Roth Question for FI People

[JBTX]

In our case we were at the 39.6% Fed + 13+% Ca tax brackets for many years. Never sniffed $15% except for the one year after we retired. My spouse's IRA is half of that. I turned mine into annuities and I really only contributed for 18 years because I lived and worked overseas until my relocation. Like what I had posted above, IRA balance really does not have a direct correlation to how much you were paid while working, but it is attributed to contributing to the maximum and hopefully getting a nice company match in the process.

Also, tax rate of 24% when RMD hits does not translate to $200K in RMD, because SS and "pension" add to the income.

Pension would, but social security wouldn’t - not directly. It’s best thought of as taxed in parallel to your regular income and is assessed from a range of other income of about $32,000 up to your combined social security payment, your SS income is not taxed above something around $100k other income max.

https://www.bogleheads.org/w/images/6/6a/SSHeatMapMFJ2023.png

So your social security tax is maxed out well before you reach the 24% bracket

 

[RetiredHappy]

Pension would, but social security wouldn’t - not directly. It’s best thought of as taxed in parallel to your regular income and is assessed from a range of other income of about $32,000 up to your combined social security payment, your SS income is not taxed above something around $100k other income max.

https://www.bogleheads.org/w/images/6/6a/SSHeatMapMFJ2023.png

So your social security tax is maxed out well before you reach the 24% bracket

My point is that if you reach RMD age and you pay 24%, which we do, the RMD amount is only about one third of the amount of the $200K. 80K divide by 4% = $2M. You used $4M to $5M to get to $200K for taxable income.

 

[TheWizard]

Pension would, but social security wouldn’t - not directly. It’s best thought of as taxed in parallel to your regular income and is assessed from a range of other income of about $32,000 up to your combined social security payment, your SS income is not taxed above something around $100k other income max.

https://www.bogleheads.org/w/images/6/6a/SSHeatMapMFJ2023.png

So your social security tax is maxed out well before you reach the 24% bracket

I've no idea what you are trying to say but the issue is whether an income stream adds to your AGI or not.
85% of my gross SS benefit is included in my AGI, along with my annuity income and my RMD, minus my QCD amount each year...

 

[TheWizard]

When discussing tax rates, either marginal or effective, I like to look at the various components of my AGI and decide whether each is "mandatory" or discretionary.
Mandatory for me is:
1) lifetime annuity income
2) SS income
3) RMD income
4) Dividend/interest income

While I'm in the 24% marginal Federal bracket, my effective, or average tax rate is around 16.8 to 17% on those sources. It doesn't matter which income stream came first or is "on top" of another.

Discretionary income at this point would be:
1) Roth conversions
2) QCDs (a "negative" income vs RMDs)
3) income from a (heaven forbid) PT job
These additions (subtractions) to/from AGI need to be considered at my full marginal 24% rate, or even 32% worst case.

I hope this makes sense to everyone...

 

[JBTX]

When discussing tax rates, either marginal or effective, I like to look at the various components of my AGI and decide whether each is "mandatory" or discretionary.
Mandatory for me is:
1) lifetime annuity income
2) SS income
3) RMD income
4) Dividend/interest income

While I'm in the 24% marginal Federal bracket, my effective, or average tax rate is around 16.8 to 17% on those sources. It doesn't matter which income stream came first or is "on top" of another.

Discretionary income at this point would be:
1) Roth conversions
2) QCDs (a "negative" income vs RMDs)
3) income from a (heaven forbid) PT job
These additions (subtractions) to/from AGI need to be considered at my full marginal 24% rate, or even 32% worst case.

I hope this makes sense to everyone...

In terms of evaluating whether a conversion makes sense, you need to compare the marginal rate at time of conversion vs marginal rate in Retirement. Due to taxability of social security, the marginal rate does not neatly follow the tax brackets. The graph I linked illustrates that.


Admittedly taxability of SS is hard to get your head around.

https://www.bogleheads.org/wiki/Taxation_of_Social_Security_benefits

 

[TheWizard]

In terms of evaluating whether a conversion makes sense, you need to compare the marginal rate at time of conversion vs marginal rate in Retirement. Due to taxability of social security, the marginal rate does not neatly follow the tax brackets. The graph I linked illustrates that.

So whether you have $120k of all other non SS income, or $1 million all other non SS income, your social security tax is the same. Once you exceed the social security taxability range, which absolute max is around $100k (less for most) SS income does not play into your marginal rate.

Admittedly taxability of SS is hard to get your head around, it took me years to do it.

https://www.bogleheads.org/wiki/Taxation_of_Social_Security_benefits

You are confused.
Those silly SS heat maps top out at around $60,000 other income (vertical axis), filing Single.
I have more than double that amount of other income.

And taxability of SS income is NOT hard to understand, especially for higher income retirees for whom 85% is taxed from day one.

