Retirement Tax Planning - Income Optimization?

[Midpack]

I understand your reasoning for converting up to the 22% bracket. My question is what account will you pay for the conversion with. Will it be taxable account or the IRA account itself? I seem to remember in the thread that you had a significant quantity of LTCG's. How are you paying for these conversions?

Indeed I am sitting on a large chunk of LTCGs, but I also have a sizeable cash allocation. So I’m paying taxes from taxable cash to maximize what remains in IRAs. If you have to sell assets from taxable and generate capital gains to pay estimated taxes, you’ll have to see how the math works out versus paying taxes from your IRA.

It's usually considered a good idea to avoid using the funds that are being converted from within your Roth to pay the tax on a conversion. By doing so, you will have less left in the account to potentially grow tax-free and, if you are under 59½, you'll also incur the 10% penalty on the amount you don't convert to the Roth IRA.

 

[RetireBy90]

Midpack and others, I've been thinking of the accepted wisdom of using taxable accounts to pay the taxes on Roth conversions. I'm about 90% of the way to accepting this as part of my conversion plans. However, my goal is to reduce future tax liability. To accomplish this, I want to reduce the TIRA accounts before RMD and before potential tax rates of 2026. Given this, if I pay taxes from IRA withdraws this will reduce the amounts subject to RMDs and future taxes. So on the one hand this will require more taxes today but less in the future.

 

[audreyh1]

I think if you are doing Roth conversions to reduce future RMDs, and your taxable investments are limited, and you are older than 59.5, then paying taxes from the conversion is certainly an option. It doesn’t matter so much if you haven’t optimized your Roth returns. You have to take the size of your taxable accounts and other incurred taxes into account too.

 

[RunningBum]

It seems to me if you have enough money to pay taxes from taxable, and are limited in how much you can convert to Roth each year (because of MAGI limits for subsidy or trying to keep under the top of a certain tax bracket), you should convert all you can, rather than convert most and withdraw some for paying taxes.

Withdrawing money from a tIRA to pay taxes on the conversion is the same as converting the full amount, and then withdrawing some of that converted money from the Roth to pay the taxes. Why would you withdraw from a Roth to pay taxes if you have enough money in your taxable account to pay them?

 

[RetireBy90]

It seems to me if you have enough money to pay taxes from taxable, and are limited in how much you can convert to Roth each year (because of MAGI limits for subsidy or trying to keep under the top of a certain tax bracket), you should convert all you can, rather than convert most and withdraw some for paying taxes.

Withdrawing money from a tIRA to pay taxes on the conversion is the same as converting the full amount, and then withdrawing some of that converted money from the Roth to pay the taxes. Why would you withdraw from a Roth to pay taxes if you have enough money in your taxable account to pay them?

Just to come clean, my IRAs are 89% of total liquid investments and TIRA is about 70% of total IRA assets. I could pay taxes from taxable assets and probably will for a couple years at least, but I'm concerned a bit about drawing down too much from taxable to pay the taxes and then be left with only the Roth IRA. So where is the problem I ask myself. No good answer at this time


Just lots of things bouncing around my head. I certainly want to get the IRAs into Roth by 2025 if I can accomplish reasonably.

 

[Montecfo]

Just to come clean, my IRAs are 89% of total liquid investments and TIRA is about 70% of total IRA assets. I could pay taxes from taxable assets and probably will for a couple years at least, but I'm concerned a bit about drawing down too much from taxable to pay the taxes and then be left with only the Roth IRA. So where is the problem I ask myself. No good answer at this time


Just lots of things bouncing around my head. I certainly want to get the IRAs into Roth by 2025 if I can accomplish reasonably.

Just to amplify Runningbum's point, you could withdraw your Roth funds tax-free in the future if needed, rather than, in effect, withdrawing them now by paying taxes from TIRA funds.

 

[RetireBy90]

Just to amplify Runningbum's point, you could withdraw your Roth funds tax-free in the future if needed, rather than, in effect, withdrawing them now by paying taxes from TIRA funds.

I understand that, my concern is rising tax rates to come and paying the tax today and be free to spend without tax concerns. I am in 22% bracket now and will be converting some in the 24% bracket. I will pay now at 24% rather than later at 22% if rates don't change. Seems to me to be a small cost that has a large upside if taxes return to historical rates.

 

[Perryinva]

It is much easier when you are already 60+ and have no ACA. Convert and pay from AT so there is very little after tax left. Draw from Roth at will as needed.

 

[SevenUp]

I will pay now at 24% rather than later at 22% if rates don't change. Seems to me to be a small cost that has a large upside if taxes return to historical rates.

Yes, if rates don't change there will have been a cost if you paid the taxes from the IRA.

If the taxes were paid from cash on hand, converting at 24% now might beat converting at 22% later. See discussion about the breakeven future withdrawal tax rate.

 

[Midpack]

Yes, if rates don't change there will have been a cost if you paid the taxes from the IRA.

If the taxes were paid from cash on hand, converting at 24% now might beat converting at 22% later. See discussion about the breakeven future withdrawal tax rate.

