Considering Target Retirement Income as only holding.

[Bustoff]

Having recently retired at 59, I am having some difficulty constructing a draw-down portfolio according to tax efficient theory.
Half of my Vanguard account is tax advantaged. I have been considering using Target Retirement Income as my only holding.
That would mean 50% of my Target Retirement Income would be held in my taxable account.
Is this a bad plan ?

[dickenjb]

It is not a bad plan but it is not optimal.

If you are in and expect to remain in the 15% tax bracket it is not bad.

If in a higher bracket you should give consideration to the three fund portfolio which for you would look like this:

Taxable

TISM 6%
TSM 14%
Int Muni 30%

Tax advantaged
TB 50%

This setup has the advantage of capturing the foreign tax credit and sheltering bond interest as well as the lower expense ratio of Admiral class funds. However, you would have to rebalance once a year. If all that is too complex for you, I see no reason not to pursue the strategy you have outlined.

[Hexdump]

I am in a similar situation, ie looking for a 1 fund solution, though mine is 100% tax deferred.
I settled on Wellesley, but could have my mind changed.

[Bustoff]

If you are in and expect to remain in the 15% tax bracket it is not bad.

If in a higher bracket you should give consideration to the three fund portfolio which for you would look like this:

Taxable

TISM 6%
TSM 14%
Int Muni 30%

Tax advantaged
TB 50%

This setup has the advantage of capturing the foreign tax credit and sheltering bond interest as well as the lower expense ratio of Admiral class funds. However, you would have to rebalance once a year. If all that is too complex for you, I see no reason not to pursue the strategy you have outlined.

Thanks ! I am in the 15% bracket.
BTY What is "Int Muni" ? I didn't see any muni funds in Vanguards list.

[livesoft]

With half one's portfolio in taxable and half in tax-advantaged, it seems like you should be in the 0% tax bracket and not the 15% tax bracket unless you also have a pension coming in. Have you read the ZERO taxes in retirement thread?
viewtopic.php?t=87471
In that thread, the tax-advantaged half of the portfolio gets converted to a Roth without paying any taxes. It would seem that you would be able to do the same thing.

[Bob's not my name]

With half one's portfolio in taxable and half in tax-advantaged, it seems like you should be in the 0% tax bracket and not the 15% tax bracket unless you also have a pension coming in. Have you read the ZERO taxes in retirement thread?

Or how about your own thread from March? livesoft made the same points back then. viewtopic.php?f=1&t=92637&p=1334252#p1334252

[retiredjg]

Is this a bad plan ?

I don't think it is a bad plan if you are in a low tax bracket and if you are using the distributions for your expenses.

As I understand it, the point of avoiding bonds in taxable while working is that the bond dividends are being taxed at a high rate when you are not even using the money that you are paying the taxes on. In retirement, the dividends would be taxed at a lower rate for most people and you are actually using the money (so paying some tax is not unreasonable).


Your approach would certainly be easy, but I'm not sure it is the best approach in the long run. You might do better to hold stocks in your taxable account and to sell some of those stocks to live on (in addition to your $20k pension). Part of the money from the stocks would be return of your investment (already taxed - no more taxes) and part would be capital gains which tend to be taxed at a lower rate than ordinary income. If the tax on long term capital gains continues to be 0%, you might not pay any federal taxes on a good part of the money you use to live on.

In the meantime, you could be systematically converting some money in a tIRA to Roth IRA each year, but don't convert enough to throw you into the 25% tax bracket. Stay in or under the 15% bracket.

[Bustoff]

If I converted my IRA to a Roth wouldn't I pay 25% tax on the converted amount ? I thought anything over $70,000 got taxed at 25%.

[livesoft]

Your question suggests that you have NOT
(a) Read the zero taxes link provided (in several threads you started) all the way to the end
(b) Did not try to use the calculator at http://www.i-orp.com, and
(c) Have not used tax software such as TurboTax to model your taxes and your Roth conversions.

[retiredjg]

If I converted my IRA to a Roth wouldn't I pay 25% tax on the converted amount ? I thought anything over $70,000 got taxed at 25%.

