Am I Headed for a Retirement Tax Bomb?

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CashFlo
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Am I Headed for a Retirement Tax Bomb?

Post by CashFlo » Wed Jun 24, 2020 8:23 pm

My S/O and I are approximately 10-12 years away from retirement.

Here are our current projections at full retirement:
$1.5m in pre-tax 401k's
$750k invested in stocks in post-tax brokerage account
$250k in cash reserves
~ $6k per month combined SS draw beginning at 70
We are currently barely hitting the 24% tax bracket.

I'M THINKING A LOT ABOUT TAXES IN RETIREMENT!
I've just started looking into RMD's.
Are walking into a tax bomb?
What should we consider doing now, if anything, to prepare?

We've been very disciplined to get where we are. I don't want tax ignorance to screw us up when we start accessing the fruits of our labor.

CF

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grabiner
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Re: Am I Headed for a Retirement Tax Bomb?

Post by grabiner » Wed Jun 24, 2020 8:51 pm

I don't see much of a tax bomb. If you take 4% out of your portfolio, growing with inflation, that is $60K annually from the 401(k), and $30K from the stocks of which probably $20K is taxable, and $60K of your Social Security will be taxable. As a married couple with $120K of ordinary income and $20K of long-term gains and qualified dividends, you will be in the middle of the 22% bracket, which is scheduled to become a 25% bracket in 2026. If the market rises so that you must take more out of the IRA as RMDs, you won't need to sell the stocks. This might push you to the 24% (future 28%) bracket. However, given the rising market, that's a good problem to have, and you can mitigate the tax issue by making qualified charitable distributions.

You might hit something of a tax bomb after one of you dies if the entire 401(k) is left to the other. The SS would be halved, but the 401(k) RMDs will continue, so if the stock market booms, RMDs might force the survivor into the 32% bracket. If the 401(k) (or rolled-over IRA) is left to a child, its RMDs won't affect you; whether this is better or worse depends on your children's tax rate.

Do you have Roth IRAs? You should be maxing out Roth IRAs (backdoor if necessary) in preference to having so much money in the taxable account. And if you retire before 70, you can use up the remainder of the lower bracket to convert some of your 401(k) to a Roth IRA.
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Re: Am I Headed for a Retirement Tax Bomb?

Post by Googliebear » Wed Jun 24, 2020 10:07 pm

CashFlo wrote:
Wed Jun 24, 2020 8:23 pm

Here are our current projections at full retirement:
$1.5m in pre-tax 401k's
$750k invested in stocks in post-tax brokerage account
$250k in cash reserves
~ $6k per month combined SS draw beginning at 70
We are currently barely hitting the 24% tax bracket.

What should we consider doing now, if anything, to prepare?
I'm not sure I'd worry too much about it. But you are correct, you will be paying more taxes depending on the amount of money you draw in retirement before RMD's and even more after RMD's. The question is; How much? When? And on who's terms?

You didn't mention your age, but if you've given thought to retiring before SS (but after 59 1/2), you could do Roth Conversions to get the pretax 401K balance down by converting half of your yearly drawdown for Roth conversions and then using the other half of the yearly drawdown for living expenses and supplementing your income with the cash reserves if you need more to keep you under a preferred tax bracket. If you also make charitable donations, you could use the pretax amount for that purpose.

When doing Roth Conversions, large stock market corrections are your friend. Had you been doing conversions during this last correction (or any correction before that for that matter) you would have been converting the stock in kind at a discounted tax burden and then the assets would recover tax free in the Roth IRA.

The ultimate goal is to convert and/or utilize the pretax account as much as possible before SS and RMD's kick in which will in turn raise your income levels while using the cash and taxable brokerage later in life, preferably with very little left in the taxable 401K accounts.

Also, IMO, it would be best to be invested in an index fund such as S&P500 (when doing these conversions to minimize risk and maximize diversification) which is pegged to the US economy which in my mind will always eventually recover under our current form of government (as ugly as it is).

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Watty
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Re: Am I Headed for a Retirement Tax Bomb?

Post by Watty » Wed Jun 24, 2020 10:16 pm

CashFlo wrote:
Wed Jun 24, 2020 8:23 pm
~ $6k per month combined SS draw beginning at 70
You should check out this web site to get a suggested Social Security claiming strategy.

https://opensocialsecurity.com/

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Re: Am I Headed for a Retirement Tax Bomb?

Post by 02nz » Wed Jun 24, 2020 10:20 pm

It's good you're thinking about taxes now. What age will you be at retirement? The time between retiring and 70 (when you plan to start SS), when you have no or little income, is generally the best time to do Roth conversions and fill up your low- and zero-tax space every year. A married couple with no other income can withdraw (or do Roth conversions on) more than $100K of tax-deferred IRA/401k every year, and pay only about 9% federal tax at current rates. And doing that in the years between retiring and start of Social Security/RMDs can also help mitigate the risk one of you has to file as single and is pushed into a much higher bracket.

Also, what rate of growth did you use to reach the $1.5M figure? It's better to use today's dollars, i.e. assume say 3.5% real growth instead of 6% nominal. This is because income tax brackets are indexed for inflation.
Last edited by 02nz on Wed Jun 24, 2020 11:42 pm, edited 1 time in total.

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Re: Am I Headed for a Retirement Tax Bomb?

