Questions regarding retirement withdrawal / tax management

[Russ2020]

Hello,

I am in need of advice regarding how we should start withdrawing from our savings as my wife and I begin retirement. I have read many posts on the board regarding this but was hoping for some advice specific to our situation. There are lots of questions at the end of this post and I appreciate any and all responses.

First, let me explain our situation. My wife is now retired and 64 years old. I will retire next month at the age of 62. We live in a state with no income tax. My wife will start SS 7/1/20 with an annual benefit of $22,222 and I will be waiting until 70. We will begin savings withdrawals January 2020. I am leaving ACA health care out of the discussion for now. We can Cobra for $950 a month. We have a meeting with a broker to discuss ACA possibilities. Our savings accounts are as follows.

Tira – Mine $606,000 Wife’s $452,000 Total $1,058,000
Roth – Mine $215,000 Wife’s $177,000 Total $392,000
Joint Taxable - $315,000 The LTG on this account is $190,000
This is everything. We do not have any other savings accounts.

Dividends from our taxable account for 2019 - (estimated and almost all qualified) $6,320

Income requirement for 2020 - $89,000/year before taxes. This is how I am figuring how to get there.
Dividends from taxable - $6,320
Wife’s SS - $11,111
Sale of assets from taxable - $71,600, estimated LTG $49,404

So if I plug all these numbers into the 1040 Tax Estimation Calculator (https://www.mortgagecalculator.org/calcs/1040-calculator.php 2019) I get the following results. I realize the numbers will change a little bit for the 2020 tax year.

The above yields a total income of $65,168 and a taxable income of $40,768 and $0 federal income tax. This leaves room for Roth conversions. Below are different scenarios.

Roth Convert - Taxable Inc. - Tax Bracket - Effec. Tax Rate - Tax
$38,000 - $78,768 - 12% - 2.32% - $2,396
$50,000 - $90,768 - 22% - 4.89% - $5,636
$60,000 - $100,768 - 22% - 6.66% - $8,336
$80,000 - $120,768 - 22% - 9.46% - $13,736

Questions

Is my methodology correct?

When deciding how much Roth conversion to do, how do you look at it? Is the goal to stay in a low marginal tax bracket? If I do no Roth conversion, my tax is zero. If I convert $80,000, my tax would be 9.46% but my marginal tax bracket would be 22%. Seems to me getting $80,000 into my Roth at a 9.46% tax rate would be a good thing OR should I look at it that converting $80,000 would increase my tax from $0 to $13,736, which would be a 17% tax rate.

I have read the following term on the board “0 percent preferenced tax bracket”. What does this mean?

When selling assets, should I make one big sale at the beginning of the year? Does selling quarterly make doing quarterly tax payments easier? Also, if selling quarterly I would have the ability to make adjustments on the last quarter’s sale to accurately hit any income limit I wanted to stay under.

Is there any circumstance where I might want to start withdrawing from our Tira instead of the taxable account?

Once I have ACA numbers how do I quantify the health care savings versus the loss of Roth conversion headroom? I am guessing I would figure the yearly amount saved for healthcare vs. the loss of Roth conversion tax savings. Seems to be not a black and white calculation.

Any other thoughts?

Thank you in advance for any responses. I appreciate all the posts and responses on the forum. They are very helpful in helping me understand the finances of retirement.

Russ.

 

[RunningBum]

It's a complicated picture, as you know by now. Lots of moving parts. I think you're on the right track with your method. I don't have the time or energy to plug in your options to try to come up with the right solution for you. Instead I'll try to answer your questions and make a couple of extra observations.

When deciding how much Roth conversion to do, how do you look at it?

The goal is to minimize your taxes over your lifetime. Keeping your tax rate at 0% now while paying a much higher rate in later years is probably not the best solution. A level rate across all years is generally a better strategy, with some exceptions. This means you have to estimate what taxes will be like when you are both taking SS and making RMDs. The control you have is to convert some or all of the tIRA before this age to smooth out your taxes.

I have read the following term on the board “0 percent preferenced tax bracket”. What does this mean?

