Withdrawal Phase Modeling -- Any Suggestions?

[ERD50]

The taxed twice part (actually two taxable events) would be caused by needing to turn around and sell some of the fund you recently reinvested in - due to rebalancing or withdrawal or both. .....

That's still not "being taxed twice" on the dividends (or I am very confused).

Sure, if I reinvest the dividends, and the investment has a gain when I sell, I pay tax on the gains (depending on my tax bracket, they may be a "0%" tax rate).

But it is irrelevant whether those shares were purchased with dividends or any other money. It appears you are conflating the two.

The dividends are taxed. Gains are taxed. Two independent events.

-ERD50

 

[RunningBum]

That's still not "being taxed twice" on the dividends (or I am very confused).

Sure, if I reinvest the dividends, and the investment has a gain when I sell, I pay tax on the gains (depending on my tax bracket, they may be a "0%" tax rate).

But it is irrelevant whether those shares were purchased with dividends or any other money. It appears you are conflating the two.

The dividends are taxed. Gains are taxed. Two independent events.

-ERD50

Agree. If you took those dividends and instead invested them in a money market, you wouldn't say the dividends are "being taxed twice" even though the money market earned taxable interest. Once your dividends are taxed, they no longer exist as dividends, it is just money and anything earned off that money can be taxed.

 

[Chuckanut]

I've been looking at tax strategies over the years with an eye towards avoiding the Tax Torpedo that will hit when I collect SS at 70.

I can't avoid it. It's the way I structured my retirement. Even if I could go back in time and change things, would I end up significantly better off than I am now? That is highly questionable. I could scream that it is unfair, punishing me for making certain choices I made over my working career, but I knew what I was doing. And, if I didn't, there's nobody else to blame but me.

The biggest mistake would be to spend valuable time fretting over the Tax Torpedo instead of doing things like playing with the grands, spending time with friends and getting in some new travel experiences.

 

[sengsational]

It's been a few years now so I can't really remember, but it seemed a little off in what I wanted to do, and I don't think it factored in managing MAGI for the ACA subsidy, at least not when I tried.

It (i-orp) does now. I'm not sure how active James is with legislative changes now, but a few years ago, I suggested it and he worked it into the optimization.

I'll check out i-ORP, but I remember working with that a long time ago, and as I recall, it didn't get me where I think I want to be.

I always recommend that you keep your equity percent the same across all tax buckets, otherwise it will pull preferentially from the lower expected rate of return bucket. Presuming you'll do asset allocation across all buckets, you want the driver to be taxes, not expected rate of return.

With respect, I think this (minimizing taxes) is fundamentally wrong.

I agree that minimizing taxes shouldn't be the goal...it should be having the most to spend. That is what i-orp optimizes. Taxes are a big part of it, but I've found that under certain assumptions about return on equities, inflation, initiating SS, etc, I can pay MORE taxes and concurrently I can spend MORE.

 

[RunningBum]

I always recommend that you keep your equity percent the same across all tax buckets, otherwise it will pull preferentially from the lower expected rate of return bucket. Presuming you'll do asset allocation across all buckets, you want the driver to be taxes, not expected rate of return.

I mostly follow the Bogleheads tax-efficient fund placement. If I have to sell for living expenses and take LTCGs I think that works better than taking non-qualified dividends from bond funds. I do have a CD ladder to provide my yearly expenses until 65, when I can stop worrying about MAGI and the ACA subsidy. Trying to optimize the whole tax/subsidy picture (really, wealth, as Old Shooter says), not just minimize taxes on withdrawals.

 

[Midpack]

Starting 8 years ago I read and fretted about it for several years, tried i-ORP, Bogleheads XLS, etc., and finally did my own elaborate spreadsheet only to conclude the most I could do was try to keep keep taxable income the same for the rest of our lives while providing the required $ for annual spending, as others have noted. There are some large unknowns (e.g. future inflation, returns, tax rates) and lots of variables (WR req'd to meet spending, someone who needs 4% is very different from someone who needs 2%) that could apply to each of us, but I've yet to see a case where attempting to keep taxable income constant wasn't central to the underlying best answer. So that's what I'm doing, spending down from taxable and deferred until we reach 70 where RMD and SS will eliminate most of our options. If there's a more sophisticated calculator or resource, I'd be most interested but I don't see how it would be possible given the unknowns.

