Early RMDs to Roth or Taxable?

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spaddlewit
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Early RMDs to Roth or Taxable?

Post by spaddlewit » Thu Jan 11, 2018 9:28 pm

My mother is 65, and I manage her investments. I have all of her stuff in Vanguard, in a 43/57 Total Bond/S&P500 mix:

Single filer
Traditional IRA: 535k
Roth IRA: 22k
Taxable: 70k

She does not withdraw from this money. Between pension & SS, she has about 55k of taxable income per year and lives off of those checks. That's why the allocation is so risky for someone her age -- I'm investing primarily for the benefit of my siblings and I.

What she is concerned about is her large Traditional IRA, that is going to start triggering RMDs when she is 70, potentially increasing her Medicare taxes, or taking her above $82.5k into another tax bracket. I'm wondering if it would be wise, especially with the tax changes in 2018, to withdraw approximately $25k per year from the IRA until then. But should I roll it into the Roth IRA, or into the Taxable account? Roth IRAs pass tax-free to the heirs, but so do Taxable accounts since their cost basis steps up.

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Epsilon Delta
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Re: Early RMDs to Roth or Taxable?

Post by Epsilon Delta » Thu Jan 11, 2018 9:41 pm

It seems totally clear that Roth is better.

In taxable only the gains during your mothers lifetime are tax free.

In the Roth the gains and dividends during and, for a significant period after, your mothers life are tax free.

The only case the Roth is worse is if you lose money.
Last edited by Epsilon Delta on Thu Jan 11, 2018 9:45 pm, edited 1 time in total.

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celia
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Re: Early RMDs to Roth or Taxable?

Post by celia » Thu Jan 11, 2018 9:42 pm

Whatever is withdrawn from the tIRA will be taxed the same if it is put into taxable or Roth. As long as there is enough money in taxable to pay the increased taxes, converting to Roth is a no-brainer.

But why limit it to 25k per year? That won't make much difference in her future RMDs. She should probably be withdrawing more, like to the top of her current (under the new tax laws) tax bracket or possibly the next one. You may want to consider putting SS on hold for a few years to give her more space in each tax bracket. Then when she resumes it, her monthly benefit will be a lot more because of the years she didn't take it.

To get a better picture of this, do an estimate now of what her age 71 tax return would look like. What are the RMDs if the tIRA continues to grow as it has in the past? Adding those RMDs and resumed SS to her income will increase her future Taxable Income, and possibly push her into a new tax bracket. You won't know until you run some numbers. :oops:
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.

spaddlewit
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Re: Early RMDs to Roth or Taxable?

Post by spaddlewit » Thu Jan 11, 2018 9:57 pm

I chose 25k because 55k + 25k = 80k, and the upper limit of her current tax bracket will be 82.5k.

If I don't start withdrawing now, the RMDs will for sure take her above 82.5k per year. If I do 25k/yr for the next 5 years, there's a chance I can keep her under that.

I also know that Medicare premiums increase when you hit about 85k, so I'd like to keep her under that, as well.

Ace1
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Re: Early RMDs to Roth or Taxable?

Post by Ace1 » Thu Jan 11, 2018 10:52 pm

+1 to celias idea!
Suspend her SS for 5 years ( to age 70), withdraw from ira to replace the SS plus convert the 25k you’re thinking of.
5 years later you haved reduced the ira by perhaps 50k times 5 years =250k, down to 275-300k +/-.
Rmd goes from 20k+/- to 10k+/- and her SS gets the benefit of delayed credits.
Depending on remaining space in the tax bracket at that time you can continue to make small Roth conversions.
Best way to tell would be to spreadsheet some projections for the next 5 or so years.

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celia
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Re: Early RMDs to Roth or Taxable?

Post by celia » Fri Jan 12, 2018 6:01 am

spaddlewit wrote:
Thu Jan 11, 2018 9:57 pm
I chose 25k because 55k + 25k = 80k, and the upper limit of her current tax bracket will be 82.5k.
You can also add a standard deduction of 12k for a Single person and still be in the 22% bracket.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.

livesoft
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Re: Early RMDs to Roth or Taxable?

Post by livesoft » Fri Jan 12, 2018 6:07 am

But delaying SS will reduce the pile of money that goes to the OP and their siblings.
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Spirit Rider
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Re: Early RMDs to Roth or Taxable?

Post by Spirit Rider » Fri Jan 12, 2018 6:15 am

celia wrote:
Fri Jan 12, 2018 6:01 am
spaddlewit wrote:
Thu Jan 11, 2018 9:57 pm
I chose 25k because 55k + 25k = 80k, and the upper limit of her current tax bracket will be 82.5k.
You can also add a standard deduction of 12k for a Single person and still be in the 22% bracket.
Also, the next bracket is only 24%, not enough difference to worry about.

theta
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Re: Early RMDs to Roth or Taxable?

Post by theta » Fri Jan 12, 2018 8:27 am

Not to worry as much about the Tax Bracket lines as to worry about the IRMAA lines.

In your case, the first line is $85,000. The second is $107,000. Here is what Kitces has to say:
"The end result: the closer retirees are to an income threshold (without already crossing it), the better it is to either stay right below the line, or rise far above it until the next threshold (or a new tax bracket) approaches, because the additional Part B and Part D premiums are a flat additional amount even if the individual is just $1 across the line (unlike tax brackets, which are always a percentage of additional income)."

So, you want to really watch the $85,000 line and convert right up to it. Then consider converting up to the $107,000 line, which is a closer call.
Just don't get caught in the high $80's or low $90's.

I also like Celia's idea. Suspending SS and using the IRA to cover the gap (in income) you've created. Then, play with the numbers to see if you want to convert up to $85,000 or $107,000.

