How tax rate is determined in retirement?

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FB01
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How tax rate is determined in retirement?

Post by FB01 »

Hi,

I read in couple of post that you will be paying tax depending what it is during retirement. How is that determined?

I am in 25% bracket now and might be in 33% after couple of years. Am in mid 30's so is an early question.

Now at 65 if have 1 million in my 401k, 500k in Roth IRA ,400K in taxable and get 2000 a month from Social security.

I am not sure how we can withdraw from 401k monthly. Can we withdraw whatever we want? If yes than if I say I take out 3000 a month.

So my taxable income will 36000 (401k- 3000x12), 24000 (SS-2000x12) and whatever interest income is generated from my taxable investment. (Whatever I withdraw/generate from Roth IRA will not be taxed)

Is this how it works in retirement? Can anyone help me understand

-FB
Thanks, | FB
livesoft
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Re: How tax rate is determined in retirement?

Post by livesoft »

Tax rate in retirement is determined exactly the same way as it is while one is not retired: Use Form 1040. Different kinds of income are taxed at different rates in both situations.

1. Tax-exempt bond income is generally not taxed.
2. Qualified ordinary dividends and long-term capital gains get a special tax rate.
3. Non-qualified ordinary dividends and short-term capital gains do not get a special tax rate.
4. Return of capital is tax-free.
5. Social security income gets taxed.
6. Too much income and one loses starts to lose tax credits and tax deductions.
7. Many things are deductible on Schedule A to reduce income and thus taxes.
8. HSA contributions are not taxed.
9. Etc, etc, etc.

Tax awareness allows one to make better investing decisions.
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FB01
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Re: How tax rate is determined in retirement?

Post by FB01 »

livesoft wrote:Tax rate in retirement is determined exactly the same way as it is while one is not retired: Use Form 1040. Different kinds of income are taxed at different rates in both situations.

1. Tax-exempt bond income is generally not taxed.
2. Qualified ordinary dividends and long-term capital gains get a special tax rate.
3. Non-qualified ordinary dividends and short-term capital gains do not get a special tax rate.
4. Return of capital is tax-free.
5. Social security income gets taxed.
6. Too much income and one loses starts to lose tax credits and tax deductions.
7. Many things are deductible on Schedule A to reduce income and thus taxes.
8. HSA contributions are not taxed.
9. Etc, etc, etc.

Tax awareness allows one to make better investing decisions.

Thanks livesoft but is my understanding about withdrawing from 401k correct. I can withdraw whatever I want any month and my taxable income will be accordingly. So in my example if I have 1 million in 401k, I can withdraw 5k for Jan and then may be 10k for Feb and so on
Thanks, | FB
livesoft
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Re: How tax rate is determined in retirement?

Post by livesoft »

Yes, you can withdraw whatever amount you want from a 401(k) or IRA at any time. You can even do that now if you want, too. It is your money. You will put the amount withdrawn annually and declare that income on your tax return. You will be taxed and/or penalized accordingly.

Here is the abiding rule: Money is taxed at least once and generally is not taxed twice. Penalties are an additional matter.
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Lynette
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Re: How tax rate is determined in retirement?

Post by Lynette »

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FB01
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Re: How tax rate is determined in retirement?

Post by FB01 »

Lynette wrote:Then at 70 1/2 you have to start taking RMDs from pre-tax 401K according to the IRS tables.

Hi Lynette,

So from 65 to 70, I take out 200k out of my million. Remaining balance is 800k in my 401k at 71. How is RMD decided for my 800k?
Thanks, | FB
stlrick
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Re: How tax rate is determined in retirement?

Post by stlrick »

FB01 wrote:
Lynette wrote:Then at 70 1/2 you have to start taking RMDs from pre-tax 401K according to the IRS tables.

Hi Lynette,

So from 65 to 70, I take out 200k out of my million. Remaining balance is 800k in my 401k at 71. How is RMD decided for my 800k?
Go here:

https://personal.vanguard.com/us/insigh ... r-rmd-tool
The Wizard
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Re: How tax rate is determined in retirement?

