withdrawal strategy during retirement

[ExHermit]

Kobydog,

Yes, you can recharacterize your 2007 conversion from a TIRA to a Roth back to the Roth after January 1, 2008. (Thanks for the correction, EngineeringMyFinances). In fact, you have until October 15, 2008, the end of the automatic extension period for filing tax returns. You can file an amended tax return if you have already filed and then decide to do a recharacterization.

I have only done a conversion and recharacterization once, from a Vanguard TIRA to a Vanguard Roth and back again. Vanguard has a specific form for the recharacterization. Note that you specify the amount of the conversion that you want recharacterized, but the amount that goes back to the TIRA is adjusted to include any gains or losses while in the Roth. Vanguard messed up this calculation when I did a recharacterization, but the error was not hard to get corrected. If you go the recharacterization route, I recommend that you keep everything within one company and verify the calculations.

It makes life easier if you can figure your taxes well enough before the end of the year in order to get the conversion amount close to right and avoid recharacterization. After my recharacterization experience I decided that getting within a few hundred dollars of the top of the tax bracket was good enough.

ExHermit

 

[jIMOh]

If one is going to be in the same tax bracket (i.e., say 15%) and not hit the top of it since it is indexed why move Traditional IRA money into a Roth IRA? Seems to me paying tax with todays dollars versus tomorrows dollars, if at the same rate, is not a rational thing to do. Additionally, to make the conversion work well, you would not want to hit the bottom of the next bracket due to the conversion. Also, if one is planing on moving, in retirement, from a state with an income tax versus one what does not have one wouldn't you just be donating tax dollars to the current state that you would not have to in the new state?

IMO this summarizes the overall goal quite well. Many people can live in the 15% tax bracket if things are managed well.

I would add up the following:

1) have dividends in taxable accounts. These are taxed at lowest rates.
2a) taxable FI in tax advantaged accounts- sell only as part of 3.
2b) tax free FI (muni bonds) in taxable accounts- add interest to #1
3) 72(t) the TIRAs to top of 15% tax bracket

If this is not enough, then take more out of the TIRAs
If this is enough, then the excess from #3 should be converted to a Roth

I would keep the taxable accounts active as long as possible (meaning don't spend it down, try to live off of dividends in this account only). I would not want to empty one bucket while another got bigger.

Roth money is first money I would spend
taxable account money is second- what is needed to stay in 15% bracket is my suggestion for a starting point.
TIRA money is third money I would spend- but make sure this is drawn down every year to convert to Roth (which is #1). This should keep TIRA withdraws in low tax brackets.

 

[bamsphd]

Roth money is first money I would spend
taxable account money is second- what is needed to stay in 15% bracket is my suggestion for a starting point.
TIRA money is third money I would spend- but make sure this is drawn down every year to convert to Roth (which is #1). This should keep TIRA withdraws in low tax brackets.

I think that is backwards. Generally Roth money is the LAST money to spend. Squeeze every year of tax avoidance you can out of the Roth money. If you are leaving an estate to children/grandchildren, the Roth is what you want to leave. The one possible exception being to manipulate marginal tax rates, for example to avoid the taxation of Social Security.

TIRA is a balancing act. On the one hand it is one of the less desirable things to leave in a taxable estate. On the other hand, maximizing the tax deferral is desirable, and is possible even with an inherited TIRA. On the third paw, the IRS rules eventually require you to distribute TIRA money anyway. On the fourth paw, you can often avoid all those problems by converting to a Roth. Where to balance depends heavily on the size of your estate and your tax bracket.

Taxable accounts should probably be down to almost zero before you touch the Roth. Otherwise, use taxable as needed to meet your needs after making your best guesses on the TIRA.

All of the above is just my layman's understanding. I'm not a lawyer, CPA, broker, politician, or annuity salesman.

 

[jIMOh]

I think that is backwards. Generally Roth money is the LAST money to spend. Squeeze every year of tax avoidance you can out of the Roth money. If you are leaving an estate to children/grandchildren, the Roth is what you want to leave. The one possible exception being to manipulate marginal tax rates, for example to avoid the taxation of Social Security.

TIRA is a balancing act. On the one hand it is one of the less desirable things to leave in a taxable estate. On the other hand, maximizing the tax deferral is desirable, and is possible even with an inherited TIRA. On the third paw, the IRS rules eventually require you to distribute TIRA money anyway. On the fourth paw, you can often avoid all those problems by converting to a Roth. Where to balance depends heavily on the size of your estate and your tax bracket.

Taxable accounts should probably be down to almost zero before you touch the Roth. Otherwise, use taxable as needed to meet your needs after making your best guesses on the TIRA.

All of the above is just my layman's understanding. I'm not a lawyer, CPA, broker, politician, or annuity salesman.

It's interesting... this discussion is on two different boards I visit... and the advice is opposite in many cases.