Here's the result (in graph form) I came up with using my own spreadsheet years ago, very roughly what we're doing but I never expected it to be perfect. It's of little to no use to anyone else except maybe as an illustration.

 

[audreyh1]

That's still not "being taxed twice" on the dividends (or I am very confused).

Sure, if I reinvest the dividends, and the investment has a gain when I sell, I pay tax on the gains (depending on my tax bracket, they may be a "0%" tax rate).

But it is irrelevant whether those shares were purchased with dividends or any other money. It appears you are conflating the two.

The dividends are taxed. Gains are taxed. Two independent events.

-ERD50

Not exactly. If someone is not careful when selling the amount reinvested in a fund, they may sell lower cost basis shares realizing a taxable gain they didn’t have to. This would be common if they are automatically set to FIFO the usual default when selling mutual fund shares.

 

[HI Bill]

That's still not "being taxed twice" on the dividends (or I am very confused).

Sure, if I reinvest the dividends, and the investment has a gain when I sell, I pay tax on the gains (depending on my tax bracket, they may be a "0%" tax rate).

But it is irrelevant whether those shares were purchased with dividends or any other money. It appears you are conflating the two.

The dividends are taxed. Gains are taxed. Two independent events.

-ERD50

While they are independent events, reinvesting dividends, then withdrawing money from an investment results in TWO taxable events (one for the dividends, and one for the second distribution). If you just spent the dividends, you'd only have one taxable event, and pay less in taxes. This is why VG, and most others, generally say you shouldn't reinvest your dividends in retirement when you're needing income. Spend the dividends first, minimize your taxes. Unless you're in the 0% LTCGs tax bracket or you're selling at a loss, I can't see any way in which reinvesting, then distributing doesn't increase your tax liability, as you're exposing gains in addition to the dividends, to taxes.

 

[HI Bill]

Not exactly. If someone is not careful when selling the amount reinvested in a fund, they may sell lower cost basis shares realizing a taxable gain they didn’t have to. This would be common if they are automatically set to FIFO the usual default when selling mutual fund shares.

Correct, and even if you're using average cost, you'd still be paying more in taxes than if you'd just withdrawn the dividends.

 

[pb4uski]

.... I can't avoid it. It's the way I structured my retirement. Even if I could go back in time and change things, would I end up significantly better off than I am now? That is highly questionable. I could scream that it is unfair, punishing me for making certain choices I made over my working career, but I knew what I was doing. And, if I didn't, there's nobody else to blame but me.

The biggest mistake would be to spend valuable time fretting over the Tax Torpedo instead of doing things like playing with the grands, spending time with friends and getting in some new travel experiences.

Chuckanut, your situation, like many of us is what I call a win-win.

Is your "tax torpedo" tax rate less than when you were working? For me it is in that it'll be 22% or 24% and when I deferred that income my marginal tax rate was 28%... so even with the dreaded torpedo... I won!.. and saved 4% or 8% as a result.

Is your "tax torpedo" tax rate more than when you were working? Then you win! You obviously didn't expect to be so financially successful because if you did you would have not deferred that income and just paid the tax at that lower rate rather than deferring the income. Congratulations on being much more successful than you planned!

 

[Chuckanut]

Chuckanut, your situation, like many of us is what I call a win-win.

Is your "tax torpedo" tax rate less than when you were working? For me it is in that it'll be 22% or 24% and when I deferred that income my marginal tax rate was 28%... so even with the dreaded torpedo... I won!.. and saved 4% or 8% as a result.

Is your "tax torpedo" tax rate more than when you were working? Then you win! You obviously didn't expect to be so financially successful because if you did you would have not deferred that income and just paid the tax at that lower rate rather than deferring the income. Congratulations on being much more successful than you planned!