Post by The Wizard »

It helps greatly if you develop the ability to do your own income taxes while still employed.
Download and do your own federal taxes for free from taxact.
Download relevant IRS publications such as pub 590.

If you end up with large tax sheltered balances in retirement, it may be better to withdraw a steady sustainable amount each month and save the excess income in a taxable account.
Due to progressive taxation, this works out better than withdrawing an extra $30,000 every seven years to buy a new vehicle, for instance...
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etarini
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Re: How tax rate is determined in retirement?

Post by etarini »

Your RMD is based on the total value of all your traditional (i.e., not Roth) IRAs on December 31 of the previous year.

The amount that must be withdrawn in each year is based on a table in Publication 590-B for 2014, "Distributions from Individual Retirement Arrangements
(IRAs))".

If your spouse is fewer than 10 years younger than you, you'd use Table III on page 58. Once you begin RMDs, each year you divide your total IRA assets by the "Distribution Period" which is simply the number by which you divide your total to determine your RMD for that year.

For example, in your first year of RMDs, you would typically divide your total IRAs by either 27.5 (~3.64%) (if born in first half of the year) or 26.5 (~3.77%) (if born in the second half of the year), assuming you take your all of your first RMD in the same year that you turn 70. Similarly, in the year in which you turn 80, you'd divide by 18.7 (~5.35%), and at age 100 it would be about 15.9%.

That's the short version; read Publication 590 for details.

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retiredjg
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Re: How tax rate is determined in retirement?

Post by retiredjg »

I'm not sure you can withdraw from a 401k whenever you want. I'm sure some plans are set up that way, but I'm not sure all plans are set up that way.

But it is of little consequence - there are many ways to work around that if you can't.
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Re: How tax rate is determined in retirement?

Post by Lynette »

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kaneohe
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Re: How tax rate is determined in retirement?

Post by kaneohe »

retiredjg wrote:I'm not sure you can withdraw from a 401k whenever you want. I'm sure some plans are set up that way, but I'm not sure all plans are set up that way.

But it is of little consequence - there are many ways to work around that if you can't.
You should ask your 401K folks about this. As mentioned, the plans probably vary in detail. Mine was an all-or-nothing plan so you definitely could not get funds out as you wished unless you took the whole thing at once...........and since you are so young, the answer you get may be irrelevant since you may have moved to 1 or more other companies before you pull funds out.
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House Blend
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Re: How tax rate is determined in retirement?

Post by House Blend »

The Wizard wrote:If you end up with large tax sheltered balances in retirement, it may be better to withdraw a steady sustainable amount each month and save the excess income in a taxable account.
Due to progressive taxation, this works out better than withdrawing an extra $30,000 every seven years to buy a new vehicle, for instance...
It never makes sense to withdraw more than you need for expenses in a given year (unless forced to do so by Required Minimum rules). Any such money should be Roth-converted.
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House Blend
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Re: How tax rate is determined in retirement?

Post by House Blend »

kaneohe wrote:
retiredjg wrote:I'm not sure you can withdraw from a 401k whenever you want. I'm sure some plans are set up that way, but I'm not sure all plans are set up that way.

But it is of little consequence - there are many ways to work around that if you can't.
You should ask your 401K folks about this. As mentioned, the plans probably vary in detail. Mine was an all-or-nothing plan so you definitely could not get funds out as you wished unless you took the whole thing at once...........and since you are so young, the answer you get may be irrelevant since you may have moved to 1 or more other companies before you pull funds out.
For instance: My employer's matching contributions go into a 401(a). You can't touch that money, roll it over, or take loans against it, regardless of employment status, until age 55.

Their plan, their rules.
rkhusky
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Re: How tax rate is determined in retirement?

Post by rkhusky »

Once you stop working you can rollover your 401K to an IRA, where you can take the money out whenever you want, subject to RMD's, taxes and/or penalties.
workingtoretire
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Re: How tax rate is determined in retirement?

