Secure act - should I shift to taxable

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Xrayman69
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Re: Secure act - should I shift to taxable

Post by Xrayman69 »

We have shifted our max 401K to max ROTH 401 as a means to diversify. Max other tax advantaged accounts and Max ROTH. When it comes time for retirement there will be no change in tax rate and thus a means for us to pay taxes on the 19K now and have 20+ years of tax free growth Along with taxable accounts.

As others have said I have no idea what and how tax laws will evolve, but I’m relatively certain they will change. Having a diverse portfolio from a taxation structure standpoint will allow us to be flexible and adjust as deemed favorable with future changes.

Currently our tax advantage and deferred comp is our largest bucket while our ROTH bucket is the smallest (with taxable and cash equivalent in the middle). The taxable and cash equivalent savings has been the largest contribution bucket annually over the past 3 years because the tax advantaged and ROTHs have annual caps. The tax advantaged bucket is the largest because it had time.

I’m so thankful for this forum as I’ve learned so much. Wish I would have done or been able to have converted some tIRAs to ROTHS when tax bracket was lower in the early years. Oh well first world problems.
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teen persuasion
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Re: Secure act - should I shift to taxable

Post by teen persuasion »

stan1 wrote: Wed Jan 01, 2020 4:27 pm
elainet7 wrote: Wed Jan 01, 2020 4:03 pm
one would be sick writing a huge tax payment to uncle sam end of year 10
Then do the Roth conversion for him while you are still alive so he won't get "sick" paying back your deferred taxes.

The IRA and 401K custodians would do account holders a big favor if they prominently displayed a tax adjusted balance on Traditional accounts (easy to ask the account owner for a tax rate to use).
Not easy to figure out what tax rate to use for us!

First, there's the problem of aggregating all our different accounts: rollover IRAs, Roth IRAs, SIMPLE IRA, 401k, 403b. One account provider has no idea about any of the others.

Then there's the issue of how much of the account's value to consider as "withdrawn" for taxation - as retirees, we would probably withdraw no more than 4%. That would result in low taxes, by itself. We certainly wouldn't include 100% of the aggregate amount in any given year! But an heir might opt for 10%, with the 10 year deadline. For that matter, how many heirs to split between? We'd have a 5 way split.

Which leads to stacking this income on top of other income, which might affect its tax rate (like SS, LTCG). The totals could easily affect phaseout ranges/cliffs for tax credits, like EITC, CTC, AOTC, retirement Saver's credit, etc. Of course, there's state tax (and credit phaseouts, too).

Then there's non tax issues, like affects on EFC for college aid. The top rate on the FAFSA is 47%, but it could be partially double counting as it would include both income and 12% of Assets (where any withdrawal/inheritance would ultimately land).


So trickling out small amounts annually from our retirement accounts, as I plan, there should be almost no tax due. Taken out in one lump sum, lots of tax as we become ineligible for all refundable and nonrefundable credits as well as progress up thru the tax brackets both fed and state, and become ineligible for any college aid for our youngest child. Or some point in between these extremes - which rate to use at any arbitrary level?
shess
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Re: Secure act - should I shift to taxable

Post by shess »

teen persuasion wrote: Wed Jan 01, 2020 11:21 pm So trickling out small amounts annually from our retirement accounts, as I plan, there should be almost no tax due. Taken out in one lump sum, lots of tax as we become ineligible for all refundable and nonrefundable credits as well as progress up thru the tax brackets both fed and state, and become ineligible for any college aid for our youngest child. Or some point in between these extremes - which rate to use at any arbitrary level?
As a first approximation, you could use the average rate paid on all tIRA withdrawals over a certain period, which could probably be estimated with some accuracy. Slightly better would be to somehow weight it by demography or account size (obviously would need to rely on the account holder providing decent info).

The problem right now is that it's kind of "Math is hard, let's go shopping", which really doesn't serve most people well. People here on the Bogleheads forums would probably handle such a reporting requirement like "It's OK as a starting point, here's how you dial it in a bit better", so it would be more-or-less same-old same-old. But people who don't already have that interest or this resource are exactly the ones you want to be a bit more conservative than they maybe are currently being.

I mean, we manage to do tax withholding by having taxpayers make often-ill-informed estimates of various things and filing a form with the results. Not sure why this would get worse results than that.
fourwheelcycle
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Re: Secure act - should I shift to taxable

Post by fourwheelcycle »

My father was an accountant. When I was growing up he always said "A tax deferred is a tax avoided". When I started working, during the mid-1970s, I had no way of knowing what the world would look like in 2020, but I trusted my father's advice and put as much of my income as possible in tax-deferred retirement accounts. My wife followed my lead and did the same. As it turns out we greatly over-saved and now we face the prospect of leaving our children very large tax bombs.