Great link/read thanks, though mostly about where to put IRA money initially - trad vs Roth, not conversions per se. Some applies, some doesn’t.

 

[corn18]

Just ran the numbers for our projections and it looks like we can be 100% Roth by around 70 if we convert to the top of the 12%/15% bracket. I'm not sure I will let my taxable go to zero, but it's good to see the data.

 

[RunningBum]

Just ran the numbers for our projections and it looks like we can be 100% Roth by around 70 if we convert to the top of the 12%/15% bracket. I'm not sure I will let my taxable go to zero, but it's good to see the data.

I'm not letting my taxable go to zero as long as I still have money because I have some shares with very large gains, so it'd be better to leave those to my heirs so they can get step-up basis. If not for that, as long as I could start tapping the Roth, it wouldn't bother me to have all my money in a Roth. Why not? It grows tax free, and you can withdraw tax free. You don't have to play any harvesting games or hold onto shares to get LTCG status, or limit what you withdraw because of the tax impact.

Whether it would really make sense to convert everything to Roth in that case is another question, because the long term tax analysis may have you keeping some taxable income of some sort in the later years rather than paying higher taxes earlier. I'm just saying that in general, 100% Roth is not in itself something I'd avoid.

 

[bingybear]

It is much easier when you are already 60+ and have no ACA. Convert and pay from AT so there is very little after tax left. Draw from Roth at will as needed.

I have only 1 of the attributes you identify and I find it quite easy to do. It does help when it makes logical or financial sense.

People's situations are different so it is often hard to understand without that knowledge.

 

[brett]

Met with our FA this past Thursday. One of the objectives was to get estimated tax data in order to make final investment and tax decisions before the end of the year. Our FA is also a CPA with a tax specialty so this helps. Income, capital gains, dividends etc. on a ss with prior year numbers and a discussion about the final numbers.

We always review our situation for tax planning in the current year and the following year. Have done so prior to and after retirement. Don't mind paying taxes, just want to minimize them where possible through good tax planning.

 

[tenant13]

I apologize if that was mentioned already - I did go through the entire thread but forgot some details: does Income Strategy have access to my banks/brokerages/CC accounts logins and can update dynamically if I'm subscribed to it? I just watched a demo for the Right Capital software and unless I missed something it requires manual input. A drag. Another thing: of all the financial tracking websites (Personal Capital, Mint etc. my favorite is Fidelity Full View - powered by eMoney - it looks clean and tracks individual holdings within accounts, a great help if you're looking for rebalancing suggestions. Provided Income Strategy can pull the data from outside sources, would that include holdings or just totals?

 

[Midpack]

I apologize if that was mentioned already - I did go through the entire thread but forgot some details: does Income Strategy have access to my banks/brokerages/CC accounts logins and can update dynamically if I'm subscribed to it? I just watched a demo for the Right Capital software and unless I missed something it requires manual input. A drag. Another thing: of all the financial tracking websites (Personal Capital, Mint etc. my favorite is Fidelity Full View - powered by eMoney - it looks clean and tracks individual holdings within accounts, a great help if you're looking for rebalancing suggestions. Provided Income Strategy can pull the data from outside sources, would that include holdings or just totals?

From IS:

 

[pb4uski]

Yes, Income Strategy can link to your investment accounts... or you can enter in tickers and counts or aggregate amounts.

 

[RME1958]

That was my first and biggest reservation as well. IMO no one in their right might would wholesale sell all their holdings and buy other holdings (some in the same asset classes), much less in one fell swoop - the cap gains tax hit is mind boggling of course.

It took me almost two weeks to figure out how to stop that “feature,” so I can save you some time, though there may be a better way.

Sounds like you have your initial profile, inputs and settings done.

Go to Manage>Investment Management. You'll see four top level options - Premium, Vanguard, Custom and None. Just choose None and your holdings will remain as is throughout your retirement, only selling to meet spending, tax and distribution-conversions $ needs if any.

That's still not ideal, but it stops the silly first year cap gains taxes.

FWIW.

I signed up for the $20 Income Strategy and have been playing around with it for a couple of days. I have inputted my assets and straightened out some of them. I followed your Settings from one of your previous posts. I tried the Investment Management - None - but still end up with the crazy first year excessive capital gains. What I did find was that by changing the Setting from rebalancing Annually to Never, I was able to greatly reduce the first year capital gains.

I have 1/3 assets in taxable and pretty much 2/3 in TIRA. I do have a relatively small Roth. I have 4 years until Medicare and I am looking at Cobra for next year and then 3 years of ACA tax credits. I am in pretty good shape with cash to keep my MAGI below $65k for my wife and I. My debate is what to do next year in terms of Roth conversion or depleting an Inherited IRA in order to make more room under the $65k. I am also debating whether it is better to do Roth conversions in lieu of the ACA tax credit.

I was considering having one of the $125 sessions with one of the Income Strategy experts but from everything I know/read, the math says to do big early Roth conversions but the mind says no way. I'm curious as to what they will say, I just don't know if it will really make that much of a difference in the long run.

