Retirement Asset Drawdown Mechanics

[damonhowatt]

Hi all: Back again to tap the knowledge and experience of the forum members. I have a question on the mechanics of how to best utilize/drawdown assets after I leave work. This will be in March/April of 2018 after I achieve my goal of fully funding my HSA for calendar year 2018 with the over-50 catch up provision.


Assets:
1) Taxable Stock Account: $306,000 >>> most of this account is in stocks (90% LTCG status) and 10% cash. Approx. $5600 in dividends generated annually.
2) IRA Account: $414,000
3) Roth IRA Account: $112,000
4) Company 401K: $575,000 >>> 60% cash reserves fund/12% Vanguard Lg Cap Index Fund/28% in multiple Canadian bank stocks
5) Miscellaneous Cash: approx. $35,000
6) Home Equity: approx. $360,000
7) HSA Account: $10,000
8) Checking Account at credit union: ~ $30,000 in cash

Total Liquid Assets (i.e. excluding home equity and checking account):
~ $1,452,000

Estimated yearly expenses: $45,000


I’ve seen the following asset drawdown sequence frequently recommended for individuals who have achieved FIRE status:
1) Taxable accounts
2) Tax deferred
3) Tax free (Roth accounts)

My assets are over weighted towards the tax-deferred side of things: about 70% of total assets are either IRA or 401K. I know I need to convert IRA assets to Roth IRA assets on an annual basis after I achieve FIRE and before the age that RMD’s kick in. I have about 13 years until I must take an RMD distribution. I think that the limit to remain in the 0% LTCG tax rate (for a single filer) is $37,950. Am I correct in assuming the following: I can convert ~ $10,400 (limits of the std. ded. + pers. exemp.) + $32,350 (the remaining balance of the 15% tax rate for earned income) for a total of $42,750. The $5600 in LTCG dividends from the taxable account fills the remainder up to $47,950.


I know from reading here that taxes on the converted IRA/401K assets should not be paid out of the converted assets themselves but rather a second account. Which one of my other accounts should these tax payments come from? Should I sell the necessary amount from the taxable account for this tax payment; that sale of stock will generate a possible tax on it's own right. Or should I pay taxes from the checking account?

My assets are not currently structured to generate income via interest, dividends, or STCG sufficient to cover all of my expenses, so needed amounts would have to come from the sale of equities.

Please let me know if I need to include more information in order for you to advise. I look forward to your replies and advice.

Steve

 

[njhowie]

This will be in March/April of 2018 after I achieve my goal of fully funding my HSA for calendar year 2018 with the over-50 catch up provision.

The catch up provision is for age 55 and over.

 

[pb4uski]

.... Am I correct in assuming the following: I can convert ~ $10,400 (limits of the std. ded. + pers. exemp.) + $32,350 (the remaining balance of the 15% tax rate for earned income) for a total of $42,750. The $5600 in LTCG dividends from the taxable account fills the remainder up to $47,950. ....

Yes, you got it.... except I think it should be $48,350 rather than $47,950

Qualified dividends.........................$ 5,600
Roth conversion...............................42,750

Total income....................................48,350
Standard deduction...........................(6,350)
Personal exemption...........................(4,050)

Taxable income...............................$37,950

Qualified income @ 0%.......................5,600
Ordinary income...............................32,350
...10% rate........................................9,235...........$ 933
...15% rate......................................23,115............3,467
....Total tax............................................................4,400...10.3% of Roth conversion, probably much better than the taxes avoided when you deferred that income... so congratulations.... you won!

And use taxable account funds to pay the $4,400 in tax.

Then each year sell taxable account equities to replenish cash and raise money for living expenses and then in your tax-deferred account sell fixed income and buy equities as needed to rebalance.

Also, change dividend election from reinvest to receive in cash if applicable.

 

[Jerry1]

I'm just getting into the same question you're asking and it was recommended I look at I-orp. (www.I-orp.com). I was a little surprised, but after looking at the summary, it made sense, that I should not follow the sequence you mentioned and that I've also seen before. The recommendation was to take out the Tax Deferred money in the early years and hold off on the Taxable Account and Roth until the end. I'm sure your situation could be different, but it was a good thought provoking tool that was pretty simple to run.