It is true that any taxable income over $70,700 would be taxed at 25% (for a couple filing jointly in 2012). What you may be overlooking is that all your income is not actually taxable.

$11,900 Standard Deduction (if you itemize, your deduction could be larger than this)
$3,800 His exemption
$3,800 Her exemption
$19,500

So the first $19,500 you get doesn't have any federal tax. This number might be greater, but I'm just doing basics here.

The next $17,400 is taxed at 10%.

The next $53,300 (up to a total of $70,700) is taxed at 15%.

Any income above that would be taxed at 25%. (Obviously, all of this is using this year's numbers.) What I was suggesting is that you not convert anything to Roth IRA that would be taxed in the 25% bracket.

We have no idea how much income you expect to need for your expenses, so what I'm saying is all just theory. But to repeat what I said in the earlier post, if you held stocks in your taxable account, and sold some of those stocks to live on, most of the money you got from selling the stocks would not be taxable income because it has already been taxed. The gains would be taxable, but the gains should not be that much (unless you've had the stocks a very long time) and whatever gains you do have would be taxed at the lower capital gains rate, not at the ordinary income rate.

Does that help any?

[Bustoff]

Your question suggests that you have NOT
(a) Read the zero taxes link provided (in several threads you started) all the way to the end
(b) Did not try to use the calculator at http://www.i-orp.com, and
(c) Have not used tax software such as TurboTax to model your taxes and your Roth conversions.

Thank you very much livesoft and retiredjg.
(a) I did read the zero tax thread, but it wasn't an easy read for me. I'll go back and study it further.
(b) I did not try to use the calculator . . . when I saw all the inputs my mind shut down. I will go back and try to work through it.
(c) I have used TurboTax, but I just follow the prompts. Never tried to do a Roth conversion.
I'm not lazy, I'm just not good with numbers and have difficulty applying the principles to my situation.
Retiredjg your posts are really helpful in that regard.

[retiredjg]

(a) I did read the zero tax thread, but it wasn't an easy read for me. I'll go back and study it further.

Livesoft's zero tax thread is not an easy read for anyone. While I agree with livesoft's conclusions, I have often wished the salient points could be summarized in some bullet points because I think a lot got lost and confused in all the discussion on those 3 pages. And I think some of the important points are not ever actually stated, just hinted at and understood by some, but not all of us.

I've tried to illustrate part of the point of the thread above when I broke down how your income is taxed (and, more importantly, not taxed). I think more could be added, but I doubt that I currently understand everything that livesoft is trying to teach us.

[livesoft]

Here are a few more points not explicitly stated so far in this thread, but they have been made elsewhere:
(1) Return of capital is tax free. That's right, you pay no tax on principal returned to you from a taxable account.
(2) Long-term capital gains tax rates are lower than your marginal income tax rate. Sometimes as low as 0%.
(3) Net realized capital losses reduce your adjusted gross income and thus your taxable income.

When these ideas are added to retiredjg's tax hints above, one's taxes may be even less than she has shown.

I equate paying extra unnecessary taxes as the same as paying a high interest rate on credit card debt.

[Bob's not my name]

I thought the March thread established that the OP is in the 0% bracket. We're doing a lot of thrashing around here trying to explain abstract tax ideas. Knowing the true circumstances might make the advice easier to give and easier to understand. If Bustoff finds the illustrative models hard to follow I suggest he post his particulars in the recommended format, or this thread will have the same effect as the March one.

[retiredjg]

Here are a few more points not explicitly stated so far in this thread, but they have been made elsewhere:
(1) Return of capital is tax free. That's right, you pay no tax on principal returned to you from a taxable account.
(2) Long-term capital gains tax rates are lower than your marginal income tax rate.

You must be speed reading. I not only said those things, I said them TWICE!.

However, a third time is certainly not going to hurt anyone and maybe the way you said it makes more sense to somebody out there.

[retiredjg]

But....I really do appreciate the bullet list, livesoft.

[livesoft]

Jan, you can hit me up side the head with a two-by-four anytime you want.

[Bustoff]

Ran the ORP calculator but couldn't figure out the reports because I got an error message when clicking on "explain report".

