Too much tax deferral?

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MoonOrb
Posts: 959
Joined: Thu Jan 24, 2013 6:58 pm

Too much tax deferral?

Post by MoonOrb » Wed Jan 03, 2018 11:59 pm

Is there a point at which it stops making sense to put funds into tax-deferred investments and switch instead to more of a mix of Roths or even taxable? I ask because 2/3 of our investments are in tax deferred vehicles with about 20% in Roths and just 13% in taxable. But beyond that, DW and I now have the capacity do all of our annual investing into tax-advantaged funds: this is more of a function of the large amount of tax advantaged space accessible to us and less a function of our inability to maximize our savings rate. Our savings rate is approximately 40% of our gross income. I’ve given a sketch of our situation below so you have an idea of how things are structured. I didn't break down our asset allocation because it's wear we want it to be right now, and I didn't provide info about other available funds because we're all set in that department for now.

The keys are that we currently have 2/3 of our low seven figure portfolio in tax-deferred space, but because of the plans offered by our (state) employer, we can contribute approximately $113k, including employer matches, into tax advantaged accounts, including both of us maxing out Roth IRAs. That doesn’t leave us anything additional to put into taxable, though. This is a change from previous years where we did not have as many tax-deferred options (she changed employers this year; in 2018 we will begin using an HSA; I changed employers just a few years ago--all are factors in us having greater tax-deferred options).

I anticipate being at the 22% tax rate and likely taking the standard deduction. It’s possible in some years we may make large enough charitable contributions that we can bunch deductions, but it won’t be that material of a difference in any event.

We expect to retire within 12-20 years, with 16 years from now our theoretical target date. I will receive a COLA’d pension of about 1/5 of our anticipated annual expenses per year beginning at age 65. We'll wait til 70 to draw SS, I imagine. The large amount of tax-deferral will put us in the position of withdrawing most of our investments as ordinary income.

My overall feeling has just been that we should plow as much as we can into tax deferred accounts and not worry about this for at least another decade, but I wanted to figure out what I’m missing here that I might be missing.

Emergency funds: Yes
Combined salary income: low $200ks
Debt: mortgage, 23 years remaining, $316k @ 3.25%
Tax Filing Status: MFJ
Tax Rate: 22% Federal, 0% State
State of Residence: WA
Age: 42/42
Desired Asset allocation: 67% stocks / 33% bonds
Desired International allocation: 33% of stocks


Portfolio size: Low 7 figures


Current retirement assets

Taxable (12.9%) at Vanguard

S&P 500 Index (VFIAX)
Total Int’l Index (VTIAX)
Small Cap Index (VSMAX)

His 403b at Fidelity (8.2%)

Vanguard S&P 500 Inst’l (VIIIX)
Vanguard Inst’l Bond (VBTIX)
Vanguard Inst’l Small Cap (VSCIX)
Vanguard Inst’l Mid Cap (VMCIX)

His 401a at WA State (1.8%)

US Large Cap Equity Index Fund (no ticker)

His 457 at WA State (1.25%)

US Large Cap Equity Index Fund (no ticker)

His Roth IRA at Vanguard (9.9%)

REIT Index (VGSLX)
Total Int’l Index (VTIAX)

His Rollover IRA at Vanguard (12%)

Total Bond Market Index (VBTLX)
Mid Cap Index (VIMAX)
REIT Index (VGSLX)
S&P 500 Index (VFIAX)

His HSA at HealthEquity (0%)

Starting in 2018…in whatever Vanguard fund is appropriate to maintain desired asset allocation

Her 403b at Fidelity (.8%)

Vanguard S&P 500 Inst’l (VIIIX)
Vanguard Inst’l Bond (VBTIX)

Her 457 at WA State (.6%)

US Large Cap Equity Index Fund (no ticker)

Her Roth IRA at Vanguard (9.2%)

S&P 500 Index (VFIAX)
Total Int’l Index (VTIAX)

Her Rollover IRA at Vanguard (43.3%)

Total Bond Market Index (VBTLX)
Small Cap Index (VSMAX)
S&P 500 Index (VFIAX)

Her HSA at HealthEquity (0%)

Starting in 2018…in whatever Vanguard fund is appropriate to maintain desired asset allocation

Contributions

New annual Contributions:

$18500 his 403b (no match)
$5680 his 401a
$18500 his 457
$26150 her 403b + $7650 match
$18500 her 457
$5500 his Roth IRA
$5500 her Roth IRA
$6950 combined HSA including $1400 match
$0 taxable (change from previous years)

Total: $112930

kaudrey
Posts: 961
Joined: Fri Nov 22, 2013 2:40 pm

Re: Too much tax deferral?