I had no crystal ball during my working years. Even with hindsight, I would follow the same retirement savings plan if I was starting again. Until our early fifties we thought we were saving primarily for our own retirement. By our mid-fifties it looked like we would be leaving some of our retirement savings to our children. By our mid-sixties it was clear we would never spend a penny of our retirement savings, except for QCDs, 529s, and gifts to our children.

Everyone is concerned about the tax bomb problem, and I agree the SECURE act looks a lot like a death tax for over-savers. However, my wife and I began our tax-deferred savings for our own retirement, and even if one of us dies early the second of us will still be able to stretch the benefit of our retirement savings until their own death.

I have a spreadsheet for our finances that goes out to age 100. About age 81 there is an inflection point where RMDs begin to outweigh annual gains in our projected retirement account value. By age 99 the total nominal dollar value of our retirement accounts will be down to 24% of their value today. At that point, if one of us lives that long, more than 75% of our excess retirement savings will have been converted to taxable savings that will receive a step-up in value when they are inherited, tax free, by our children.
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teen persuasion
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Re: Secure act - should I shift to taxable

Post by teen persuasion »

shess wrote: Thu Jan 02, 2020 5:02 am

I mean, we manage to do tax withholding by having taxpayers make often-ill-informed estimates of various things and filing a form with the results. Not sure why this would get worse results than that.
The difference here is that tax withholding is for a single year, right now, you have a pretty good idea of the variables *right now*, and if you are off/wrong it gets corrected at tax time annually (or you face a nasty surprise then, so there's a built in incentive to course correct). With retirement account balances and tax liability, the variables need to be projected years, even decades into the future: growth, tax rates, withdrawal rates, other income, longevity, marital status...
dayzero
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Re: Secure act - should I shift to taxable

Post by dayzero »

I would say if

a) you are very high income and
b) most or all of your income is subject to the QBI 199A deduction and
c) you live in a no state income tax state

then yes it makes sense to shift from 401k to taxable investing. 37% tax rate (the highest) becomes 29.6% with the 199A deduction. It seems unlikely to me that a very large inherited 401k/IRA distributed over 10 years will be able to beat this. If any of a, b, or c is false I would say stick with 401k.
MnD
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Re: Secure act - should I shift to taxable

Post by MnD »

What the age, situation, income, tax bracket and general tax rates of heirs will face decades into the future is a third-order effect and in my opinion it is foolish to be paying more taxes now to attempt to manage it. Coming back to 1st-order effects, almost all of our retirement savings was deferred at 28%, 31% and higher and now in early retirement we are paying a blend of 12% and 22% on realizing that deferred income. "Big win" for traditional tax deferral and our base case has that win continuing for 2+ decades at least. 2nd order effects are widow/widower rates but with the size of the 22% bracket and 24% bracket, a 50% cut for survivor pension and loss of 1 of 2 SS benefits, a minimal concern for us.

Looking at speculative third order effects, joint/last survivor life expectancy for a couple is around 91 years old. Assuming a 30 year gap on kids, they would be 61 years old with a 10-year window age 61-71 to deal with inherited IRA. So assume 2 kids at or near retirement age, maybe 4 grandkids in their early 30's perhaps with student loans, preschoolers with day care and/or one income, home purchase need/wants etc. Seems ridiculously easy to put an inherited tax deferred IRA to fantastic use to improve the lives of many with a little late in life inheritance planning down the road and without any tax anxiety now.

It is a demonstrated fact in the literature that people will make very sub-optimal decisions to avoid taxation, even if they are incurring multiple dollars of additional costs to avoid $1 in tax - and you sure see that playing out here. :mrgreen:
70/30 AA for life, Global market cap equity. Rebalance if fixed income <25% or >35%. Weighted ER< .10%. 5% of annual portfolio balance SWR, Proportional (to AA) withdrawals.
cherijoh
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Re: Secure act - should I shift to taxable

Post by cherijoh »

stan1 wrote: Mon Dec 30, 2019 10:18 am You need to give us some data to work with. Spouse? Age? Size of account balances? Your tax rate? Your daughters tax rate?

One approach you didn't mention was to switch to Roth 401K contributions. You can also do Roth conversions after you retire and might be in a lower tax bracket.

It is a mistake to think of it as a "tax bomb". The money in a Traditional 401K/IRA is tax deferred not tax free. It is not yours even though it shows up in your account. You still get decades of tax deferral.