Post by workingtoretire »

kaneohe wrote:
retiredjg wrote:I'm not sure you can withdraw from a 401k whenever you want. I'm sure some plans are set up that way, but I'm not sure all plans are set up that way.

But it is of little consequence - there are many ways to work around that if you can't.
You should ask your 401K folks about this. As mentioned, the plans probably vary in detail. Mine was an all-or-nothing plan so you definitely could not get funds out as you wished unless you took the whole thing at once...........and since you are so young, the answer you get may be irrelevant since you may have moved to 1 or more other companies before you pull funds out.
Definitely ask your 401k provider, but be prepared to be flexible. My provider told me that in retirement I could withdraw however I wanted; monthly, quarterly, annually, whatever. Turns out that it is twice per year. I think the biggest problem is that there are so many plans, and they all have their small differences, that the rep speaks in general terms.
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Re: How tax rate is determined in retirement?

Post by The Wizard »

House Blend wrote:
The Wizard wrote:If you end up with large tax sheltered balances in retirement, it may be better to withdraw a steady sustainable amount each month and save the excess income in a taxable account.
Due to progressive taxation, this works out better than withdrawing an extra $30,000 every seven years to buy a new vehicle, for instance...
It never makes sense to withdraw more than you need for expenses in a given year (unless forced to do so by Required Minimum rules). Any such money should be Roth-converted.
I disagree.
I feel it's optimal to maintain an approximately constant or slightly increasing taxable income in retirement, from before age 70 to past it, when RMDs and possibly SS both start.
In my case, I'm close to maxing out the 25% federal bracket, so taking out an additional lump sum sufficient to buy a $40,000 vehicle in one year would not be tax efficient.
YMMV...
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kaneohe
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Re: How tax rate is determined in retirement?

Post by kaneohe »

The Wizard wrote:
House Blend wrote:
The Wizard wrote:If you end up with large tax sheltered balances in retirement, it may be better to withdraw a steady sustainable amount each month and save the excess income in a taxable account.
Due to progressive taxation, this works out better than withdrawing an extra $30,000 every seven years to buy a new vehicle, for instance...
It never makes sense to withdraw more than you need for expenses in a given year (unless forced to do so by Required Minimum rules). Any such money should be Roth-converted.
I disagree.
I feel it's optimal to maintain an approximately constant or slightly increasing taxable income in retirement, from before age 70 to past it, when RMDs and possibly SS both start.
In my case, I'm close to maxing out the 25% federal bracket, so taking out an additional lump sum sufficient to buy a $40,000 vehicle in one year would not be tax efficient.
YMMV...
Perhaps guys might actually agree that the leveling of income is a good thing and that since you're going to pay taxes on that withdrawal anyway, you might as well
Roth convert it so that future withdrawals will be tax free (subject to restrictions).
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Re: How tax rate is determined in retirement?

Post by Lynette »

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Re: How tax rate is determined in retirement?

Post by House Blend »

The Wizard wrote:
House Blend wrote:
The Wizard wrote:If you end up with large tax sheltered balances in retirement, it may be better to withdraw a steady sustainable amount each month and save the excess income in a taxable account.
Due to progressive taxation, this works out better than withdrawing an extra $30,000 every seven years to buy a new vehicle, for instance...
It never makes sense to withdraw more than you need for expenses in a given year (unless forced to do so by Required Minimum rules). Any such money should be Roth-converted.
I disagree.
I feel it's optimal to maintain an approximately constant or slightly increasing taxable income in retirement, from before age 70 to past it, when RMDs and possibly SS both start.
In my case, I'm close to maxing out the 25% federal bracket, so taking out an additional lump sum sufficient to buy a $40,000 vehicle in one year would not be tax efficient.
YMMV...
Then maybe we misunderstand each other.

Sounds like your current marginal rate is X. And in year +7, you would expect to be paying rate Y > X on at least some income, due to a $30K purchase.