Thanks for the enlightened affirmation. You make good points.

One fellow who has a radio show I listen to refers to things like the Tax Torpedo, Umbrella insurance, etc. as a Success Tax. I like that description.

 

[Winemaker]

Folks have mentioned I-ORP
There is also the Retiree Portfolio Model over at bogleheads
https://www.bogleheads.org/wiki/Retiree_Portfolio_Model

+10

 

[jollystomper]

I've been looking at tax strategies over the years with an eye towards avoiding the Tax Torpedo that will hit when I collect SS at 70.

I can't avoid it. It's the way I structured my retirement. Even if I could go back in time and change things, would I end up significantly better off than I am now? That is highly questionable. I could scream that it is unfair, punishing me for making certain choices I made over my working career, but I knew what I was doing. And, if I didn't, there's nobody else to blame but me.

The biggest mistake would be to spend valuable time fretting over the Tax Torpedo instead of doing things like playing with the grands, spending time with friends and getting in some new travel experiences.

+1

After spending more and more time on this the last several months, I am developing a similar mindset. From a tax standpoint, even the "worse case" 401K + IRA RMDs still live us with more enough after the tax on them is paid. The moves are more along the lines of "tweaking" rather than "substantial tax savings". My 401K + IRA contributions helped us when were in the 28% and 33% tax brackets so we are still ahead at the current rates.

 

[ERD50]

While they are independent events, reinvesting dividends, then withdrawing money from an investment results in TWO taxable events (one for the dividends, and one for the second distribution). If you just spent the dividends, you'd only have one taxable event, and pay less in taxes. This is why VG, and most others, generally say you shouldn't reinvest your dividends in retirement when you're needing income. Spend the dividends first, minimize your taxes. Unless you're in the 0% LTCGs tax bracket or you're selling at a loss, I can't see any way in which reinvesting, then distributing doesn't increase your tax liability, as you're exposing gains in addition to the dividends, to taxes.

Nope, nope, nope, nope, nope. I'm digging in my heels on this one. You are conflating things in a way that isn't helpful, and totally unnecessary.

Yes, if you reinvest divs and then sell those shares at a gain, there is a second taxable event. But it has nothing to do with the dividends - you have a taxable event whenever you sell at a gain. The source of the funds have nothing to do with it. Divs have nothing to do with it. It's a taxable event, period. If you want to say you were taxed twice, well, then you are still taxed twice regardless of the source of the funds (salary, lottery winnings, gift, anything). That's why I say it's not helpful to say the divs are taxed twice - anything is taxed twice by that definition, so there is no meaningful distinction.


The stock you bought with the divs could go down, and you'd have a loss. Now what do you say?

I don't think that's the reason that it is recc to not reinvest divs when you need income. It is recc because it just makes sense. Why reinvest, take a short term risk, possibly pay fees and/or bid-ask spread, and sell when you could have just used the income to begin with? What do you do for income while the divs are reinvested? It makes no sense if you need income. What's your option - sell something else while you buy with your divs? It makes no sense. But it's not a tax issue.

Look at it this way - if you could always count on gains for those reinvested divs, well, the tax is only a percentage of the gains, so why not reinvest? So what if it's a taxable event? You are still ending up with more money in your pocket, and that's all that counts.

-ERD50

 

[RunningBum]

Chuckanut, your situation, like many of us is what I call a win-win.

Is your "tax torpedo" tax rate less than when you were working? For me it is in that it'll be 22% or 24% and when I deferred that income my marginal tax rate was 28%... so even with the dreaded torpedo... I won!.. and saved 4% or 8% as a result.

Is your "tax torpedo" tax rate more than when you were working? Then you win! You obviously didn't expect to be so financially successful because if you did you would have not deferred that income and just paid the tax at that lower rate rather than deferring the income. Congratulations on being much more successful than you planned!