Is this calculator supposed to help you figure out if it's beneficial to do Roth conversions prior to Social Security and RMD's kicking in ?

BTW, my understanding is that each year of a Roth conversion starts a new five year holding period for that years conversion amount.

[retiredjg]

Jan, you can hit me up side the head with a two-by-four anytime you want.

Ah, ha ha! No need.

But I am glad to see you got that phraseology right. You never know with a Texan - if they'll get southern sayings out right or not.

[retiredjg]

BTW, my understanding is that each year of a Roth conversion starts a new five year holding period for that years conversion amount.

Can't help with the ORP calculator, but I might be able to help with this one.

It is true that each Roth conversion starts a new five year holding period. But that doesn't necessarily mean it will affect you.

Once you have had anything in Roth IRA for a 5 year holding period AND you hit 59.5 or are disabled, all the money in all your Roth IRAs becomes qualified (can be withdrawn with no tax and no penalty) and you can forget counting any other 5 year holding periods. So you only need to pay attention if you are just now starting your first Roth IRA.

Since you have half your money in a taxable account, and also some money in tIRA, you can surely put off pulling these conversions out of Roth IRA for 5 years. So don't let this 5 year thing worry you at all. I'm not saying you have to do conversions, but don't let that 5 year thing keep you from doing them.

Edit: on reading some notes I have from Alan S., this above is not precisely correct. At 59.5, the person could withdraw the conversion amount without tax or penalty. However, the 5 year holding period would still apply to the earnings.

If you currently have money in Roth IRA (ordinary contributions) that money can be taken out any time for any reason. But you can't take the earnings without penalty and/or tax until the 5 year and 59.5 year old requirements are met.

[Bob's not my name]

Jan, you can hit me up side the head with a two-by-four anytime you want.

Ah, ha ha! No need.

Jan, you should have taken a vote first.

[retiredjg]

Jan, you should have taken a vote first.

Made me laugh!

[Hexdump]

BTW, my understanding is that each year of a Roth conversion starts a new five year holding period for that years conversion amount.

Can't help with the ORP calculator, but I might be able to help with this one.

It is true that each Roth conversion starts a new five year holding period. But that doesn't necessarily mean it will affect you.

Once you have had anything in Roth IRA for a 5 year holding period AND you hit 59.5 or are disabled, all the money in all your Roth IRAs becomes qualified (can be withdrawn with no tax and no penalty) and you can forget counting any other 5 year holding periods.

Retiredjg, I need to verify this with you cause that sure is not how I understand it.
I opened my Roth, probably 20 years ago and I am well past 59.5.
In 2008 I converted some of my Trad IRA into the Roth, so I started the 5 year clock and figured that on 1/1/2013 I could begin withdrawing it without penalties nor taxes.
Also in 2009, 2010, and 2011, I did more conversions.
Are you saying that the I can withdraw these last 3 conversions in 2013, that they don't have a 5 year waiting period ?

That's very different from what I was thinking.

Thanks

[retiredjg]

Yes. I'm saying that all your Roth IRA money became available without tax and or penalty the day you turned 59.5 (because your 5 years had been met long before you turned 59.5). That's how I understand it anyway.

http://www.irs.gov/publications/p590/ch ... 1000231057

[Bustoff]

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.

In other words:
If you convert a Traditional IRA into a Roth IRA, then you must wait at least five years from the first day of the tax year in which you made the conversion before you can take a qualified distribution. For example, if you convert a Traditional IRA on March 30, 2013, then the five-year clock starts on January 1, 2013.

Unlike the five-year rule that applies to contributions, the five-year rule that applies to a conversion is unique to each conversion. That is to say, each conversion has its own five-year waiting period before a qualified distribution can occur.

[retiredjg]

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.

This is correct, but it does not apply after your distributions become "qualified" (at age 59.5 if your Roth IRA has met its 5 year holding period). See the chart in the link just above.

If your Roth IRA has not met its 5 year holding period, it gets a little more complicated. Would that apply to you?

[lks]

LifeStrategy Moderate Growth in taxable and Total Bond in tax deferred=30% stocks/70% bonds in only two funds.Personally, I would add Tips to the deferred, for a three fund portfolio.