Tax preferences of taxable accounts could change too. Lower tax rates for qualified dividends and capital gains as well as stepped up cost basis could change too.
Also what is your AA and do you maintain the same AA in all accounts or vary it by tax treatment?

I am an early retiree who currently has an overall AA of ~ 55/45, but almost all my bonds are in my rollover IRA/401k. Therefore, if I look only at my IRA/401k assets, my AA is close to 25/75. Even though I have seen healthy growth in my overall portfolio, I don't have to worry about my traditional balances exploding. (To proponents of tax-adjusted AAs - yes I am aware of the concept, so please don't derail the thread with comments about my numbers not being accurate. For purposes of tax treatment by account type they are correct).

Another thing to consider is whether your workplace plan allows for in-plan conversions from traditional to Roth. (My former employer implemented that as an option last year). If your plan permits this, it opens up the option of timing when you take your tax hit on 401k assets. If the stock market tanks, you could choose to do conversions when stocks are on sale without having to have the funds in an IRA. I did similar Roth conversions from my rollover IRA during the Great Recession and happily watched the Total Stock Market Index bounce back in my Roth IRA instead of traditional. If done while still employed, you just need to watch out for the impact on marginal tax rates - they are likely to be higher than if done after retirement.
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Leif
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Re: Secure act - should I shift to taxable

Post by Leif »

MnD wrote: Thu Jan 02, 2020 9:16 am "Big win" for traditional tax deferral and our base case has that win continuing for 2+ decades at least. 2nd order effects are widow/widower rates but with the size of the 22% bracket and 24% bracket, a 50% cut for survivor pension and loss of 1 of 2 SS benefits, a minimal concern for us.
All good points. However current law has the return of old rates, and bracket sizes, after 2025. Since I don't know the future I'm planning based on current law.
StarTrekFan
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Re: Secure act - should I shift to taxable

Post by StarTrekFan »

We're debating the same thing continue funding the 403b tax deferred vs moving the new savings to taxable and do Roth Conversions on existing eligible IRA accounts.

Situation: mid40s and passed FI last year. TaxDeferred accounts ~$1.8M. Tax Bracket mid 24% - future post retirement anticipated: 24% also if tax brackets remain same. Retirment ~10-15 years with ~$40k savings going to taxdeferred space at this time.

Our planning was in most cases ~$2.5M in taxdeferred dollars would be flowing to the next generation and was anticipated that the stretch would get them out the their peak earning years for the majority. That is now totally there with the 10 year distribution and hitting its full tax bracket.

OTOH -- If using taxable there is significant advantage at death: Step up basis is enforced. With a conservative measure, if we start saving taxable at 40k per year, any earnings will have a fulls stepup. We're talking about a 50%+ if not closer to 80-100% step up at death. AND the potential of not tapping these inherited funds until well after peak earning years (vs the 10 year max of an inherited IRA).

Thoughts of this? Now the challenge for us would be not to access that tantalizing taxable account :)
shess
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Re: Secure act - should I shift to taxable

Post by shess »

StarTrekFan wrote: Sun Jan 05, 2020 9:28 pm OTOH -- If using taxable there is significant advantage at death: Step up basis is enforced. With a conservative measure, if we start saving taxable at 40k per year, any earnings will have a fulls stepup. We're talking about a 50%+ if not closer to 80-100% step up at death. AND the potential of not tapping these inherited funds until well after peak earning years (vs the 10 year max of an inherited IRA).
You'll meanwhile have tax drag on the earnings thrown off by the taxable account. To get the funds from a tIRA into a taxable account requires paying the same amount in taxes as you'd pay on a Roth conversion, but with the Roth you won't be taxed on earnings.

The 10-year thing still applies to inherited Roth, but that isn't a big issue - your heirs can always just liquidate the Roth and buy whatever taxable stocks they'd like to have instead.
StarTrekFan
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Re: Secure act - should I shift to taxable

Post by StarTrekFan »

True, but not talking about existing pretax funds. Our plan for those are ROTH conversions when the time comes to access them (mostly in TSP and 403b).