Your plan is to withdraw an extra $4K per year for the next 7 years, while paying rate X on each $4K lump, plus the continuing tax costs (or opportunity costs) due to holding an extra $30K (or 7 x $4K) in taxable for an average of 3.5 years.

You'll come out ahead by converting an extra $4K to Roth for the next 7 years and then using Roth money for the purchase. The tax costs are lower -- you still pay rate X, but there are no extra costs due to holding the vehicle money in taxable.

I stand by my statement that there's no reason to make non-required withdrawals from tax-deferred accounts for spending later. Converting that money to Roth until the actual need arises is clearly superior.
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Re: How tax rate is determined in retirement?

Post by The Wizard »

kaneohe wrote: Perhaps guys might actually agree that the leveling of income is a good thing and that since you're going to pay taxes on that withdrawal anyway, you might as well
Roth convert it so that future withdrawals will be tax free (subject to restrictions).
Leveling of income, yes, that's my plan.

Roth conversions are a related topic and they definitely make sense if you are in a lower bracket initially and expect a higher bracket later. Best example might be 15% bracket now and 25% later.

But in my case, I'm in 25% or 28% bracket now and expect 28% bracket later if no changes aside from inflation tweaks to the brackets. So if both Roth conversions and RMDs are taxed at 28% federal, then less motivation to do conversions now.
Plus Roth conversions increase my AGI and can bump my Medicare bill up to the next level...
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kaneohe
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Re: How tax rate is determined in retirement?

Post by kaneohe »

The Wizard wrote:
kaneohe wrote: Perhaps guys might actually agree that the leveling of income is a good thing and that since you're going to pay taxes on that withdrawal anyway, you might as well
Roth convert it so that future withdrawals will be tax free (subject to restrictions).
Leveling of income, yes, that's my plan.

Roth conversions are a related topic and they definitely make sense if you are in a lower bracket initially and expect a higher bracket later. Best example might be 15% bracket now and 25% later.

But in my case, I'm in 25% or 28% bracket now and expect 28% bracket later if no changes aside from inflation tweaks to the brackets. So if both Roth conversions and RMDs are taxed at 28% federal, then less motivation to do conversions now.
Plus Roth conversions increase my AGI and can bump my Medicare bill up to the next level...
ok, it is a given that you are taking distributions from your IRA to level income. You withdraw funds and must pay taxes on that withdrawal at whatever bracket you are in. You then presumably put the leftover funds in a taxable account. Given that you are withdrawing those funds and that you are paying taxes on that withdrawal, and that the same taxes would be incurred if you did a Roth conversion (no extra) , doesn't it make more sense to put the funds in a Roth where the proceeds are not taxable at all (subject to some rules) than to put them in taxable where the withdrawals might be subject to ST/LT CGs taxes?

Yes , Roth conversions increase your AGI but so does the simple withdrawal from the TIRA. There is not one increase due to the withdrawal and another for the Roth conversion...........they are one and the same..............perhaps you might say the Roth conversion consists of 2 steps.....the withdrawal from TIRA and then the conversion and that it is the first step that creates the AGI that is taxed.
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Re: How tax rate is determined in retirement?

Post by JW-Retired »

Not sure exactly what some posters here have in mind, but you can't Roth convert any of your RMD. Only extra amounts taken out in excess of the RMD amount can be converted.
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Re: How tax rate is determined in retirement?

Post by GerryL »

rkhusky wrote:Once you stop working you can rollover your 401K to an IRA, where you can take the money out whenever you want, subject to RMD's, taxes and/or penalties.
Some company 401k plans allow in-service rollovers to a tIRA after a certain age. (59.5?) I rolled most of my 401k to a VG tIRA a few years before I planned to retire. BTW, my plan also allowed normal distributions after age 59.5, so they regarded the rollover as just a variation. It was up to me to make sure that it was done correctly so it wouldn't be taxable.
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Re: How tax rate is determined in retirement?