I'm not certain, but I believe it it means keeping all of your taxable income below $78,750 such that LTCGs and qualified dividends are taxed at 0%. If you go above this, not only is the extra amount taxed (probably 12%), but you push that amount in LTCGs into being taxed at 15%, for a marginal tax rate of 27%. When people talk about converting to the top of the 12% bracket, they usually mean to the top of this mark, to avoid making any LTCGs or QDivs from being taxed. If you're going to go beyond this, you might want to go well beyond it to make them all taxable and drop back to the 22% rate and fill that, and maybe 24% too. So one strategy might be to alternate years where you stay under the limit one year, and the next do a heavy conversion to the top of 24%. So this is one of the exceptions to a smooth tax rate through the years.

See the 3 posts starting at http://www.early-retirement.org/for...-conversion-this-year-100754.html#post2324695 for a more complete description of how the 0% LTCG/QDiv rate works, and the higher rate once you overflow it.

When selling assets, should I make one big sale at the beginning of the year? Does selling quarterly make doing quarterly tax payments easier? Also, if selling quarterly I would have the ability to make adjustments on the last quarter’s sale to accurately hit any income limit I wanted to stay under.

I don't think it really matters. I sell when I need it. I leave room at the end of the year to do just enough conversion to stay under whatever my limit is.

For estimated taxes, if you have "safe harbor" (see below), you can do even quarterly payments. Or you can make your estimated payments each quarter based on income realized that quarter. You might need to file tax form 2210 to show this, but that's no big deal.

Safe harbor is:

• If you expect to owe less than $1,000 after subtracting your withholding, you're safe.
• If you pay 100% of your tax liability for the previous year via estimated quarterly tax payments, you're safe. If your adjusted gross income for the year is over $150,000 then it's 110%.
• If you pay within 90% of your actual liability for the current year, you're safe.

Is there any circumstance where I might want to start withdrawing from our Tira instead of the taxable account?


Maybe. A big one is if you plan to leave something behind for heirs. Your heirs get a stepped up basis on the assets you leave, so if you can hold off on selling the shares with the largest gains, they get a new basis and nobody pays the tax on the gain.


Once I have ACA numbers how do I quantify the health care savings versus the loss of Roth conversion headroom? I am guessing I would figure the yearly amount saved for healthcare vs. the loss of Roth conversion tax savings. Seems to be not a black and white calculation.

Yes, that's another complication. It depends on how large your subsidy is. I've had years where it was under $2000/yr. I used those years to make larger conversions or reposition assets in my taxable account to buy funds that have lower distributions, which made it easier to get the subsidy other years. If you can really calculate your overall taxes over your lifetime with various Roth conversions, you may be able to estimate whether taking the subsidy or doing larger conversions is a better play. That's a tricky calculation though, because you have to make assumptions on your investment growth rate and future tax rates, as well as inflation effects on tax brackets and SS benefits. When I see the subsidy for the next year, I decide more on gut feel whether it's worth limiting income for, or skipping and do larger conversions.

In subsidy years, I try to convert to the brink of the ACA subsidy cliff, but make sure I don't go over. You have to do your own calculation to see if it's better to maximize the ACA subsidy and not do Roth conversions.

-----

My summary on the whole picture is:

1) Try to minimize taxes over my lifetime, which generally means trying to keep a level rate of income.

2) Avoid tax cliffs, namely
- The 12+15% tax rate when I push LTCGs/QDivs into being taxed
- Going over the ACA subsidy amount. $1 over can cost you many $1000s.
- Avoiding the SS tax hump, where extra income is not only taxed, but it pushes more of your SS benefit into being taxed. You can search this forum or the internet for more on this. You may be past the SS hump anyway, where SS is fully taxed (max 85% of benefits taxed). This would eliminate this concern.
- Look at IRMA limits, to avoid the smaller cliffs where high income can push you into paying more for medicare.

3) Tax harvest losses to make more room for conversions or ACA subsidies. Keep big gainers to pass to my heirs with a stepped up basis.