I'm talking about new savings from 2020 onwards for the next 10-15 years --- do we shift to taxable? Say straight index and reinvest. They will have a stepup basis at death. That's a huge savings that isn't available in inherited IRAs. The stretch was a very valuable counterbalance to that lack of stepup. It's now gone, so straight forward taxable with stepup has a very compelling point.
wolf359
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Re: Secure act - should I shift to taxable

Post by wolf359 »

grabiner wrote: Mon Dec 30, 2019 8:45 pm
nix4me wrote: Mon Dec 30, 2019 10:10 am So after reading the changes coming with secure act, I have even more concerns now with retirement account tax bombs. I absolutely do not want to leave a multi-million dollar tax bomb to my daughter that she will have to liquidate in 10 years, that is insane.
The way to avoid this is to take the withdawals over a longer period of time. Instead of leaving $3M to your daughter, convert some from traditional to Roth every your during your retirement, up to the top of the appropriate tax bracket. You might pay tax on 2/3 of the money in your own retirement, and then leave $1M in a traditional IRA (and a large Roth IRA) to your daughter who can withdraw $100K per year. Another advantage of doing this is that you reduce your own RMDs, so you can keep more tax-deferred space in retirement (unless you are already donating all your RMDs to charity).

If your employer offers a Roth 401(k), this may also be a better option for money you expect to be inherited, as you can roll the Roth 401(k) into a Roth IRA when you retire. Your heirs will still have to withdraw the inherited Roth IRA within ten years, but it won't increase their tax bill by any more than the tax on the dividends they earn when they move it to a taxable account.
+1 about taking the withdrawals over a longer period of time.

Other strategies that spread it out:

- Give your daughter TWO inheritances. Whichever spouse passes first bequests the surviving spouse enough assets to live on, and bequests some assets to the daughter. This starts two separate 10 year clocks, with smaller amounts to be taxed. The second 10 year clock doesn't start until the surviving spouse passes.

- Gift some of the money annually, and use it to pay for a prepaid life insurance premium on yourself, payable to her. Life insurance set up correctly will pass tax free. As you get older, you may not be coverable. Second to die policies may allow some coverage and be cheaper, based on the spouse who can be eligible. I'm not an expert on this -- you need to consult one if you pursue this. Or a life insurance policy could be set up in a smaller amount to offset the taxes.

Shifting all assets to taxable means you're paying taxes now. If you're paying taxes now, you might as well put the money in a Roth 401k and keep them tax free.

Having some tax-deferred income throughout your life is actually beneficial for you. Once you pay your taxes and put the money in a Roth, the tax rate is locked in. When you get towards your later years, your health care and other deductible expenses may increase. You can't use these to offset your taxes if you don't have any taxes. And you don't want to use valuable Roth dollars to pay otherwise deductible expenses.
nolesrule
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Re: Secure act - should I shift to taxable

Post by nolesrule »

StarTrekFan wrote: Mon Jan 06, 2020 10:22 am True, but not talking about existing pretax funds. Our plan for those are ROTH conversions when the time comes to access them (mostly in TSP and 403b).

I'm talking about new savings from 2020 onwards for the next 10-15 years --- do we shift to taxable? Say straight index and reinvest. They will have a stepup basis at death. That's a huge savings that isn't available in inherited IRAs. The stretch was a very valuable counterbalance to that lack of stepup. It's now gone, so straight forward taxable with stepup has a very compelling point.
Why not Roth contributions? (Roth is a name, not an acronym)
shess
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Re: Secure act - should I shift to taxable

Post by shess »

StarTrekFan wrote: Mon Jan 06, 2020 10:22 am True, but not talking about existing pretax funds. Our plan for those are ROTH conversions when the time comes to access them (mostly in TSP and 403b).

I'm talking about new savings from 2020 onwards for the next 10-15 years --- do we shift to taxable? Say straight index and reinvest. They will have a stepup basis at death. That's a huge savings that isn't available in inherited IRAs. The stretch was a very valuable counterbalance to that lack of stepup. It's now gone, so straight forward taxable with stepup has a very compelling point.
I'm not sure why the point is different. You will have tax drag on dividends in the taxable account, you will not have tax drag in the Roth. At death the Roth is inherited tax-free, so the step-up on the taxable account is no advantage. The only advantage of taxable in this case is that your heirs can hold onto their investments longer after you die as compared to the Roth, which would be GREAT if it was something like a position in a closely-held family business, but if it's an index fund I'm not sure why anyone would care if they hold that position.
Chadnudj
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Re: Secure act - should I shift to taxable

Post by Chadnudj »

fourwheelcycle wrote: Thu Jan 02, 2020 8:33 am My father was an accountant. When I was growing up he always said "A tax deferred is a tax avoided". When I started working, during the mid-1970s, I had no way of knowing what the world would look like in 2020, but I trusted my father's advice and put as much of my income as possible in tax-deferred retirement accounts. My wife followed my lead and did the same. As it turns out we greatly over-saved and now we face the prospect of leaving our children very large tax bombs.
I'll just note for the record that you probably made the correct decision deferring your tax, EVEN AFTER the SECURE Act, because marginal tax rates were uniformly so much higher in the 1970s/1980s/1990s/2000s than today. That may not tell us much about the future, but it certainly tells us that even if your heirs face a "tax bomb," it's almost surely far lower than what you would have faced if you had invested in the 1970s in Roth accounts.