There are various reasons for doing Roth conversions. Tax rate arbitrage is not the only one...

 

[RetiredHappy]

@JTBX I was responding to your post where you were wowed by the fact that someone paying 24% tax rate when taking RMD means that the person must have $5M in IRA. That is an entirely wrong assumption. You are confused about Social Security amount being taxed or not. At 24% tax bracket, 85% of SS is taxed, and that 85% forms part of the taxable income. So SS + pension + annuities + dividends + RMD gets you to the 24% tax bracket. IRA is not at $5M. If IRA is at $5M, we are looking at 32% and up.

 

[JBTX]

@JTBX I was responding to your post where you were wowed by the fact that someone paying 24% tax rate when taking RMD means that the person must have $5M in IRA. That is an entirely wrong assumption. You are confused about Social Security amount being taxed or not. At 24% tax bracket, 85% of SS is taxed, and that 85% forms part of the taxable income. So SS + pension + annuities + dividends + RMD gets you to the 24% tax bracket. IRA is not at $5M. If IRA is at $5M, we are looking at 32% and up.

ok I think I see what you are saying

 

[somber]

The 24% bracket is somewhere around $200k. At 4% approx RMD $200k Is $5,000,000 IRA balance. Getting $5 million in an IRA with income in the 15% bracket most of your life is a pretty impressive feat.

At age 77 RMD % is 4.37. The RMD amount that takes us above $206K non-dividend taxable income is $181K. But it's not all that impressive a feat on my part - it's impressive what the market's done. I looked at it the other day. I started contributing in January of 1985, into an approximation of total market index. Every dollar I contributed that month is now worth over $83.

Another factor is that while we're no longer adding to our tax deferred balance, we won't be taking distributions (other than Roth conversions and QCDs starting at age 70.5) until RMDs. My asset allocation is 100/0, and I use 7% real return in my modeling. I will be 65 later this year, so this is looking 12 years out, with a doubling of my current TDA balance.

 

[JBTX]

At age 77 RMD % is 4.37. The RMD amount that takes us above $206K non-dividend taxable income is $181K. But it's not all that impressive a feat on my part - it's impressive what the market's done. I looked at it the other day. I started contributing in January of 1985, into an approximation of total market index. Every dollar I contributed that month is now worth over $83.

Another factor is that while we're no longer adding to our tax deferred balance, we won't be taking distributions (other than Roth conversions and QCDs starting at age 70.5) until RMDs. My asset allocation is 100/0, and I use 7% real return in my modeling. I will be 65 later this year, so this is looking 12 years out, with a doubling of my current TDA balance.

I see what you are saying. I would say assuming a 7% real going forward 100% stocks at 65+ is an aggressive assumption and position, but nonetheless if all goes as to your plan the math probably works

 

[RetiredHappy]

At age 77 RMD % is 4.37. The RMD amount that takes us above $206K non-dividend taxable income is $181K. But it's not all that impressive a feat on my part - it's impressive what the market's done. I looked at it the other day. I started contributing in January of 1985, into an approximation of total market index. Every dollar I contributed that month is now worth over $83.

Another factor is that while we're no longer adding to our tax deferred balance, we won't be taking distributions (other than Roth conversions and QCDs starting at age 70.5) until RMDs. My asset allocation is 100/0, and I use 7% real return in my modeling. I will be 65 later this year, so this is looking 12 years out, with a doubling of my current TDA balance.

RMD starts at 75 yo for you, not 77.

 

[JBTX]

RMD starts at 75 yo for you, not 77.

I think he said year 3 is when he gets to 24%. At 7% real growth assumption his Ira balance will continue to grow substantially, in theory anyway.

 

[TheWizard]

...I started contributing in January of 1985, into an approximation of total market index. Every dollar I contributed that month is now worth over $83...

Umm, no.
Total stock market has NOT had a factor of 83 total return in the last forty years.
Try again when you're feeling better...

 

[RetiredHappy]

I think he said year 3 is when he gets to 24%. At 7% real growth assumption his Ira balance will continue to grow substantially, in theory anyway.

I haven't been drinking but it's not in his post. I am definitely having a slow day to be responding to so many posts.

 

[SecondCor521]

Umm, no.
Total stock market has NOT had a factor of 83 total return in the last forty years.
Try again when you're feeling better...

I think he's pretty close.

https://finance.yahoo.com/quote/VFINX/history/?period1=473385600&period2=475891200

shows the adjusted close for VFINX at around $8. It's around $578 now. That's about 72x.

The adjusted close takes into account reinvested dividends, which is what the other poster may be including. If you just look at price appreciation, it's $578 / $20, or about 29x.

(I tried VTSMX first, but Yahoo didn't have the historical data back that far.)

 

[JBTX]

I haven't been drinking but it's not in his post. I am definitely having a slow day to be responding to so many posts.