Post by kaudrey » Thu Jan 04, 2018 8:56 am

Hi,

Just for background; I'm 48 and about 1/4 of my portfolio is in taxable. And I plan to retire at 52.

The main reason for needing money in taxable is if you plan to retire early (before 59 1/2, the age when it is easiest to get money penalty-free out of IRAs/401(k)s). If you retire at 58 (16 years from now), you'll only need a year and a half of taxable money to get you to your IRA withdrawal.

Another thing to think about: the future RMDs that arise when you hit 70, which can get really large if you have large tax-deferred accounts; however, this can be offset by doing Roth conversions to the extent possible during the years you have low income (for you, this would be from 58 to 65, before your pension starts). So, you could potentially get a lot of IRA money out of the IRAs at a lower tax rate later, as compared to paying tax on that money now.

In general, I'm of the belief that you'll be better off using the tax-deferred space in most cases, unless you have a specific reason for needing the money early or if your specific tax situation will be much different from the norm.

Smokey21
Posts: 85
Joined: Fri Oct 31, 2014 7:07 am

Re: Too much tax deferral?

Post by Smokey21 » Thu Jan 04, 2018 9:13 am

There are other ways to get to your tax deferred $ before 59.5 years of age. Read about Substantially Equal Periodic Payments (SEPP 72t). Roth ladder is another way. I believe some 401ks allow penalty free withdrawals at 55 too.

KlangFool
Posts: 10402
Joined: Sat Oct 11, 2008 12:35 pm

Re: Too much tax deferral?

Post by KlangFool » Thu Jan 04, 2018 9:23 am

OP,

The short answer: you may need to evaluate whether you have too much tax referral when your tax-deferred account is more than 1 million to 1.25 million.

The longer answer: it is dependent the actual amount of your COLA pension, your annual expense, the actual amount in your Roth IRA, taxable account, and the tax-deferred account.

If you provide those numbers, someone could probably show you the calculation need in order to make this decision.

For example, if your annual expense is 60K and your Roth IRA contribution is 120K, when you retire early, you could the Roth IRA contribution for 2 years and generate zero income. Hence, you could do Roth conversion up to whatever tax bracket for 2 years.

KlangFool

KlangFool
Posts: 10402
Joined: Sat Oct 11, 2008 12:35 pm

Re: Too much tax deferral?

Post by KlangFool » Thu Jan 04, 2018 9:26 am

Smokey21 wrote:
Thu Jan 04, 2018 9:13 am
There are other ways to get to your tax deferred $ before 59.5 years of age. Read about Substantially Equal Periodic Payments (SEPP 72t). Roth ladder is another way. I believe some 401ks allow penalty free withdrawals at 55 too.
Smokey21,

457 has no early withdrawal penalty like the 401K. You can withdraw the money any time as long as you are no longer with the employer. You just need to pay tax.

KlangFool

KlangFool
Posts: 10402
Joined: Sat Oct 11, 2008 12:35 pm

Re: Too much tax deferral?

Post by KlangFool » Thu Jan 04, 2018 9:30 am

OP,

Another short answer: defer all the money in the 22% tax bracket.

KlangFool

retiredjg
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Re: Too much tax deferral?

Post by retiredjg » Thu Jan 04, 2018 9:55 am

I think it is possible to have too much tax deferral if you work until your mid 60's or later. Working that long does not give you a lot of time to do Roth conversions before RMDs start. And the start of SS if you delay it. And with IRMAA calculations your space for Roth conversions is limited starting about age 63 without raising your Medicare premiums 2 years later.

For people who retire in their 50's and who then drop into a low bracket, there is a lot of time to do Roth conversions and the space is not limited by IRMAA so too much tax deferral is not likely to be an issue. And you can use more of your IRA because the pension is not yet started.

As a general thought, I think having about 66% in tax deferred and 33% in Roth is a good balance for many people. I'd modify those numbers depending on the the things listed above.....when you retire, when pension starts, etc. For example, if i planned to work until 70, I might use more Roth now with the thought that RMDs may not let me ever drop into a lower bracket.