For example, the 2019 tax brackets for married filing jointly were:
10%: $0-$19,400
12%: $19,401-$78,950
22%: $78,951-$168,400
24%: $168,401-$321,450
32%: $321,451-$408,200
35%: $408,201-$612,350
37%: $612,351+

Compare that to the 1970 married filing jointly tax brackets, using inflation adjusted (to 2013 dollars -- can't find a table with 2019 current) dollars -- literally every dollar you earned was getting taxed at higher rates:
14%: $0-$2,959
15%: $2,959-$5,917
16%: $5,917-$8,876
17%: $8,876-$11,835
19%: $11,835-$23,669
22%: $23,669-$35,504
25%: $35,504-$47,339
28%: $47,339-$59,174
32%: $59,174-$71,008
36%: $71,008-$82,843
39%: $82,843-$94,678
and it goes on all the way up to a 70% tax bracket for money over $591,737.
Chadnudj
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Re: Secure act - should I shift to taxable

Post by Chadnudj »

Also, there is a really easy way to reduce the pain of that "tax bomb" your heir(s) may face if you/they are in the fortunate position of having such a large tax-deferred balance that the 10-year provision of the SECURE Act bumps them into seriously high brackets:

Start withdrawing extra money now and gift them, while you're alive. 2 spouses could give $30k to an individual every year with no tax to the recipient (and, if you're pulling from your tax-deferred account, you'd only be paying your marginal rate). If your heir(s) are married/have kids, you could do $30k to each of them, too.
StarTrekFan
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Re: Secure act - should I shift to taxable

Post by StarTrekFan »

All - thanks for the responses.

-Roth conversions WILL be done on the existing pretax accounts to fill out the 24% bracket we're in -- that's planned.

-Taxes today are at a historical LOW- so doing them now vs in 9 years when these tax brackets sunset, that's going to be a bit higher IMHO for our retirement range: 200k-250k annual

-So the question is today- 10+ years on the anticipated 40k annual savings --- where to put it?
--Our best answers so far:
Gift 15k (we want to get them past college for just in case they can qualify for some schollies)
Roth IRA backdoor same year 6k

--What else to do--- and again will have left over savings -- to continue 403b deferring -- taxable -- or just spend it :)
Nowizard
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Re: Secure act - should I shift to taxable

Post by Nowizard »

We have been generous with our children when younger and in terms of their education. Partially due to that, they graduated without debt and, lo and behold, are doing considerably better at their ages than we were at comparable ages. Yep, we could withdraw and pay the taxes to give our children a greater inheritance but our approach is to satisfy our convenience while considering taxation. They will still receive what is left happily.
A problem with gifting for some is that substantial gifting can also raise taxes if the money gifted is withdrawn from retirement accounts.

Tim
letsgobobby
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Re: Secure act - should I shift to taxable

Post by letsgobobby »

the problem with all the proposed solutions is that they require one reach life expectancy to optimize. That’s great if you end up living to 87 or 92 and have all the time and foresight needed to convert to Roths up to the top of your marginal tax bracket or the next, taking into account your heirs’ tax brackets, job prospects, marital status, future grandchildren and so forth.

Unfortunately this will not be the case for many of us, approximately half of whom will die before our life expectancy. Some of us will get hit by a truck tomorrow, or cancer next decade, and so on, and for some of us that will occur while we are still gainfully employed, possibly at peak earnings. There will be no low income years to Roth convert, and furthermore no visibility as to the optimal time to do it.

Planning correctly takes into account not only the statistically likely outcome but the unlikely outcomes as well. The SECURE act seems to make it impossible to plan correctly, because depending on when you die, how much your assets have grown, how much if any of the money you end up needing for your own use, what tax brackets your heirs will be in, whether they will be minors or not when they inherit, whether they will be chronically ill or disabled or not, etc, will materially impact what the optimal strategy should have been.

The OP’s question is important because we have to consider under what set of circumstances an investor would be better served forgoing the upfront tax break and investing in taxable instead. It is not hard to concoct a scenario in which taxable outperforms pretax, for the purposes of estate planning. How likely is this to happen to you?
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