Are you sure about that 22 or 24% rate? I still don't fully comprehend that spreadsheet the guy who seems to be a one trick pony on the tax hump makes, but I think he is right. I made these notes for myself on it:

There is a point where every $1000 of income:
- is taxed at 12%, $120 tax
- makes another $850 of SS taxed @12$, $102 tax
- The $1850 of income pushes $1850 LTCGs/QDivs to be taxed. At 15%, $277.50
- Total tax on that $1000 = 499.50, or 49.95%.

At some point, SS is fully taxed at 85%.
This removes 20.4% incremental tax if some LTCGs not yet taxed, 10.2% otherwise.
And at some point, all LTCGs are taxed, @ 15%.
This removes 15% incremental tax, 27.75% if SS tax not maxed.

You may not hit all those conditions at the same time. I think it's possible to not hit the hump. Or it may be a pretty small window. For me it looks like it may be a $10,000 window where I'm taxed at nearly 50% federal. And there may be nothing you can do to avoid it. I think I can limit it by having no MRDs--fully convert my tIRA to a Roth before I start taking SS. I can do this without going above 22 or 24%. I know some with larger tIRAs cannot.

 

[pb4uski]

Yes, I'm sure... though for us some RMDs that will be taxed at 12% and the rest at 22%... but from other discussions we have had here I know there are others with more pension income that are into the 22% tax bracket based on their income before RMDs... so by default RMDs are 22% or more.

The point at which 85% of SS is taxable is if your income, including 50% of SS, exceeds $44,000 for a couple, so it isn't a particularly high bar, especially if you have a DB pension. That is one of the issues that I have with the hump graph... for many people it is academic since they start out of the gate with 85% of SS taxed anyway due to their other income.

If I take our interest and taxable account dividends plus my pension plus 50% of what we'll receive in SS benefits, we would be be well above the $44,000 level for a couple, so out of the gate 85% of our SS will be taxable.

If I take our income assuming that 85% of SS is taxable less the standard deduction then our taxable income is more than the top of the 10% tax bracket before any RMDs and well into the 12% bracket... so any RMDs will some at 12% and the rest at 22%.

 

[RunningBum]

Nope, nope, nope, nope, nope. I'm digging in my heels on this one. You are conflating things in a way that isn't helpful, and totally unnecessary.

I was guessing you might dig in your heels, so I wouldn't have to. I'm happy at this point to be in agreement that a retiree probably shouldn't reinvest dividends no matter if the reasons are flawed, but your post is spot on.

 

[RunningBum]

Yes, I'm sure... though for us some RMDs that will be taxed at 12% and the rest at 22%... but from other discussions we have had here I know there are others with more pension income that are into the 22% tax bracket based on their income before RMDs... so by default RMDs are 22% or more.

The point at which 85% of SS is taxable is if your income, including 50% of SS, exceeds $44,000 for a couple, so it isn't a particularly high bar, especially if you have a DB pension. That is one of the issues that I have with the hump graph... for many people it is academic since they start out of the gate with 85% of SS taxed anyway due to their other income.

If I take our interest and taxable account dividends plus my pension plus 50% of what we'll receive in SS benefits, we would be be well above the $44,000 level for a couple, so out of the gate 85% of our SS will be taxable.

If I take our income assuming that 85% of SS is taxable less the standard deduction then our taxable income is more than the top of the 10% tax bracket before any RMDs and well into the 12% bracket... so any RMDs will some at 12% and the rest at 22%.

OK, that all makes sense. At one point I thought I had too much income to be in the hump too, but I think I didn't consider that a lot of it will be QDivs. My pension is pretty small. I agree that a larger pension can push you into 85% taxable from the start, so no hump.

As I get closer to that age I'm understanding it better--I hope. I don't think I've done anything wrong, short of maybe not taking advantage of that one time Roth conversion deal a few years back where you could split the income and taxes over the next two years. IIRC that lined up nicely with a market recovery, so you could convert, see a nice tax free appreciation, and then pay the taxes on the conversion amount only.