Pigeye Brewster
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Re: Too much tax deferral?

Post by Pigeye Brewster » Thu Jan 04, 2018 10:11 am

MoonOrb wrote:
Wed Jan 03, 2018 11:59 pm
Is there a point at which it stops making sense to put funds into tax-deferred investments and switch instead to more of a mix of Roths or even taxable? I ask because 2/3 of our investments are in tax deferred vehicles with about 20% in Roths and just 13% in taxable.
Great question and I look forward to the responses.

We're older than you and your spouse and our situation is even more pronounced than yours: 76% tax-deferred, 16% Roth, and 8% taxable. We won't have pensions, though, so I plan on being able to aggressively do Roth conversions after retirement. My current goal is to work on building up the taxable bucket prior to retirement, though I'm not willing to give up any available tax-advantaged opportunities.

OldSport
Posts: 309
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Re: Too much tax deferral?

Post by OldSport » Thu Jan 04, 2018 10:30 am

OP wants to retire at 58. The OP would only be able to convert 401k/403b to Roth with little to no tax (low income bracket) after reaching 59.5?

I think it pays to have some taxable in low cost index funds with lower cost capital gains and qualified dividends.

Tal-
Posts: 358
Joined: Fri Apr 22, 2016 10:41 pm

Re: Too much tax deferral?

Post by Tal- » Thu Jan 04, 2018 10:41 am

I think you're in great shape.

Your allocation is pretty great for long-term income. And, that allocation can easily handle normal variances like retiring at 55 or 58. This is especially true for you given that you have fast-growing 457 plans, and large chunks of cash (in terms of dollars) in both a Roth and taxable account.

I wouldn't worry about RMDs, or Roth conversions, or anything like that.

Normally, my bigger concerns would be either a large one-time expense (50K wedding, 500K vacation home, etc.) or longer-term unemployment. Neither of these seem especially likely for you - and even if they were to happen, you look to be in decent shape to weather them.

In a 22% tax bracket, with 39K going into a 457 and 11K into a Roth, I think your saving allocation is spot-on. Barring a relevant goal that you haven't mentioned, I think you are hitting the nail on the head.

Props!
Debt is to personal finance as a knife is to cooking.

retiredjg
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Re: Too much tax deferral?

Post by retiredjg » Thu Jan 04, 2018 10:57 am

OldSport wrote:
Thu Jan 04, 2018 10:30 am
OP wants to retire at 58. The OP would only be able to convert 401k/403b to Roth with little to no tax (low income bracket) after reaching 59.5?
Roth conversions can be done at any time - you do not have to be 59.5. Whether there is little or no tax depends entirely on the total income (which includes the amount converted).

smithers
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Joined: Mon Sep 15, 2014 1:03 pm

Re: Too much tax deferral?

Post by smithers » Thu Jan 04, 2018 11:27 am

MoonOrb wrote:
Wed Jan 03, 2018 11:59 pm
Is there a point at which it stops making sense to put funds into tax-deferred investments and switch instead to more of a mix of Roths or even taxable?
Yes, there is. IMHO, too many people rely on the legal max to dictate how much they put in tax-advantaged space.

My approach is to first decide how much I'd put away if there were no limits. If that amount so happens to be over the legal max, then I have to adjust. But it forces me to think about it.

The only reason to ever pick tax-deferred over Roth is if you think the tax rate on withdrawal will be lower than the tax rate on contributions. Simple as that. Of course, It is the case for the vast majority of folks (who contribute at high marginal rates during working years, expect years where income will be lower, and often have a negligible amount in their tax-advantaged accounts anyway). But it's not a guarantee. It could work the other way for a number of reasons, such as:

- You don't end up having many low income years ahead (due to pension, SS, etc)
- RMDs require you to pay tax on more than you want/need
- Government policy increases tax rates
- You move to a state with higher income tax rates
- You contribute during lower income years (e.g. at the start of your career)

Almost all of those involve a lot of uncertainty, so run some numbers but don't put too much weight in them. I think it's fair game to even trust your gut and ultimately do what "feels right" as far as splitting between Roth and tax deferred.

Tal-
Posts: 358
Joined: Fri Apr 22, 2016 10:41 pm

Re: Too much tax deferral?

Post by Tal- » Thu Jan 04, 2018 12:23 pm

MoonOrb wrote:
Wed Jan 03, 2018 11:59 pm
Is there a point at which it stops making sense to put funds into tax-deferred investments and switch instead to more of a mix of Roths or even taxable?
I wanted to clarify my previous post, which was really talking about tax advantaged retirement accounts (tax deferred or Roth) vs taxable accounts. I believe my previous point here still holds: I agree that you should max all tax advantaged accounts (including Roth) before you invest anything in taxable accounts.

With that said, the question of traditional vs roth accounts is more complicated. Generally speaking, there are lots of reasons why you may want to fund one over the other, or do a combination of the two. Comparing today's vs future tax rates is probably the most common approach, but a Roth will have many advantages over a traditional account even if there is no/minimal tax rate savings. These include earlier/easier access to the money prior to 59.5, more flexibility at 70.5 (RMDs), tax rate diversification, and the ability to save more today (18.5k in a Roth is worth more than 18.5K in a traditional account).

In your situation, you are maxing both traditional and roth accounts, and I don't see any reason to change your plans. I just wanted to clarify that tax advantaged (traditional or Roth) is almost always better than taxable. However, the decision to invest in a traditional 401k/IRA vs roth is more nuanced.
Debt is to personal finance as a knife is to cooking.

smithers
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Re: Too much tax deferral?

Post by smithers » Thu Jan 04, 2018 12:55 pm

Tal- wrote:
Thu Jan 04, 2018 12:23 pm
I just wanted to clarify that tax advantaged (traditional or Roth) is almost always better than taxable
That's true if you're saving for retirement. It's not true if you're saving for something you'll want before retirement: houses, cars, weddings, starting or buying a business, taking an unpaid sabbatical, being unemployed, kid's college, etc. Most of life (and sometimes, unfortunately, all of life) happens before age 59 1/2.

Sounds like the OP is primarily saving for retirement, in which case maxing tax advantaged space (whether Roth or traditional) is indeed wise.

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celia
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Location: SoCal

Re: Too much tax deferral?

Post by celia » Thu Jan 04, 2018 1:38 pm

Here are 4 retirement scenarios for someone who has the great majority of their savings in tax-deferred:

1. They have large enough pensions or taxable assets that they don't need the tax-deferred for living expenses. When RMDs start, they each can give up to $100K of it each year to charity. Neither they nor the charity would have to pay taxes on it. But that means their tax-deferred IRA can only be $2.7M per person. A $3M tIRA at 70.5 will generate RMDs of $109K and they would have to pay taxes on withdrawals over the QCD. The RMDs will increase each year until the rate of withdrawal is more than the growth rate of the tIRA.

2. Their living expenses are more than their pensions and partial spend-down of taxable assets. They will need to withdraw $x from their tax-deferred before 70.5 or RMDs after 70.5. If they don't have enough money in taxable to pay the taxes, they will have to withhold taxes from the tax-deferred withdrawal, which may necessitate a bigger withdrawal so that the part that goes into checking will cover the remaining living expenses.

3. They retired early with the idea of living off their taxable funds until age 70.5 when RMDs and SS starts. They are quite proud of themselves as their taxes are almost non-existent before 70.5 (except for a small pension and Capital Gains as they sell off some holdings). Everything was timed perfectly and at age 70.5, their taxable is gone and RMDs and SS starts. Whoaaa! Their taxes suddenly jumped and they don't understand why. Their large SS benefits are totally taxed as well as everything they withdraw from the tIRA. They come here to post, asking how they can save on taxes.

4. You haven't been feeling well the last few years of working, so you retire a little earlier than planned. You try to keep your expenses low but eventually you need to go into a nursing home (for medical reasons). It ends up costing more than you planned, but you withdraw from tax-deferred the same amount as the nursing home expenses since that is a medical expense you can itemize. Only the medical expenses over 7.5% or 10% of your AGI are eligible. Funny thing is, as you withdraw more from tax-deferred for medical expenses, that makes your AGI increase.

Mike Scott
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Re: Too much tax deferral?

Post by Mike Scott » Thu Jan 04, 2018 1:59 pm

Since I am in a lower tax bracket and will probably never move up unless tax brackets change dramatically, my priority is Roth and then as much as possible in taxable while saving some IRA space to the end of the year for any last minute tax adjustments using TIRA. Waiting is not a lost opportunity because it takes all year to get there with contributions. The general plan is to end up with 3 similar amounts of $ in the 3 different categories with different tax status. I have a huge amount of space available for additional deferred comp (no matching) if I happened to pop up in the tax brackets. I have added an HSA for the first time this year but plan to use it to directly pay ongoing medical expenses. I've been moving in this direction for a while and have three more years to go before the calendar tells me I must reevaluate this path as well as major career etc decisions.

Lynette
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Re: Too much tax deferral?

Post by Lynette » Thu Jan 04, 2018 2:40 pm

Try to do better planning than I did as I did not know about Medicare IRMAA premiums - rarely go to a doctor and assumed Medicare would be about the same amount as I paid for health care while working. This was $2,400 p.a. My planning was based on traveling a great deal and working longer till 73 so that my pensions would grow. I only did a small amount of Roth conversions as my accountants told me it was a wash as I was in the 28% marginal tax bracket. I saved the recommended amount in a tax-deferred 401K. I did not know that there was something called Medicare IRMAA. Now about 75% of my portfolio is in tax-deferred, 15% in taxable and 10% in a Roth IRA. I have full Social Security as I only started to withdraw it at 70.

In 2017, I also withdrew additional money for a driveway from my 401K. I did not take into account that I would also get a bonus from my former employer. Medicare increased IRMAA in 2018 by adding a new bracket. So for 2019 I am going to have to pay about $450 per month for Medicare B and D premiums. In addition I am paying about $200 for Medigap and Drug coverage. So I am paying close to $8,000 p.a. for something I don't use. Of course, 85% of SS is taxable. There isn't much point in thinking about what I should have done now and I'm somewhat stunned that Medicare regards me as high income!

About all I can do now is QCDs. I rolled my 401K over to Vanguard and Fidelity so I can make QCDs from my RMD and so lower my MAGI that determines how much you pay in IRMAAs.
Last edited by Lynette on Thu Jan 04, 2018 2:58 pm, edited 2 times in total.

KlangFool
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Re: Too much tax deferral?

Post by KlangFool » Thu Jan 04, 2018 2:56 pm

celia wrote:
Thu Jan 04, 2018 1:38 pm
Here are 4 retirement scenarios for someone who has the great majority of their savings in tax-deferred:

1. They have large enough pensions or taxable assets that they don't need the tax-deferred for living expenses. When RMDs start, they each can give up to $100K of it each year to charity. Neither they nor the charity would have to pay taxes on it. But that means their tax-deferred IRA can only be $2.7M per person. A $3M tIRA at 70.5 will generate RMDs of $109K and they would have to pay taxes on withdrawals over the QCD. The RMDs will increase each year until the rate of withdrawal is more than the growth rate of the tIRA.

2. Their living expenses are more than their pensions and partial spend-down of taxable assets. They will need to withdraw $x from their tax-deferred before 70.5 or RMDs after 70.5. If they don't have enough money in taxable to pay the taxes, they will have to withhold taxes from the tax-deferred withdrawal, which may necessitate a bigger withdrawal so that the part that goes into checking will cover the remaining living expenses.

3. They retired early with the idea of living off their taxable funds until age 70.5 when RMDs and SS starts. They are quite proud of themselves as their taxes are almost non-existent before 70.5 (except for a small pension and Capital Gains as they sell off some holdings). Everything was timed perfectly and at age 70.5, their taxable is gone and RMDs and SS starts. Whoaaa! Their taxes suddenly jumped and they don't understand why. Their large SS benefits are totally taxed as well as everything they withdraw from the tIRA. They come here to post, asking how they can save on taxes.

4. You haven't been feeling well the last few years of working, so you retire a little earlier than planned. You try to keep your expenses low but eventually you need to go into a nursing home (for medical reasons). It ends up costing more than you planned, but you withdraw from tax-deferred the same amount as the nursing home expenses since that is a medical expense you can itemize. Only the medical expenses over 7.5% or 10% of your AGI are eligible. Funny thing is, as you withdraw more from tax-deferred for medical expenses, that makes your AGI increase.
celia,

As far as I can tell, at any of your 4 scenarios, Roth conversion before 70.5 years old will solve the problem. Do I miss anything?