I don't try to be precise on all of this, mostly because it involves a lot of guestimating, as I said before. I feel like as long as I try to keep income and taxes more or less even as best I can, I'll be ok. If I under or over estimate conversions, the effect probably isn't big. The important thing is to avoid those cliffs, especially the ACA subsidy. If you go a few dollars over, you can lose a large subsidy with little advantage of doing conversions. So I either make sure I stay under the limit, or decide to blow past and max out conversions that year. Avoid the big mistakes, and don't lose sleep if you can't figure out how to make it perfect, because the uncertainties of the future make that impossible.

 

[RunningBum]

Are you sure about this?

Yes, I am. Or at least I think so. OK, really, it's maximizing my wealth, and the amount I can spend. I don't see these as being contradictory with minimizing taxes at all.

When I started my Roth conversion yes/no quest, I assumed lower taxes would mostly translate to a larger portfolio/more spending. What I found was lower taxes did NOT translate to a larger ending balance - in one scenario I ran federal taxes were 31% lower but portfolio ending balance was only 9% higher. Since my goal was a higher portfolio balance/more spending first, lower taxes with no gain on goal #1 threw me.

Taxes are only part of your expenses, so it doesn't surprise me at all that 31% lower taxes only results in 9% portfolio gain. 9% seems like a big gain. I don't see how you can call that "no gain on goal #1". If you have a $1M portfolio, that's $90K of free money, just by doing some basic calculations and paying off some of that tax liability now before it grows bigger. Sounds great to me!

Though Roth conversions will lower can lower your taxes, you're front end loading your tax payments, and that money is no longer invested for the long haul - so the net effect is small on the portfolio.

Your tax liability grows along with your investments, so front end loading your tax payments is not a negative thing, as long as you aren't paying a higher rate now than you would in the future. This has been proven here before so I'm not going to try again. Some people have this false notion that all the money in a tax deferred account is there. That's like saying I will get 100% of my salary. It's not all yours. Taxes will be paid sooner or later. By converting some of it now and paying the taxes, you are reducing your future tax liability.

I think others who have done the math extensively as I have, found lower taxes don't always mean a bigger portfolio/more spending.

The above is all else being equal. So if future tax rates are higher (as I expect long term), lifetime taxes may be even lower converting now and more beneficial to the portfolio.

And of course there are lots of other variables and caveats, some we can plan for, others we simply best guess.

I'd have to see the math where lower taxes doesn't mean at least a small amount of improvement on your portfolio/spending.

We're agreed that you can't know the whole future, so just go for the more obvious likely big gainers and don't sweat the final details to try to get the extra fraction of a percent that might not be right anyway.

As I've said other places here, I'm on a plan to fully convert my tIRA. If it turns out I'm at a lower tax rate later in life, I won't kick myself because I just don't see that at all likely to happen right now. I'm educating myself and making my best guess and I'll live with that even if I'm wrong.

P.S., I like being challenged like this, because it makes me think harder to make more certain what I'm doing is right. If I'm proven wrong, I'm happy to admit it because I come out ahead by changing my strategy to what is right. So, prove me wrong, if you can.

 

[Russ2020]

Thanks for your help RunningBum. It was a long response and I appreciate the time you invested. I understand it is not likely/possible to get it 100% right. There is much information there I need to noodle. Thank You.

 

[Midpack]

Yes, I am. Or at least I think so. OK, really, it's maximizing my wealth, and the amount I can spend. I don't see these as being contradictory with minimizing taxes at at all.

Please show where I said they were contradictory?

You posted “The goal is to minimize your taxes over your lifetime.” I don’t know anyone for whom minimizing taxes is the primary goal but I know lots of people who are interested in maximizing their portfolio, and reducing taxes is invariably a lever.

I was simply pointing out after weeks of looking at many Roth conversion scenarios, I was surprised at how little of tax savings translates to improving ones portfolio. Note my updated example, 18% less taxes but only 1.1% portfolio ending value, and it takes many years to reach “breakeven” so there’s still considerable risk.

At least I offered up some real actual detailed results versus vague statements.

I won’t bother with the rest...

 

[RunningBum]

Russ, one more factor that others have brought up in other threads is to consider what happens when one of you dies. The survivor will then be filing single, and in a higher bracket. This is another factor in favor of being more aggressive in conversions.