Post by DSInvestor »

FB01 wrote:
So my taxable income will 36000 (401k- 3000x12), 24000 (SS-2000x12) and whatever interest income is generated from my taxable investment. (Whatever I withdraw/generate from Roth IRA will not be taxed)
Watch out for terms like taxable income which is not the same as income that is taxable.
On a tax return, Taxable Income = Adjusted Gross Income - deductions - exemptions.

Try running some numbers with tax calculators like taxcaster:
https://turbotax.intuit.com/tax-tools/c ... taxcaster/

I put in your numbers 36K TradIRA/401k withdrawal + 22K social security for a single filer age 62 with standard deduction and 1 exemption.
Total Income = 51,550 (not all of social security is taxable)
std deduction = 6200
exemption = 3950
Taxable income = AGI - deductions - exemptions = $41400
Fed Tax = $6,213
Federal Tax bracket = 25%

The numbers will be very different if you are married filing jointly. Tools like taxcaster let you see results immediately upon entry. For example, start with 22K of social security income. Now start with zero your 401k/IRA withdrawals and increase $1000 at a time and watch how the tax increases if it increases. You may find that you're not taxed on the first X thousand of withdrawals. This is the amount that is consuming the 0% tax bracket provided by your deductions and exemptions. Once you see a tax number,continue to increase withdrawals by $1000 and watch for the amount of increase in the tax. If $1000 of extra income increases tax by $150, that income was taxed at 15% tax rate. Only the income that falls into a bracket is taxed at that higher rate.

While taxcaster is running calculations using today's tax rates, it will give you an idea of how things work. As long as the tax system continues to provide for deductions and exemptions, there will be a 0% tax bracket.
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Re: How tax rate is determined in retirement?

Post by grabiner »

FB01 wrote:So my taxable income will 36000 (401k- 3000x12), 24000 (SS-2000x12) and whatever interest income is generated from my taxable investment. (Whatever I withdraw/generate from Roth IRA will not be taxed)
At most 85% of SS is taxable; there is a simplified formula at Taxation of Social Security benefits on the wiki. At current tax rates, you would not quite have the full 85% of your SS taxed with $36K other income and $24K SS income; however, SS will increase with inflation, and your 401(k) will probably grow as well, but the SS taxation rules are not indexed for inflation.
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Re: How tax rate is determined in retirement?

Post by The Wizard »

DSInvestor wrote:
FB01 wrote:
So my taxable income will 36000 (401k- 3000x12), 24000 (SS-2000x12) and whatever interest income is generated from my taxable investment. (Whatever I withdraw/generate from Roth IRA will not be taxed)
Watch out for terms like taxable income which is not the same as income that is taxable.
On a tax return, Taxable Income = Adjusted Gross Income - deductions - exemptions.

Try running some numbers with tax calculators like taxcaster:
https://turbotax.intuit.com/tax-tools/c ... taxcaster/

I put in your numbers 36K TradIRA/401k withdrawal + 22K social security for a single filer age 62 with standard deduction and 1 exemption.
Total Income = 51,550 (not all of social security is taxable)
std deduction = 6200
exemption = 3950
Taxable income = AGI - deductions - exemptions = $41400
Fed Tax = $6,213
Federal Tax bracket = 25%

The numbers will be very different if you are married filing jointly. Tools like taxcaster let you see results immediately upon entry. For example, start with 22K of social security income. Now start with zero your 401k/IRA withdrawals and increase $1000 at a time and watch how the tax increases if it increases. You may find that you're not taxed on the first X thousand of withdrawals. This is the amount that is consuming the 0% tax bracket provided by your deductions and exemptions. Once you see a tax number,continue to increase withdrawals by $1000 and watch for the amount of increase in the tax. If $1000 of extra income increases tax by $150, that income was taxed at 15% tax rate. Only the income that falls into a bracket is taxed at that higher rate.

While taxcaster is running calculations using today's tax rates, it will give you an idea of how things work. As long as the tax system continues to provide for deductions and exemptions, there will be a 0% tax bracket.
There's a line on the backside of Form 1040 that says Taxable Income.
I don't see any confusion on this at all...
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DSInvestor
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Re: How tax rate is determined in retirement?