KlangFool

SGM
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Re: Too much tax deferral?

Post by SGM » Thu Jan 04, 2018 4:31 pm

You might consider making conversions now as you will be in a higher bracket with RMDs and SS. Your taxable account should continue to grow and you may have a lot of taxes on dividends and gains. Do you have a legacy motive? It is better to inherit a Roth than a tIRA.

Roth conversions are a wash at the time of conversion, but if you pay the taxes out of a taxable account you do get a small advantage by lowering the taxable dividends and capital gains. The real advantage comes after age 70 1/2 in reduced RMDs.

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Peter Foley
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Re: Too much tax deferral?

Post by Peter Foley » Thu Jan 04, 2018 9:06 pm

MoonOrb wrote:
Is there a point at which it stops making sense to put funds into tax-deferred investments and switch instead to more of a mix of Roths or even taxable? I ask because 2/3 of our investments are in tax deferred vehicles with about 20% in Roths and just 13% in taxable.
For some savers/investors there is a point. Celia notes a few scenarios.

However, in your case I would say that the answer is close to, but not absolutely "no." Your plan is to retire relatively early and that will create a number of low income years. Because you have access to a 457 plan (note KlangFool's comment) there is no penalty for early withdrawal after separation from the employer. However, you do want to have some funds in taxable when you retire - it gives you more flexibility to control your marginal tax rate. Sticking with your current 10% to 13% in taxable is probably enough.

Try to imagine how you would fill up the 12% tax bracket when retired, and will that be enough money to live on? My wife and I retired early with a scenario similar to yours. We filled up the 15% bracket with pension and Roth conversions and lived off our pension and taxable savings.

MoonOrb
Posts: 959
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Re: Too much tax deferral?

Post by MoonOrb » Thu Jan 04, 2018 10:16 pm

All of these responses have been great, thank you. I'm singling out celia's below because it was particularly helpful for me to frame this question.
celia wrote:
Thu Jan 04, 2018 1:38 pm
Here are 4 retirement scenarios for someone who has the great majority of their savings in tax-deferred:

1. They have large enough pensions or taxable assets that they don't need the tax-deferred for living expenses. When RMDs start, they each can give up to $100K of it each year to charity. Neither they nor the charity would have to pay taxes on it. But that means their tax-deferred IRA can only be $2.7M per person. A $3M tIRA at 70.5 will generate RMDs of $109K and they would have to pay taxes on withdrawals over the QCD. The RMDs will increase each year until the rate of withdrawal is more than the growth rate of the tIRA.

2. Their living expenses are more than their pensions and partial spend-down of taxable assets. They will need to withdraw $x from their tax-deferred before 70.5 or RMDs after 70.5. If they don't have enough money in taxable to pay the taxes, they will have to withhold taxes from the tax-deferred withdrawal, which may necessitate a bigger withdrawal so that the part that goes into checking will cover the remaining living expenses.

3. They retired early with the idea of living off their taxable funds until age 70.5 when RMDs and SS starts. They are quite proud of themselves as their taxes are almost non-existent before 70.5 (except for a small pension and Capital Gains as they sell off some holdings). Everything was timed perfectly and at age 70.5, their taxable is gone and RMDs and SS starts. Whoaaa! Their taxes suddenly jumped and they don't understand why. Their large SS benefits are totally taxed as well as everything they withdraw from the tIRA. They come here to post, asking how they can save on taxes.

4. You haven't been feeling well the last few years of working, so you retire a little earlier than planned. You try to keep your expenses low but eventually you need to go into a nursing home (for medical reasons). It ends up costing more than you planned, but you withdraw from tax-deferred the same amount as the nursing home expenses since that is a medical expense you can itemize. Only the medical expenses over 7.5% or 10% of your AGI are eligible. Funny thing is, as you withdraw more from tax-deferred for medical expenses, that makes your AGI increase.
I'm anticipating we're in situation 2 (4 of course is possible, but not likely and not one I want to do my planning on at this point). Only one of us will have a pension, and the pension will be modest. It will cover about 20% of what I can reasonably forecast our living expenses to be and will start at age 65 (I could start it earlier, but it will be reduced as a result and it seems to make sense to me to defer it, but I'm open to ideas on this). We plan to take SS at 70. The question I'm wrestling with now is whether it makes sense to reduce contributions to traditional tax-deferred plans in favor of doing 403b Roths. Or, possibly, to forego tax-advantaged investing to some degreed in favor of investing more in a taxable account. I don't like the latter idea at all and I can't yet imagine a convincing case for it. But I think there is, possibly, an argument for contributing less to traditional plans and more to Roths.