The majority of my traditional 401k contributions were made at 15% marginal rate. I had a handful of years where my income tipped barely into 25%, before that bracket became 22%. From the projections I've run in several tools (home grown spreadsheets, Right Capital, RPM), if I don't do some fairly aggressive Roth conversions, by the 3rd year of RMDs I will be in the 24% bracket. That's even with us doing some significant QCDs. If my wife and I make it into our late 80s, we hit 32%.

This post kind of started it all - I questioned how he could get to such a high RMD and IRA balance when his income historically has been in the 15% bracket, which obviously limits your contributions. Part of the answer is he is 100% stocks and assume 7% real growth per year going forward

 

[RetiredHappy]

This post kind of started it all - I questioned how he could get to such a high RMD and IRA balance when his income historically has been in the 15% bracket, which obviously limits your contributions. Part of the answer is he is 100% stocks and assume 7% real growth per year going forward

Ah, didn't read that, it's kind of wishful thinking on the growth - a bit of counting the chickens before they are hatched. If he is worried about it tax rate going up, he should be doing ROTH conversionnow,

 

[somber]

Umm, no.
Total stock market has NOT had a factor of 83 total return in the last forty years.
Try again when you're feeling better...

Try it here: S&P 500 Historical Return Calculator [With Dividends] – Of Dollars And Data

I enter start month as January 1985, end month June 2025. Initial investment $1000, with dividends reinvested, investment grew to $83,794.04.

 

[TheWizard]

Try it here: S&P 500 Historical Return Calculator [With Dividends] – Of Dollars And Data

I enter start month as January 1985, end month June 2025. Initial investment $1000, with dividends reinvested, investment grew to $83,794.04.

Fine.
I stand corrected...

 

[JBTX]

Try it here: S&P 500 Historical Return Calculator [With Dividends] – Of Dollars And Data

I enter start month as January 1985, end month June 2025. Initial investment $1000, with dividends reinvested, investment grew to $83,794.04.

While just about anything is theoretically possible, the market appreciating by that factor, again, seems unlikely.

Look at the total stock market capitalization to GDP

The Buffett Indicator: Market Cap to GDP - Updated Chart | LongtermTrends

Market Cap to GDP is a long-term valuation indicator for stocks. It has become popular in recent years, thanks to Warren Buffett.

www.longtermtrends.net

Currently at around 200% of GDP and about twice the long term average and it has only been over 150% since 2000

Future GDP growth will likely be around 2.0% real, with current demographics but let’s be generous and say 3.0% real.

Dividend yield is about 1.25%, but let’s be generous and say 2.0%

7% real - 2% dividends = 5% real growth. This would mean the market cap would continue to grow 2% more than the US economy indefinitely. So that 200% record keeps growing and growing.

If you take 1.25 dividend yield then 7-1.25=5.75, and compare that to a more conservative and likely 2.0% real GDP growth, then the market cap is growing faster than the economy 3.75% every year.

Also, there is plenty of evidence that longer term market returns tend to be more subdued, on average, when starting at high CAPE10’s

I hope I’m wrong and we get 7% real growth going forward, but I’m certainly not banking on it and consider it highly unlikely.

 

[somber]

While just about anything is theoretically possible, the market appreciating by that factor, again, seems unlikely.

Look at the total stock market capitalization to GDP

The Buffett Indicator: Market Cap to GDP - Updated Chart | LongtermTrends

Market Cap to GDP is a long-term valuation indicator for stocks. It has become popular in recent years, thanks to Warren Buffett.

www.longtermtrends.net

Currently at around 200% of GDP and about twice the long term average and it has only been over 150% since 2000

Future GDP growth will likely be around 2.0% real, with current demographics but let’s be generous and say 3.0% real.

Dividend yield is about 1.25%, but let’s be generous and say 2.0%

7% real - 2% dividends = 5% real growth. This would mean the market cap would continue to grow 2% more than the US economy indefinitely. So that 200% record keeps growing and growing.

If you take 1.25 dividend yield then 7-1.25=5.75, and compare that to a more conservative and likely 2.0% real GDP growth, then the market cap is growing faster than the economy 3.75% every year.

Also, there is plenty of evidence that longer term market returns tend to be more subdued, on average, when starting at high CAPE10’s

I hope I’m wrong and we get 7% real growth going forward, but I’m certainly not banking on it and consider it highly unlikely.

My using 7% real is kind of a worst case scenario to see how bad taxes could get for my heirs if I don't do the Roth conversions. But I find that adjusting it doesn't dramatically change the need to do Roth conversions. If I use 6% real, instead of reaching 24% bracket at age 77, it's age 79. If I use 5% real, I hit 24% bracket at age 81.

I don't know what returns are going to be, but I've always been an optimist. It may be why I never considered selling during the several market plunges we've been through since 1985.