EDIT:
I take this back. I took my 2018 return and added my expected SS benefit. It's not fully taxed at 85%. The numbers aren't exactly the same as when I put in the estimator but very close. Actually slightly higher. I'm close to full SS taxation but when I added $1000 in ordinary income, taxes went up $499.

A lot can change in 7 years. Not much I can do anyway, but I think try to fully convert is the best plan since I should be able to do most at 12%, and some at 22% (with the penalty of 12+15% as QDivs become taxable, which I'll try to limit to one year).

 

[HI Bill]

Nope, nope, nope, nope, nope. I'm digging in my heels on this one. You are conflating things in a way that isn't helpful, and totally unnecessary.

Yes, if you reinvest divs and then sell those shares at a gain, there is a second taxable event. But it has nothing to do with the dividends - you have a taxable event whenever you sell at a gain. The source of the funds have nothing to do with it. Divs have nothing to do with it. It's a taxable event, period. If you want to say you were taxed twice, well, then you are still taxed twice regardless of the source of the funds (salary, lottery winnings, gift, anything). That's why I say it's not helpful to say the divs are taxed twice - anything is taxed twice by that definition, so there is no meaningful distinction.


The stock you bought with the divs could go down, and you'd have a loss. Now what do you say?

I don't think that's the reason that it is recc to not reinvest divs when you need income. It is recc because it just makes sense. Why reinvest, take a short term risk, possibly pay fees and/or bid-ask spread, and sell when you could have just used the income to begin with? What do you do for income while the divs are reinvested? It makes no sense if you need income. What's your option - sell something else while you buy with your divs? It makes no sense. But it's not a tax issue.

Look at it this way - if you could always count on gains for those reinvested divs, well, the tax is only a percentage of the gains, so why not reinvest? So what if it's a taxable event? You are still ending up with more money in your pocket, and that's all that counts.

-ERD50

You are correct, the dividends are not taxed twice. I said that you're paying taxes on the dividends (at ordinary income tax rates), and on the distribution; which is uneccessary. One last example:

My brokerage account pays $10K in dividends. I want to withdraw $10K from the fund for living expenses. I have two choices:

1) Pay taxes (let's say 12%, or $1,200) on the dividends, then reinvest. Then I withdrawy $10K from the same fund, paying taxes on the taxable portion of the distribution. Let's assume that the taxable portion of the withdrawal is $5,000, and they're subject to the 15% LTGCs tax rate. I pay 15% of $5,000, or $750. Total taxes paid are $1,200 + $750 = $1950. I have $10K to spend, less the $1,950, which means I really have $8,050 to spend.

2) Pay taxes (let's say 12%, or $1,200) on the dividends, then spend that money. I don't take any additional funds out of the account. Total taxes paid are $1,200. I have $10K, less $1,200 to spend ($8,800).

Now, please choose which option you prefer, or if I am in error in my example, please explain to me what I'm misunderstanding. Thanks!

 

[pb4uski]

OK, that all makes sense. At one point I thought I had too much income to be in the hump too, but I think I didn't consider that a lot of it will be QDivs. My pension is pretty small. I agree that a larger pension can push you into 85% taxable from the start, so no hump.

As I get closer to that age I'm understanding it better--I hope. I don't think I've done anything wrong, short of maybe not taking advantage of that one time Roth conversion deal a few years back where you could split the income and taxes over the next two years. IIRC that lined up nicely with a market recovery, so you could convert, see a nice tax free appreciation, and then pay the taxes on the conversion amount only.

For the SS income test (how much is taxable) all dividends, qualified or non-qualified, count the same.

 

[pb4uski]

...Yes, if you reinvest divs and then sell those shares at a gain, there is a second taxable event. But it has nothing to do with the dividends ....

+1 You receive dividends and they are a taxable event. Then you decide whether to save them (in your bank account) or invest them (reinvest) or spend them on hookers. Two events.

 

[HI Bill]

It's complicated. But in retirement, you should not reinvest dividends in taxable accounts...cash them out! No need to pay taxes on them twice!