 

[rayvt]

I just don't know if it will really make that much of a difference in the long run.

I do not see how it could make a difference in the long run.

The IRS has a claim on X% of your IRA. It's either X% of your account today, or X% of the (presumably grown) account in the future.
Either way, your after-tax account value in the future will be the same.

Paying the tax on a conversion with outside money doesn't change this. It's just adding money to the account and pretending that you didn't add money.

 

[Midpack]

I do not see how it could make a difference in the long run.

The IRS has a claim on X% of your IRA. It's either X% of your account today, or X% of the (presumably grown) account in the future.
Either way, your after-tax account value in the future will be the same.

Paying the tax on a conversion with outside money doesn't change this. It's just adding money to the account and pretending that you didn't add money.

If tax rates stay the same you’re probably right, but I don’t think there’s any chance they’ll stay the same. The more confiscatory they become in the long run, the more you could save in taxes and increase your final ending balance. In addition (from a previous post of mine in another thread):

I just went through all this, and I think the advice above is sound. But even if your ending portfolio value doesn’t change much with or without Roth conversions, there are other reasons to consider conversions:

• You think tax rates will increase for your bracket at withdrawal time.
• A Roth has advantages for your heirs to inherit.
• The extra income from RMDs of a traditional IRA will push you into higher tax Brackets.
• If one spouse dies, traditional IRA RMDs would push the remaining spouse to a higher bracket.
• Phaseouts and benefits based on AGI and MAGI could push you into a higher bracket with a Traditional IRA.
• More money in a Roth lowers your AGI which may make less of your social security taxable.

If none of these apply, then you probably don’t have any reason to convert...

 

[RME1958]

I am not considering a future change in tax rates. They may go up and they may go down. 5 years ago, I doubt anyone would have predicted the reduction that took place. For my analysis, I assume that they will stay as they are now, knowing that they will most likely change one way or the other. Also, if they do go up, I assume that one will have at least one tax season to take action before the effect of the new rates.

Due to the stepped nature of the tax brackets, I believe that by recognizing income to bring one up to the bottom of the next tax bracket may reduce taxes in the RMD years. This is why the change in brackets from married to single is probably the biggest thing to think about.

 

[RetireBy90]

I am not considering a future change in tax rates. They may go up and they may go down. 5 years ago, I doubt anyone would have predicted the reduction that took place. For my analysis, I assume that they will stay as they are now, knowing that they will most likely change one way or the other. Also, if they do go up, I assume that one will have at least one tax season to take action before the effect of the new rates.

Due to the stepped nature of the tax brackets, I believe that by recognizing income to bring one up to the bottom of the next tax bracket may reduce taxes in the RMD years. This is why the change in brackets from married to single is probably the biggest thing to think about.

I have to agree with your last point about change in brackets from married to single. If you disregard all the other points quoted in midpack's recent post this is enough for me to convert. Bold in quote is my doing.

 

[tenant13]

I read through the learning center on the Income Strategy page (https://www.incomestrategy.com/wp/learningcenter/) and the case under: Roth Conversion: Single, Age 62 with $1,500,000 of assets makes it pretty clear that the best strategy for ROTH conversions would be an occasional conversion of some funds.
And to slightly change the subject, I'm also eyeing access to the RightCapital software. It's a one time expenditure of $150 (and the risk that the guy using it will shut his business down along with the access) but using the software seems fairly well documented on youtube. So between $20/month + $125 phone call and $150 + youtube tutorials it looks like a wash.
BUT... as I was watching the video explaining how to calculate ROTH conversion, comment below stated: "the software doesn't allow you to pick from which account to pull income from, which stinks. It'll default to taxable first, tax deferred second and then Roth."

That's 70% of what I want to learn from financial software. How does Income Strategy deal with that? Ideally I was thinking about something like this: https://www.fidelity.com/viewpoints/retirement/tax-savvy-withdrawals

 

[tenant13]

Can Income Strategy create different withdrawal strategies and shows the effect of them on taxes? (https://www.fidelity.com/viewpoints/retirement/tax-savvy-withdrawals)

 

[Midpack]

I read through the learning center on the Income Strategy page (https://www.incomestrategy.com/wp/learningcenter/) and the case under: Roth Conversion: Single, Age 62 with $1,500,000 of assets makes it pretty clear that the best strategy for ROTH conversions would be an occasional conversion of some funds.
And to slightly change the subject, I'm also eyeing access to the RightCapital software. It's a one time expenditure of $150 (and the risk that the guy using it will shut his business down along with the access) but using the software seems fairly well documented on youtube. So between $20/month + $125 phone call and $150 + youtube tutorials it looks like a wash.
BUT... as I was watching the video explaining how to calculate ROTH conversion, comment below stated: "the software doesn't allow you to pick from which account to pull income from, which stinks. It'll default to taxable first, tax deferred second and then Roth."
That's 70% of what I want to learn from financial software. How does Income Strategy deal with that? Ideally I was thinking about something like this: https://www.fidelity.com/viewpoints/retirement/tax-savvy-withdrawals

There are several options with Income Strategy: