Can I reduce future taxes on IRA with earlier withdrawals ?

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Can I reduce future taxes on IRA with earlier withdrawals ?

Postby Bustoff » Mon Dec 24, 2012 7:27 am

Conventional wisdom advises that during retirement, IRA's withdrawals shouldn't precede withdrawals from taxable accounts.
However, now that I am 59 1/2, wouldn't it be better to take IRA withdrawals now since my tax bracket will be lower without Social Security ?

Or in other words, if I delay IRA withdrawals until I am collecting Social Security, won't the combination of IRA withdrawals and Social Security income push me into a higher marginal tax rate ?

If my IRA withdrawals are now taxed at 10% why should I wait until later when the additional SS income results in my IRA withdrawals being taxed at 25% ?
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby Naikansha » Mon Dec 24, 2012 7:51 am

I don't think it is a good idea to withdraw only for tax reasons. If you need the money for living expenses before social security, that may be another matter but it is a much better idea to save up a several years' rainy day/emergency fund in one or more very safe environments such as a savings account and cds while keeping your IRA growing over the long term in a tax-advantaged way. Remember the IRA is for your retirement and should be kept growing for that purpose. Growing a rainy day fund is good savings discipline as well.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby trasmuss » Mon Dec 24, 2012 8:01 am

If you don't need to live on the money and are primarily thinking about taxes, you have another option. Convert enough of your IRA to bring you to the top of your marginal tax bracket. If you feel you will be in a higher tax bracket when you need the money a Roth IRA conversion is a good value. Even if you need to use part of it to pay current taxes.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby bottlecap » Mon Dec 24, 2012 8:16 am

Bustoff wrote:Or in other words, if I delay IRA withdrawals until I am collecting Social Security, won't the combination of IRA withdrawals and Social Security income push me into a higher marginal tax rate ?


Yes, this could happen. If it looks like it will, early withdrawals, or even better, converting to a Roth as trasmuss mentions, is a smart thing.

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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby Naikansha » Mon Dec 24, 2012 8:20 am

Converting to a Roth might be a good idea IF you have extra funds in taxable accounts you can use to pay the taxes, not a good idea if some of the tax money has to come from your IRA.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby Bustoff » Mon Dec 24, 2012 8:53 am

If I start converting portions of my IRA to my existing Roth, do those new conversions start a new five year waiting period on my Roth.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby livesoft » Mon Dec 24, 2012 9:04 am

Good thinking about reducing taxes. Many retirees don't pay taxes. We had this thread on that: viewtopic.php?t=87471 Note how the couple in that thread did Roth conversions in order to not pay taxes. They used the calculator at http://www.i-orp.com and TurboTax to help them decide how much to convert each year.
Last edited by livesoft on Mon Dec 24, 2012 9:05 am, edited 1 time in total.
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby bottlecap » Mon Dec 24, 2012 9:05 am

Bustoff wrote:If I start converting portions of my IRA to my existing Roth, do those new conversions start a new five year waiting period on my Roth.


Here what appears to be a decent explanation: http://online.wsj.com/article/SB125754645803734655.html

If you are converting because you will have too much money to withdraw once rmds kick in, is it really an issue anyway? Do you plan to tap these assets before 70 and a half?

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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby dickenjb » Mon Dec 24, 2012 9:05 am

Bustoff wrote:If I start converting portions of my IRA to my existing Roth, do those new conversions start a new five year waiting period on my Roth.


Edited as it appears I gave an incorrect response. Sorry.
Last edited by dickenjb on Tue Dec 25, 2012 3:19 pm, edited 1 time in total.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby Bustoff » Tue Dec 25, 2012 10:40 am

Thanks so much for suggestions and links.

Anyone know if there is a link that compares the tax efficiency of Vanguard funds ?
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby livesoft » Tue Dec 25, 2012 10:43 am

See Table 1 in Wiki article link: Principles of Tax-Efficient Fund Placement
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby umfundi » Tue Dec 25, 2012 1:08 pm

While you're looking at all these options, you should consider delaying SS until age 69 or 70.

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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby 1210sda » Tue Dec 25, 2012 2:40 pm

bottlecap wrote:
Bustoff wrote:If I start converting portions of my IRA to my existing Roth, do those new conversions start a new five year waiting period on my Roth.


Here what appears to be a decent explanation: http://online.wsj.com/article/SB125754645803734655.html

If you are converting because you will have too much money to withdraw once rmds kick in, is it really an issue anyway? Do you plan to tap these assets before 70 and a half?

JT


Bottleneck, thanks for the link to the WSJ article.

At the end of the third paragraph in the article, it states "each (Roth) coversion has its own five-year clock."

Huh? This means I have to keep track of each years conversion to see that it meets the 5 year clock requirement ??? I hope the author got it wrong and that some wise Boglehead can explain.

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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby sscritic » Tue Dec 25, 2012 2:54 pm

1210sda wrote:
At the end of the third paragraph in the article, it states "each (Roth) coversion has its own five-year clock."

Huh? This means I have to keep track of each years conversion to see that it meets the 5 year clock requirement ??? I hope the author got it wrong and that some wise Boglehead can explain.

Some bogleheads spend Christmas with their families. Some bogleheads give wrong answers. I like to ask the IRS my tax questions; the IRS never sleeps.
Distributions of conversion and certain rollover contributions within 5-year period. If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA or rollover an amount from a qualified retirement plan to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to include in income (recapture amount). A separate 5-year period applies to each conversion and rollover. See Ordering Rules for Distributions, later, to determine the recapture amount, if any.
Pub 590

If I can use google, does that make me a wise boglehead?
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby FNK » Tue Dec 25, 2012 3:22 pm

Naikansha wrote:Converting to a Roth might be a good idea IF you have extra funds in taxable accounts you can use to pay the taxes, not a good idea if some of the tax money has to come from your IRA.

Why?
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby Watty » Tue Dec 25, 2012 4:13 pm

However, now that I am 59 1/2, wouldn't it be better to take IRA withdrawals now since my tax bracket will be lower without Social Security ?


For certain ranges of income the effective tax rate of that social security gets taxed at can be very high so it would be silly to not take that into account.

http://www.bogleheads.org/wiki/Taxation ... y_benefits

Some people will have lower income in retirment so this will not be a problem, some people whill have higher income and all their social security will always be taxed to this is a non-issue, but if you are in the middle and can do something by changing the order that you spend your money then that could make a big difference.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby retiredjg » Tue Dec 25, 2012 4:31 pm

1210sda wrote:At the end of the third paragraph in the article, it states "each (Roth) coversion has its own five-year clock."

Huh? This means I have to keep track of each years conversion to see that it meets the 5 year clock requirement ??? I hope the author got it wrong and that some wise Boglehead can explain.

1210

It is true that each taxable Roth IRA conversion has its own 5 year clock. But when the person reaches 59.5 (or is disabled) and has had something in Roth for the 5 year period (maybe even starting back at age 25 or whatever), the clock turns into a pumpkin and all withdrawals from Roth IRA are "qualified" and will have no tax and no penalty.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby 1210sda » Tue Dec 25, 2012 5:40 pm

retiredjg wrote:
1210sda wrote:At the end of the third paragraph in the article, it states "each (Roth) coversion has its own five-year clock."

Huh? This means I have to keep track of each years conversion to see that it meets the 5 year clock requirement ??? I hope the author got it wrong and that some wise Boglehead can explain.

1210

It is true that each taxable Roth IRA conversion has its own 5 year clock. But when the person reaches 59.5 (or is disabled) and has had something in Roth for the 5 year period (maybe even starting back at age 25 or whatever), the clock turns into a pumpkin and all withdrawals from Roth IRA are "qualified" and will have no tax and no penalty.



Thanks "retiredjg". Your comments motivated me to do research on Publication 590. And there it was....on page 63, Figure 2.1. In my case the following would be true: "Has it been at least 5 years from the begining of the year for which you first set up and contributed to a Roth IRA?" My answer is "Yes". Then, "Were you at least 59 1/2 years old at the time of the distribution?" My answer is "Yes". Then, "The distribution from the Roth IRA is a qualified distribution. It is not subject to tax or penalty."

So maybe the article was either wrong or poorly worded..........

Any other views on this ????

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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby Peter Foley » Tue Dec 25, 2012 6:10 pm

Bustoff asked:
Conventional wisdom advises that during retirement, IRA's withdrawals shouldn't precede withdrawals from taxable accounts.
However, now that I am 59 1/2, wouldn't it be better to take IRA withdrawals now since my tax bracket will be lower without Social Security ?


To echo others who have responded - absolutely! If you retire prior to receiving SS benefits you will have a number of years during which you can make withdrawals from deferred accounts at a low tax rate or convert some of those savings to Roth. The approach I would take would be to calculate/estimate what your tax rate will be when you start taking SS. At least fill up your 15% bracket with Roth conversions and deferred account withdrawals each year if you are going to be in a 25% or high bracket when you take SS. Some Roth conversion is advisable because you can avoid some RMDs much later and/or use some Roth withdrawals to help minimize the impact of taxation of SS benefits when you first start taking them.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby kaneohe » Tue Dec 25, 2012 6:27 pm

1210sda wrote:
retiredjg wrote:
1210sda wrote:At the end of the third paragraph in the article, it states "each (Roth) coversion has its own five-year clock."

Huh? This means I have to keep track of each years conversion to see that it meets the 5 year clock requirement ??? I hope the author got it wrong and that some wise Boglehead can explain.

1210

It is true that each taxable Roth IRA conversion has its own 5 year clock. But when the person reaches 59.5 (or is disabled) and has had something in Roth for the 5 year period (maybe even starting back at age 25 or whatever), the clock turns into a pumpkin and all withdrawals from Roth IRA are "qualified" and will have no tax and no penalty.


So maybe the article was either wrong or poorly worded..........

Any other views on this ????

1210


You might want to re-read retiredjg's reply.........under age 59.5, there are 5 yr clocks on each conversion. Past the trigger pt of age 59.5, that is replaced by a 5 yr clock on the oldest Roth........so both are true but depending on the circumstances..........the wsj article basically says the same thing: x or y , whichever comes first........
Last edited by kaneohe on Tue Dec 25, 2012 6:30 pm, edited 1 time in total.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby retiredjg » Tue Dec 25, 2012 6:28 pm

1210sda wrote:So maybe the article was either wrong or poorly worded..........

I think it is extremely difficult to write an article on this issue that is easy (or even possible) for everybody to understand. The subject is just mind-bogling. And even if the author gets it right, people can understand it wrong.

Here is another article - by Christine Benz - that people might find easier.

http://ibd.morningstar.com/article/arti ... ,%20brf295
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby kaneohe » Tue Dec 25, 2012 6:37 pm

..........which is why some of us appreciate this wonderful table by KAWill.......


Roth IRA Distribution Table

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No ;Penalty-Yes (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No ;Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes ;Penalty-Yes

OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-No

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Distributions Are Qualified

No Taxes
No Penalties

Note: The table is not applicable to timely distributions of excess contributions or return of regular contributions.
The ordering of withdrawals is contributions first, conversions (from oldest to youngest)(taxable part first, then non-taxable within each conversion) next, then finally earnings.....just like in the table.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby kaneohe » Wed Dec 26, 2012 11:24 am

FNK wrote:
Naikansha wrote:Converting to a Roth might be a good idea IF you have extra funds in taxable accounts you can use to pay the taxes, not a good idea if some of the tax money has to come from your IRA.

