tax law changes, investment balances, etc.

 

[tulak]

Makes sense. I’m a few years away from having to think about this, but it’s good to read about strategies for when I have to figure this out.

 

[pb4uski]

I like option 2 best as the main objective is to drain as much tax-deferred as possible while in a lower tax bracket.

I was doing option 1 for a while.... actually only a couple months in 2020 and then I ended up selling all of my taxable account equities so it no longer made sense.

Now back to living off of taxable and doing Roth conversions to the top of the 12% tax bracket.