If we do retire at age 58 as planned, we won't need to worry about bridging the gap to age 59.5--there are lots of options there (457s being the most obvious). But what I am thinking about is our ability to do Roth conversions in the years from retirement up to 70.5. It will be hard for us to stay for many years in lower tax brackets if so much of our income is pulled from our traditional IRAs, 457s, and 403bs. I'm not complaining, this is a fine problem to have. But I want to be as smart about it as I can.

If more specific numbers help, our portfolio currently sits at just north of $1.2M, with annual contributions of about $114k. We're estimating our retirement living expenses to be around $100k, about the same as they are now. $234k is in Roth IRAs, $816k in traditional tax deferred vehicles, and $158k in taxable. We have no legacy plans (childless and plan to stay that way), except we'll likely donate whatever is left over to charity.

I think the problem may end up turning into a non-problem if we maintain our employment and good health for the next 16 years. The growth in our accounts may make it unnecessary to worry about taxes; we'll have enough to maintain the standard of living we hope to maintain in any case.

But I'm nagged by the idea that it might make sense for us to put less into traditional tax-deferred and more into Roths. The conventional wisdom on this seems to boil down to (a) put it in a Roth if you expect your marginal tax rate to be higher in the future and (b) your marginal tax rate in retirement will be lower than you think because you'll be drawing income from things like taxable investments and Roths and because you've been living within your means for so long, your marginal tax rate will end up being lower as you no longer need to set aside 40% of whatever of your salary every year (I hope that last part makes sense). But what about a situation where you can defer large parts of your salary every year into traditional vehicles? It keeps our current marginal rate pretty low and it also means that when we do take this money out, it's taxed at ordinary rates. I guess that's the heart of my question.

getthatmarshmallow
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Re: Too much tax deferral?

Post by getthatmarshmallow » Thu Jan 04, 2018 11:21 pm

Excellent question! Although I'm not as far along with respect to my retirement goals as you, I have had similar thoughts, mostly because I am *not* planning to retire early (goal is a more modest FI by 60), which means it will be harder to do Roth conversions.

One thing to check is whether your 403b contributions can be designated as Roth contributions. If so, you'd still have tax-advantaged space, but would minimize the amount that you're deferring, should you choose that path.

MoonOrb
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Re: Too much tax deferral?

Post by MoonOrb » Thu Jan 04, 2018 11:40 pm

Roth 403b is an option. However, if we were to max out our Roth 403b's, we wouldn't be able to max out our 457s. If our income increased, my strategy would be to max out the Roth 403b's before doing any taxable investing.

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celia
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Re: Too much tax deferral?

Post by celia » Fri Jan 05, 2018 4:18 am

Here are more scenarios to consider to see if one has "too much" in tax-deferred:

5. As Lynette pointed out above, there are other increased payments you will be subject too if your RMDs plus your other taxable income go above certain limits:
increased Medicare premiums
increased Part D (Medicare drug plan) premiums
AMT (not sure if this is staying in effect under the changed tax law)
and you may lose out on tax credits that you would normally be eligible for (like residential energy credits)

6. If you are married, when either you or your spouse dies, the survivor will need to take the RMDs (assuming he/she is the beneficiary for the accounts of the deceased). But then filing as Single instead of MFJ will cause their tax bracket to increase since the space in each tax bracket for a Single is about half of what it is for MFJ.

7. After you and your spouse die, you may be subject to estate taxes. The Estate Tax Exemption was recently changed from $5.5M per person to $11M per person. (The higher exemption is until 2025.) But for those whose assets are subject to estate taxes, a tax-deferred account will be included at full value, even though a part of it will go to income taxes, assuming the heir(s) will be subject to income taxes on the RMDs. Instead of paying estate taxes, it may be advantageous to convert to Roth at a lower rate.

KlangFool wrote:
Thu Jan 04, 2018 2:56 pm
As far as I can tell, at any of your 4 scenarios, Roth conversion before 70.5 years old will solve the problem. Do I miss anything?
Nope. I know you understand this, KlangFool, based on your comments in other threads! :sharebeer

My favorite thread that discusses how much to convert each year is Small Law Survivor's thread. Although the tax laws have recently been changed, the same idea can be followed by anyone who wants to do her own planning for Roth conversions.