One possible goal is to get to the point where Income + RMD's + SS < $85,000; if that seems difficult, then aim for Income + RMD's + SS < $107,000.

Note that the IRMAA limits will get raised but not until 2019 or 2020, and then likely only a couple percent or so.

You've got to set up a spreadsheet and play with the numbers...

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Epsilon Delta
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Re: Early RMDs to Roth or Taxable?

Post by Epsilon Delta » Fri Jan 12, 2018 11:25 am

livesoft wrote:
Fri Jan 12, 2018 6:07 am
But delaying SS will reduce the pile of money that goes to the OP and their siblings.
Depends when the mother dies.
If she dies soon it makes little difference.
If she dies at 70 the heirs lose.
Somewhere near life expectancy it's a wash.
If she becomes a centenarian the heirs win, but it's probably the grandchildren, not the OP and siblings.

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celia
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Re: Early RMDs to Roth or Taxable?

Post by celia » Fri Jan 12, 2018 12:55 pm

livesoft wrote:
Fri Jan 12, 2018 6:07 am
But delaying SS will reduce the pile of money that goes to the OP and their siblings.
It depends if she saves it or spends it each year. If she doesn't need it to cover her living expenses, she can save it in taxable. If she is willing to suspend it, she would then cover the living expenses from additional TIRA withdrawals.

But if the primary goal at this point is to reduce RMDs and taxes after 70, then the life-time tax savings (money she would otherwise send to the IRS and state) would benefit her heirs.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.

spaddlewit
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Re: Early RMDs to Roth or Taxable?

Post by spaddlewit » Sat Jan 13, 2018 11:08 am

Thanks everyone, this is all really great info. While pausing SS is probably the optimal plan, I'm not sure either of us are up to going through the red tape to make that happen -- plus she would not like the risk that she'd then carry until she hits 70. (We're kind of both of the opinion that it's best to get what you can out of SS while it lasts, :mrgreen: ).

You're absolutely right that with such a large tIRA balance, 37k/yr isn't likely to get her RMDs under 37k/yr by the time she is 70 (unless the market tanks). It might be worth it to pay the slightly higher Medicare premium up to $107k, or maybe even $133.5k for the first year or two to really whittle it down. I'll have to run some simulations.

pshonore
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Re: Early RMDs to Roth or Taxable?

Post by pshonore » Sat Jan 13, 2018 11:18 am

spaddlewit wrote:
Sat Jan 13, 2018 11:08 am
Thanks everyone, this is all really great info. While pausing SS is probably the optimal plan, I'm not sure either of us are up to going through the red tape to make that happen -- plus she would not like the risk that she'd then carry until she hits 70. (We're kind of both of the opinion that it's best to get what you can out of SS while it lasts, :mrgreen: ).

You're absolutely right that with such a large tIRA balance, 37k/yr isn't likely to get her RMDs under 37k/yr by the time she is 70 (unless the market tanks). It might be worth it to pay the slightly higher Medicare premium up to $107k, or maybe even $133.5k for the first year or two to really whittle it down. I'll have to run some simulations.
I believe "pausing" SS is only possible if one has been collecting less than 12 months or has reached FRA, or is not FRA and returns to work.

spaddlewit
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Re: Early RMDs to Roth or Taxable?

Post by spaddlewit » Sat Jan 13, 2018 2:25 pm

Hmm.. when I go to do a conversion on Vanguard's website, they offer to withhold a portion of the conversion. I don't want to do this, since we'd rather pay the taxes later on from a taxable account (or let that money grow all year in the Roth IRA before taking it out of there).

But they mention that she could be subject to penalties if not enough is withheld -- ??? I thought that penalty only applied to earned income (i.e., if you claim too many exemptions on your W-4).

I'd prefer to convert, then pay a lump sum to the IRS next April. Is this not possible?

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Phineas J. Whoopee
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Re: Early RMDs to Roth or Taxable?

Post by Phineas J. Whoopee » Sat Jan 13, 2018 2:32 pm

spaddlewit wrote:
Sat Jan 13, 2018 2:25 pm
Hmm.. when I go to do a conversion on Vanguard's website, they offer to withhold a portion of the conversion. I don't want to do this, since we'd rather pay the taxes later on from a taxable account (or let that money grow all year in the Roth IRA before taking it out of there).

But they mention that she could be subject to penalties if not enough is withheld -- ??? I thought that penalty only applied to earned income (i.e., if you claim too many exemptions on your W-4).

I'd prefer to convert, then pay a lump sum to the IRS next April. Is this not possible?
The penalty applies to adjusted gross income less deductions (or the standard deduction).

PJW

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celia
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Re: Early RMDs to Roth or Taxable?

Post by celia » Sat Jan 13, 2018 2:46 pm

spaddlewit wrote:
Sat Jan 13, 2018 2:25 pm
But they mention that she could be subject to penalties if not enough is withheld -- ??? I thought that penalty only applied to earned income (i.e., if you claim too many exemptions on your W-4).
The penalty applies if you hadn't withheld or sent in at least 90% of the tax liability for the year of the tax return or (other conditions). Google "safe harbor IRS".

The money doesn't have to be withheld from "income" (which is more than wages). You can make quarterly tax payments throughout the year in question. Or you can send in the payment near the time the large chuck of income is received. Think of this as making a good faith effort to pay the taxes as the income comes in. The withholdings and estimated tax payment must be sent in by January 15 of the following year.

The simplest thing to do is to estimate her tax liability for the year and then have 1/12 of it withheld from her SS or pension each month, although, by this month, she has already received a check, so divide by 10 or 11 instead. (It may take time for the changes to take effect.)

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