My opinion is that it is better for me to minimize my taxes during my lifetime and then let the estate tax fall where it may...

meaning do not exhaust one account (taxable) to leave another alone (Roth) because that increases current tax bill considerably.

My advice would be to withdraw out of the TIRA every year to top of 15% tax bracket at minimum. If person needs to withdraw TIRA into 25% or 28% bracket, I would suggest capping off appropriate bracket, then using remainder of bracket to convert to a Roth or taxable account- both of which are taxed at rates much much less than 25 and 28% currently.

 

[nun]

I think that is backwards. Generally Roth money is the LAST money to spend. Squeeze every year of tax avoidance you can out of the Roth money.

I agree, ROTH should be the last that you touch.

I have a slightly strange combo of retirement vehicles, TIRA, ROTH, a State 401k type plan that is after tax for State tax but tax deferred for federal and a 457 plan that is state and federal tax deferred, but I can access it without penalty as soon as I ER from state employment. The order I'd use my accounts in ER until I'm 59.5 years old would be:

Regular taxable accounts
457 plan, as there is no withdrawal penalty

After 59.5 it would be

Regular taxable accounts
State 401k plan as its free of state income tax.
457 plan and TIRA at the same time
ROTH last

 

[nun]

It's interesting.
My advice would be to withdraw out of the TIRA every year to top of 15% tax bracket at minimum. If person needs to withdraw TIRA into 25% or 28% bracket, I would suggest capping off appropriate bracket, then using remainder of bracket to convert to a Roth or taxable account- both of which are taxed at rates much much less than 25 and 28% currently.

I agree that simply spending down a taxable account is a bit stupid. Its good to have after tax money so you can make big purchases if necessary without taking large sums from your TIRA and maybe bumping you into another tax bracket. What it really comes down to is how much you need to live. If you can use your after tax FI and dividends for a good portion of your expenses you may only need to withdraw from the TIRA up you your tax free exemption/deduction level, or it might be to the 10% level.....etc

 

[jIMOh]

I agree, ROTH should be the last that you touch.

I have a slightly strange combo of retirement vehicles, TIRA, ROTH, a State 401k type plan that is after tax for State tax but tax deferred for federal and a 457 plan that is state and federal tax deferred, but I can access it without penalty as soon as I ER from state employment. The order I'd use my accounts in ER until I'm 59.5 years old would be:

Regular taxable accounts
457 plan, as there is no withdrawal penalty

The longer a person waits to withdraw from Roth, the more likely the years spending down other accounts had them pay more in taxes. Roth is tax free income. Continually spending money which needs to be taxed now, as opposed to spending money which is tax free suggests to me there is a common sense factor missing.

After 59.5 it would be

Regular taxable accounts

taxed at rates of 5-15%, depending on tax bracket level

State 401k plan as its free of state income tax.

taxed at rates of 10-35%, depending on federal tax bracket level

457 plan and TIRA at the same time

taxed at rates of 10-35%, depending on federal tax bracket level

ROTH last

taxed at 0% rate

IMO the order should be

a) 401k/TIRAs to 15% tax bracket level
b) Roth (0%)
c) taxable accounts (5% rate at 15% tax bracket level)
d) 401k/TIRAs to 25%+ income tax bracket level

a)-c) are done at same time to meet income level
d) is only done if the amount in a-c) is not enough to live on.

 

[nun]

a) 401k/TIRAs to 15% tax bracket level
b) Roth (0%)
c) taxable accounts (5% rate at 15% tax bracket level)
d) 401k/TIRAs to 25%+ income tax bracket level

a)-c) are done at same time to meet income level
d) is only done if the amount in a-c) is not enough to live on.

I can see your point about the ROTH, people still saving for ER put the ROTH last because they put accumulation first, let those dollars grow tax free. When you ER reducing tax probably takes on more significance. However, I'd still put spending of taxable accounts first to keep the tax deferred growth of the TIRA etc going as long as I could.

 

[bamsphd]

I think that is backwards. Generally Roth money is the LAST money to spend. Squeeze every year of tax avoidance you can out of the Roth money. If you are leaving an estate to children/grandchildren, the Roth is what you want to leave. The one possible exception being to manipulate marginal tax rates, for example to avoid the taxation of Social Security.

Emphasis added above.

The longer a person waits to withdraw from Roth, the more likely the years spending down other accounts had them pay more in taxes. Roth is tax free income. Continually spending money which needs to be taxed now, as opposed to spending money which is tax free suggests to me there is a common sense factor missing.
taxed at rates of 5-15%, depending on tax bracket level taxed at rates of 10-35%, depending on federal tax bracket level taxed at rates of 10-35%, depending on federal tax bracket level taxed at 0% rate

IMO the order should be

a) 401k/TIRAs to 15% tax bracket level
b) Roth (0%)
c) taxable accounts (5% rate at 15% tax bracket level)
d) 401k/TIRAs to 25%+ income tax bracket level

a)-c) are done at same time to meet income level
d) is only done if the amount in a-c) is not enough to live on.