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Re: Too much tax deferral?

Post by aristotelian » Sat Jan 06, 2018 8:09 am

I think you are correct OP. See this thread. It is possible to have very high spending with zero taxable income in retirement. See this thread:
viewtopic.php?t=87471

IMO, this reduces the gap between 401k and Roth. Especially if you anticipate some early retirement years with no other taxable income, and supplement your maxed 401k with Roth funds.

Keep an eye on your 401k balance and expected withdrawals, but I would say with a bit of planning the odds of you paying high taxes on your withdrawals is low. If it turns out that you are in a high tax bracket in retirement, that is a good problem to have because you have won the game.

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Re: Too much tax deferral?

Post by aristotelian » Sat Jan 06, 2018 8:13 am

KlangFool wrote:
Thu Jan 04, 2018 2:56 pm

celia,

As far as I can tell, at any of your 4 scenarios, Roth conversion before 70.5 years old will solve the problem. Do I miss anything?

KlangFool
Exactly. One can withdraw the money from traditional accounts without spending the money.

MoonOrb
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Re: Too much tax deferral?

Post by MoonOrb » Sat Jan 06, 2018 5:03 pm

I've given this more consideration since I posted it.

I think what's been weighing on me is I felt guilty or weird about not taking advantage of all tax-advantaged space we have. The explosion of available tax-advantaged space is a combination of (1) my awareness and greater understanding about how much space we actually have and (2) the consequence of my wife now working at the same employer as I do. So at least part of this dilemma I feel like I'm in stems from awakening from a state of ignorance about the availability and feasibility of tax-advantaged space.

It turns out, there's a lot:

DW's 403b plan has a mandatory component (with 100% match) that does not count against the annual $18500 limit. I have a similar component (without a match, since I'll get a pension) in a 401a plan. So collectively, we can contribute $37000 + $13330 + $7560 match to just those plans.

We can also contribute to 457 deferred comp plans, up to $18500 each, for an additional $37000.

On top of that, we can contribute, including a $1400 employer contribution, a total of $6950 to an HSA.

Add to that Roth IRAs of $11000 total (backdoor Roth not an option because of high traditional IRA balances).

When it's all said and done, that's about $113k of tax advantaged space, which is more than half of our gross annual income. We're not in a position where we want to or feel like we can happily invest more (HCOL and a mortgage is the main factor but not the only factor here).

The $113k breaks down this way:

$94980 into traditional tax deferred vehicles
$11000 into Roths
$6950 into HSA

Deferring $95k each year into traditional tax deferred vehicles means that when we retire the gap between our ordinary income in retirement and ordinary income in our working days is not as big as it will be for people who have less ability to defer as much and consequently will grow larger taxable balances (or, for those who can backdoor Roths, large Roth balances). This has a pretty significant consequence when it comes to the key consideration in the Traditional v Roth debate: do we expect to be in a lower tax bracket in retirement?

It is, of course, impossible to know the future. But in making this judgment it's a no-brainer if you can draw a lot of income from Roths/taxable sources and live in an area where you can keep expenses low. Even if the tax brackets were to stay exactly the same, there's a high probability many people would move from 22% to 12% if they don't need to tap 457s/traditional IRAs to pay for living expenses and they don't have expenses that are that high to begin with. Those folks can happily do Roth conversions up to the top of the 12% bracket and draw down their taxable and Roth accounts in the meantime. We wouldn't be able to do that as easily. We'd end up with modest Roth and taxable balances that wouldn't fund as many years of retirement, leaving us few years in which we can do any Roth conversions. Then, obviously, in the years we did have to fund ourselves through our traditional accounts, we'd be withdrawing at the same 22% rate. That would be a wash IF tax rates don't increase. I'm not very optimistic about that prospect, I guess, so I'm moving things around to where we'll be contributing less to investments overall, but the mix of what goes into Roths will be a lot higher.

It was just freaking me out or something that I felt like there is tax-advantaged space I'm missing out on. This is an okay problem to have. And if for any reason our income jumps in the next several years, we'll probably be able to max it all out again and I'll feel just fine.

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