Sorry, I should have said, "No need to pay taxes twice". I never meant to infer that you're paying taxes on the dividends twice. Only that you'd pay taxes on the dividends, then again on whatever distribution that you take. They are independent events, but if you need to withdraw funds, and reinvest dividends, while you pay ordinary income tax and LTCGs tax, you'll pay more in taxes if you don't just use the divdends first.

 

[RunningBum]

You are correct, the dividends are not taxed twice. I said that you're paying taxes on the dividends (at ordinary income tax rates), and on the distribution; which is uneccessary. One last example:

My brokerage account pays $10K in dividends. I want to withdraw $10K from the fund for living expenses. I have two choices:

1) Pay taxes (let's say 12%, or $1,200) on the dividends, then reinvest. Then I withdrawy $10K from the same fund, paying taxes on the taxable portion of the distribution. Let's assume that the taxable portion of the withdrawal is $5,000, and they're subject to the 15% LTGCs tax rate. I pay 15% of $5,000, or $750. Total taxes paid are $1,200 + $750 = $1950. I have $10K to spend, less the $1,950, which means I really have $8,050 to spend.

2) Pay taxes (let's say 12%, or $1,200) on the dividends, then spend that money. I don't take any additional funds out of the account. Total taxes paid are $1,200. I have $10K, less $1,200 to spend ($8,800).

Now, please choose which option you prefer, or if I am in error in my example, please explain to me what I'm misunderstanding. Thanks!

Alright, I can't help myself but stay in the discussion. Sorry!

You're doing it wrong in scenario 1. If you want to minimize current taxes, you should be selecting the highest basis shares, which might be the recently reinvested shares. You might pay tax on whatever gain you got while those were invested, but less than 100% so it's not a bad thing.

You claimed in an early post that you cannot select those reinvested shares to sell. This is flat out wrong, unless you've already committed to using average cost basis for that holding, which means you previously made a bad choice.

 

[HI Bill]

Alright, I can't help myself but stay in the discussion. Sorry!

You're doing it wrong in scenario 1. If you want to minimize current taxes, you should be selecting the highest basis shares, which might be the recently reinvested shares. You might pay tax on whatever gain you got while those were invested, but less than 100% so it's not a bad thing.

You claimed in an early post that you cannot select those reinvested shares to sell. This is flat out wrong, unless you've already committed to using average cost basis for that holding, which means you previously made a bad choice.

RunningBum - you are correct, and thank you for helping me to understand (no need to apologize). I thought I could only choose First In First Out (FIFO), or Average Cost, but I see now that there's an option to use Specific Identification (SpecID). If you use SpecID, then it doesn't really matter whether you reinvest or not, as long as you pay close attention when you sell. I'm here to learn, as well as to try to help others, so I do appreciate it when people call me out for saying something wrong!

P.S. I just found this, which may help others using SpecID: "If your taxable income including capital gains is below (for 2019) $78,750 if married filing jointly, long-term capital gains have a 0% tax rate. So you may want to sell the shares with the lowest cost basis. That is, you may want to “harvest” the largest gain possible." My plan, prior to RMD age, is to sell as many shares as possible with the lowest cost basis, while keeping MFJ to <$78.75K, so that my future tax liability is lower.

 

[RunningBum]

For the SS income test (how much is taxable) all dividends, qualified or non-qualified, count the same.

That damn spreadsheet confused me. It's got so many lines drawn on the same graph and made up terminology in some of the boxes that I don't know what's what. I think I'm over the hump as well with all divs included in MAGI. I ran taxcaster with an approximation of where I'll be at 71 with pension, SS, and dividends. If I add another $1000 IRA distribution, it increases my taxes by $222. Far from 49%. I'll update my notes on that spreadsheet.

I'm still 8 years from doing anything about it, unless the ACA subsidy goes away or is worth less to me than it is now. It's from 65 to 70 that I really need to decide how much to convert.

Thanks for clarifying. I should probably just pitch that spreadsheet.