Why?


Consider the following situations: Assume you start w/ 10K TIRA and will pay taxes at 25% rate now or later when withdrawing; you also have 2.5K in a side-fund taxable account that you may/may not choose to use to pay the taxes depending on circumstances (you may/may not have extra funds)

1) Leave TIRA alone; in N yrs, it doubles to 20K TIRA. After you pay 5K taxes, you have 15K in taxable.
The 2.5K side fund has doubled to 5K . You have a gain of 2.5K and you pay CG taxes of say 0.4K leaving 4.6K in side fund.
After taxes you have 19.6K.

2) Convert TIRA to Roth. You pay 2.5K taxes on the 10K conversion from the 2.5K side-fund leaving you w/ a 10K Roth.
In N yrs, it doubles to a 20K Roth. Under certain conditions detailed in this thread, you may be able to withdraw all of these funds w/o taxes leaving you 20K in taxable , slightly ahead of the TIRA option 1) above

3) Convert TIRA to Roth but tax 2.5K taxes on the 10K conversion from the TIRA itself (usually not recommended). That leaves you w/ a 7.5K Roth and the 2.5K side-fund intact (e.g. , reserved as emergency fund). After N yrs, the funds double and you have a 15K Roth and a 5K side fund. As in the previous options, under certain conditions you may be able to withdraw all the funds from the Roth w/o taxes (15K) and after paying CG taxes (0.4K) on the side-fund, end up w/ 4.6K there for a total of 19.6K . This is the same as in option 1) above and so doesn't appear to be so horrible.
However, if you did the conversion at age < 59.5, then you would have had an additional 10% penalty on the part not converted and so would have had even less to put in the Roth so this option would have been the worst of the 3.
An interesting exercise for the reader to calculate.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby FNK » Wed Dec 26, 2012 3:07 pm

kaneohe wrote:However, if you did the conversion at age < 59.5, then you would have had an additional 10% penalty on the part not converted and so would have had even less to put in the Roth so this option would have been the worst of the 3.

Thank you, that's the (kind of obvious) kicker: you should not pull cash out of Trad to pay the taxes before you're 59.5.

I was imagining various scenarios after 59.5. Say, you retire at 60 and have 10 years to Rothify your 401(k) before SS kicks in. Once you've wiped out your taxable savings, you're going to have to withdraw enough from 401(k) to cover your living expenses, taxes and whatever's left in your chosen tax bracket for Roth. Not much flexibility to speak of. ;-) But if you still have taxable savings, do you have flexibility in choosing which account to draw down? The answer is: yes; generally you prefer to shift income-generating assets to Roth, but there are still tax loss and cap gain games to be played.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby Epsilon Delta » Wed Dec 26, 2012 4:51 pm

retiredjg wrote:
1210sda wrote:So maybe the article was either wrong or poorly worded..........

I think it is extremely difficult to write an article on this issue that is easy (or even possible) for everybody to understand. The subject is just mind-bogling. And even if the author gets it right, people can understand it wrong.

Here is another article - by Christine Benz - that people might find easier.

http://ibd.morningstar.com/article/arti ... ,%20brf295


The difficulty with most articles is in which path they consider "normal" and which path they consider the "exception". In my view it is much clearer if they follow the example of pub 590 and treat qualified distributions as normal. They should begin "If you are over 59.5 and your oldest Roth is more than 5 years old all of your distribution are tax and penalty free. Stop here, do not read the rest of this article. ... ".

IMHO even KAWill's table could be improved by following this rule.
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Re: Can I reduce future taxes on IRA with earlier withdrawal

Postby crow » Wed Dec 26, 2012 10:22 pm

Once you are receiving medicare, keep in mind that any conversions that up your income could result in extra income related premiums for Medicare. I did a conversion a couple of years ago and got unexpectedly nailed with that extra premium, which I hadn't considered in the calculations for the cost effectiveness of the conversion.
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