 

[pb4uski]

FWIW, I have always been skeptical of i-orp.... in any event I have been unwilling to write the big checks to the IRS that following their plan would require.

 

[JoeWras]

Hi all: Back again to tap the knowledge and experience of the forum members. I have a question on the mechanics of how to best utilize/drawdown assets after I leave work. This will be in March/April of 2018 after I achieve my goal of fully funding my HSA for calendar year 2018 with the over-50 catch up provision.

Congrats, and welcome to Class of 2018.

As mentioned, HSA catch up is 55+. 401k is 50+. There is a difference.

Fully funding your HSA is an excellent idea, but be sure you are enrolled in an HSA plan for the rest of the year. I'm going to switch plans mid year when I retire, and can only fund my HSA pro-rata for the year.

 

[damonhowatt]

#2: NJ Howie: you're correct. Thanks for pointing out the age; not sure why it's different than the 401K catch up.

#3: pb4uski: I always appreciate reading your comments; very concise and to the point. My IRA is in almost all cash currently. I need to purchase bond funds and equity index funds to make it more efficient. My dividends are all received in cash/not reinvested. My math was off: LOL!!

#4: Jerry1: I'm curious; what was the reasoning for iorp stating you should use the tax deferred money first? It would be interesting to hear the supporting arguments.

#6: JoeWras: I've not investigated yet HSA options for post retirement (another thing to do!). Are you able to switch to a new HSA and not mandated to enter some type of ACA plan?

 

[damonhowatt]

Oh, thank you to all for your comments on my original post.

 

[damonhowatt]

BTW, thank you all for your replies to my original post.

 

[JoeWras]

#6: JoeWras: I've not investigated yet HSA options for post retirement (another thing to do!). Are you able to switch to a new HSA and not mandated to enter some type of ACA plan?

I'm not going to take Cobra and continue the HSA. I'm switching to DW's plan which is not HSA compliant. Therefore, my HSA eligibility will be only part year.

The ACA HSA plans were pretty expensive. If I were to go to ACA in my region, I'd also get out of the HSA. Unfortunately. I like the HSA concept. I've saved up quite a bit over the last 6 years.

 

[Jerry1]

#4: Jerry1: I'm curious; what was the reasoning for iorp stating you should use the tax deferred money first? It would be interesting to hear the supporting arguments.

Still working on fully understanding but I think it has to do with the fact that my spending is right at the 15% tax bracket cut off. Therefore, there doesn't appear to be any value in holding off on drawing from the tax deferred accounts. It also appears that unless I draw down the tax deferred accounts, I will have a bigger RMD. In the chart they produced, I move into the 28% tax bracket in my 70's due to RMD's.

I would not take this to heart without more research, but it seems reasonable to me. It's the first look I've had at potential RMD's and the impact on my tax brackets so I definitely need to evaluate this further.

 

[sengsational]

FWIW, I have always been skeptical of i-orp.... in any event I have been unwilling to write the big checks to the IRS that following their plan would require.

I've run the i-orp numbers in my own spreadsheets and if (and it's a big bunch of "if's") the plan duration is accurate and tax rates don't change, it's hard to see how the results are wrong. But even if things go exactly as i-orp predicts, how much are you saving? If it lets me spend another $500 per year, is it worth the risk of paying taxes early? There is probably some number, if it got big enough, it would be worth the risk of paying taxes early.

So there's the "bird in the hand" situation; we KNOW that we can pay less tax now and only MAYBE pay more later. There might be tax breaks later, and we'd have spent a bunch of money on taxes now. It's hard to get one's head around paying more than we "have to", given we've probably spent our whole life trying to defer paying taxes.

My recommendation is to run a few scenarios in i-orp. There's even a feature that will limit conversions to the top of certain tax brackets. You can run unlimited and also run with those limitations and see what kind of money it's saying you can save. One i-orp recommendation I have is that when you are analyzing your Roth conversions, use a realistic (shorter) plan duration.