Tax advantaged saving tends to beat taxable saving over longer periods of time. Over short time periods the difference is minor. However, over long time periods, the money that would have been taxed away grows with tax free compounding, and eventually wins.

So I suppose the answer to this question depends heavily on your investment horizon, whether you expect to "spend down" your assets, and your current asset mix. I hope my safe withdrawal rate will leave me with a significant estate. Not so much because I want to leave a huge estate, but because as a couple our combined longevity risk is otherwise unacceptable. So my planning horizon includes my full life, my spouse's full life, and our heir's full life. If our investments do at least average, I hope to never touch the Roth money in my life, and perhaps never in my wife's life. Over my heir's life, the Roth tax advantage easily beats the alternatives.

If instead we were already retired, and my calculations indicated that we were in a race between life expectancy and spending down our portfolio, my calculations would be different, and more complex. I would probably be using something like Laurence J. Kotlkoff's planning software to optimize my withdrawals so that we always captured at least the standard deduction, and probably tried to level out our marginal tax rate over our combined life expectancy. I still think the software would probably recommend deferring Roth withdrawals for quite awhile, but it would also keep around some taxable and T-IRA funds to even out our tax burden.

The gamble is that the rules may change. I'm betting that income taxes will stay around, that thanks to means testing tax rates will not go down much for millionaires, and that the Roth tax treatment will be maintained for existing accounts. That is certainly not a sure bet, but I've misplaced my crystal ball.

 

[nun]

The gamble is that the rules may change.

I go back to a statement I made in a earlier post "Keep It Simple". With multiple accounts and changing tax rules the variable space is enormous. I'd recommend applying the rules of thumb that we've discussed to make sensible withdrawals. They my not be the optimum, but at least you can comprehend your strategy and you will not have to worry about every cent.

If you want to leave money to your kids don't touch the ROTH, if you want to minimize your taxes while you can still vacation in Aruba then use the ROTH and spend down your estate.

 

[jIMOh]

Emphasis added above.


Tax advantaged saving tends to beat taxable saving over longer periods of time. Over short time periods the difference is minor. However, over long time periods, the money that would have been taxed away grows with tax free compounding, and eventually wins.

This assumes "growth and accumulation" is the goal. If money is being spent (withdrawn) the same conclusion/process will be inefficient.

What is most tax efficient going in (401k, Roth, Taxable accounts) is NOT the most tax efficient coming out (Roth, taxable accounts, 401k).

So I suppose the answer to this question depends heavily on your investment horizon, whether you expect to "spend down" your assets, and your current asset mix. I hope my safe withdrawal rate will leave me with a significant estate. Not so much because I want to leave a huge estate, but because as a couple our combined longevity risk is otherwise unacceptable. So my planning horizon includes my full life, my spouse's full life, and our heir's full life. If our investments do at least average, I hope to never touch the Roth money in my life, and perhaps never in my wife's life. Over my heir's life, the Roth tax advantage easily beats the alternatives.

This adds an inheritance factor into both the accumulation phase and the draw down phase not previously discussed to much detail.

If instead we were already retired, and my calculations indicated that we were in a race between life expectancy and spending down our portfolio, my calculations would be different, and more complex. I would probably be using something like Laurence J. Kotlkoff's planning software to optimize my withdrawals so that we always captured at least the standard deduction, and probably tried to level out our marginal tax rate over our combined life expectancy. I still think the software would probably recommend deferring Roth withdrawals for quite awhile, but it would also keep around some taxable and T-IRA funds to even out our tax burden.

My premise was to even out the tax burden over time while drawing down close to 100% of assets by time of death. Your goal is similar to this (even out tax burden). The lowest taxes are currently paid on Roth and taxable accounts, IMO to achieve this goal the Roth needs to be used to withdraw, as well as taxable accounts at same time, to keep tax bracket low for the 401k withdraws.

The gamble is that the rules may change. I'm betting that income taxes will stay around, that thanks to means testing tax rates will not go down much for millionaires, and that the Roth tax treatment will be maintained for existing accounts. That is certainly not a sure bet, but I've misplaced my crystal ball.

This gamble (rules changing) is another reason to draw down all 3 account types at same time. If a person relies on taxable accounts only, and the tax rates on those accounts goes to 50%, then it makes sense to change the withdraw technique.

 

[WilliamG]

If you haven't already check out this calculator. Tries to optimize withdrawals using already taxed, IRA and Roth monies... bill

Retirement Calculator

 

[Rich_by_the_Bay]

If you haven't already check out this calculator. Tries to optimize withdrawals using already taxed, IRA and Roth monies... bill

Retirement Calculator

Don't bother, y'all. That's the link REWahoo gave way back on message 8 of this thread.