Post by DSInvestor »

The Wizard wrote:There's a line on the backside of Form 1040 that says Taxable Income.
I don't see any confusion on this at all...
Yes, but OP did not use the term in the way that you and I would use the term (i.e. line 43 on page 2 of 1040 form).
FB01 wrote:So my taxable income will 36000 (401k- 3000x12), 24000 (SS-2000x12) and whatever interest income is generated from my taxable investment. (Whatever I withdraw/generate from Roth IRA will not be taxed)
Doesn't OP's description of his/her "taxable income" sound more like gross income?
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Re: How tax rate is determined in retirement?

Post by The Wizard »

House Blend wrote: Then maybe we misunderstand each other.

Sounds like your current marginal rate is X. And in year +7, you would expect to be paying rate Y > X on at least some income, due to a $30K purchase.

Your plan is to withdraw an extra $4K per year for the next 7 years, while paying rate X on each $4K lump, plus the continuing tax costs (or opportunity costs) due to holding an extra $30K (or 7 x $4K) in taxable for an average of 3.5 years.

You'll come out ahead by converting an extra $4K to Roth for the next 7 years and then using Roth money for the purchase. The tax costs are lower -- you still pay rate X, but there are no extra costs due to holding the vehicle money in taxable.

I stand by my statement that there's no reason to make non-required withdrawals from tax-deferred accounts for spending later. Converting that money to Roth until the actual need arises is clearly superior.
I thought about this a bit and I think you're correct.

I also looked at my recently filed form 1040 for 2014 and I was mistaken about my marginal tax bracket; I'm actually in the beginning of the 28% federal tax bracket and will likely always be in that bracket if no major changes to the tax code.
My retirement income comes from TIAA-CREF, a combination of lifetime annuity payout and systematic monthly withdrawals. The systematic withdrawal cash flow has the potential to be put in a Roth account one way or another.
So I would have the same taxable income for the year, but a fraction of it would now enjoy Roth tax shelter as opposed to sitting in my checking account or taxable account.

This would be a routine process rather than waiting till December and conniving how much of a Roth conversion to do that year as I've done previously.
I'll be checking with my T-C WMA to see what my easy options are. One complication is that my existing Roth IRA is entirely at Vanguard so will be amusing to see if they can link to that on a monthly basis.
Thanks...
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Impromptu
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Re: How tax rate is determined in retirement?

Post by Impromptu »

In retirement I plan on having 4 sources of income, two pre and two post tax.
Roth IRA
Variable Universal Life Insurance (VUL).
401(k)
Social security

Say I receive $30,000/year in social security and withdraw $40,000/year from my 401(k). That is $70,000/year that is taxed at the 15% married bracket (let's disregard exemptions and deductions for a moment). What if I took out an additional $100,000 from my roth IRA and VUL? That $100,000 won't be taxed, but will it increase the marginal tax bracket for the original $70,000? Will that impact that $70,000 in any way?
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Re: How tax rate is determined in retirement?

Post by retiredjg »

Impromptu wrote:Say I receive $30,000/year in social security and withdraw $40,000/year from my 401(k). That is $70,000/year that is taxed at the 15% married bracket (let's disregard exemptions and deductions for a moment).
This is incorrect because only 85% of your SS will be taxed at the most. So at most, you will be starting at $65,500. I know that is not relevant to your question, but it is something you need to know.
What if I took out an additional $100,000 from my roth IRA and VUL? That $100,000 won't be taxed, but will it increase the marginal tax bracket for the original $70,000? Will that impact that $70,000 in any way?
The Roth IRA doesn't (if age and time requirements are met), but I don't know about the VUL.
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Re: How tax rate is determined in retirement?

Post by kaneohe »

http://lifeinsurance.prudential.com/vie ... umer/30389
taxation of VUL..........generally you are not taxed until you withdraw more than your basis.........the amount paid in for all premiums and investments.
(exception: MEC see link)
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