Post by Vanguard Fan 1367 » Wed Jun 24, 2020 11:21 pm

I think that figuring out some way to get some Roth IRA savings might be a good idea. I am newly retired and using the few years till I have to do RMDs to convert some of my traditional IRA money to Roth.
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Re: Am I Headed for a Retirement Tax Bomb?

Post by celia » Thu Jun 25, 2020 7:52 am

We don’t know what you consider a ‘tax bomb’ but, yes, those who are not prepared for it can be blind-sighted if they don’t prepare for it. If you can continue to have your Taxable Income in retirement the same as when working, your tax bill will remain relatively the same as now, except for changes in tax laws.

To understand RMDs, please read a recent post of mine: viewtopic.php?f=1&t=317684&p=5332915#p5332915

Here are specific things you can do now to prepare for retirement:

* Stop contributing so much to tax-deferred now. It only makes the ‘problem’ (of too much tax-deferred) worse.

* Be sure your current Roths contain only stock funds. That is to maximize as much future growth to be tax-free as possible. (Good job on having so much in Roth so far!)

* Keeping bonds in tax-deferred slows down growth there.

* If the stock markets drop in half at any time (including while still working), do a big Roth conversion. When your shares are only half their original value, you can convert twice as many shares for the same tax hit. Then when shares return to their previous high, it will be as if you paid ‘half price’ on the Roth conversion taxes! (I’m so glad I did this during the 2008 crash even though I was still working at near my highest earned income year.)

* If not married and one of you owns 3/4 or more of the tax-deferred, you could consider getting married so you can use the MFJ tax brackets, which have twice as much room in them as the Single brackets.

* Hold off on SS until age 70 while living off withdrawals from tax-deferred. (This also increases your monthly SS benefit by 8% per year for each year past your Full Retirement Age that you wait.) During that time, convert extra withdrawals to at least the same amount of Taxable Income as when working. Ditto to holding off on pensions, if it is possible to delay them a few years.

* Understand the IRMAA rules which make your Medicare premiums increase. See link in referenced page above.

* If there is a chance either of you will inherit a TIRA, prepare for that by doing more Roth conversions early in retirement, saving later retirement for withdrawals from the Inherited IRA. After age 70.5, you can donate some/all of the Inherited IRA or your own IRA withdrawals to charity by using Qualified Charitable Contributions (QCDs) which are tax-free to you and the charity.
Last edited by celia on Thu Jun 25, 2020 8:11 am, edited 3 times in total.
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Re: Am I Headed for a Retirement Tax Bomb?

Post by midareff » Thu Jun 25, 2020 7:59 am

CashFlo wrote:
Wed Jun 24, 2020 8:23 pm
My S/O and I are approximately 10-12 years away from retirement.

Here are our current projections at full retirement:
$1.5m in pre-tax 401k's
$750k invested in stocks in post-tax brokerage account
$250k in cash reserves
~ $6k per month combined SS draw beginning at 70
We are currently barely hitting the 24% tax bracket.

I'M THINKING A LOT ABOUT TAXES IN RETIREMENT!
I've just started looking into RMD's.
Are walking into a tax bomb?
What should we consider doing now, if anything, to prepare?

We've been very disciplined to get where we are. I don't want tax ignorance to screw us up when we start accessing the fruits of our labor.

CF
I would dig out the tax books looking at the IRS costs of converting some of those IRA monies to a Roth. Keep in mind once you retire your employment "earned income" is no more.

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Re: Am I Headed for a Retirement Tax Bomb?

Post by Nowizard » Thu Jun 25, 2020 8:01 am

You can, of course, convert to a ROTH-IRA depending on your circumstances. We do have a tax bomb in that most all of our money is in retirement accounts. That does have the convenience of being able to adjust allocations without tax consequences if not withdrawing, but there are still the taxes to pay when withdrawn. However, there is one mitigating factor. If you become more conservative with allocations in retirement in order to protect assets, you will not accumulate as rapidly during bull markets while protecting against bear markets. That will reduce your theoretical totals in retirement (and other) accounts and reduce RMD's, at least theoretically in some cases. Another consideration when RMD's begin is Medicare costs. If you have substantial RMD's, it can affect IRMAA.

Tim

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Re: Am I Headed for a Retirement Tax Bomb?

Post by dbr » Thu Jun 25, 2020 8:20 am

You prepare by estimating your tax obligations in retirement as Grabiner has shown you. The other side of the estimate is that those tax payments are part of your retirement living expenses and taken into account as such. This is not changed in any way from how a person manages before retirement.

There can be some decision making about Roth conversions and the effect of when one selects Social Security. So that is worth analyzing.

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Re: Am I Headed for a Retirement Tax Bomb?

Post by retiredjg » Thu Jun 25, 2020 8:41 am

Your taxes do not know what to do with SO. For taxes, you are either single or married and that could make a difference in the answer to your question.

If you are married and there is no pension coming there is no obvious tax bomb coming. But I can imagine a few scenarios.

For example, if you both work until age 70 and your living expenses are low enough that SS takes care of most everything, the $1.5 million could cause you to be pushed into a higher bracket. If one dies, the bracket could go up another time. Some might consider that a tax bomb.

If you retire at 65 and spend some from your $1.5 million every year for your living expenses and maybe make some smaller Roth conversions, it seems less likely a "problem" will occur.

You need to consider when you retire and what your living expenses will be in order to look into this fully.

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Re: Am I Headed for a Retirement Tax Bomb?

Post by David Jay » Thu Jun 25, 2020 8:50 am

Read everything that Celia wrote, including at her link.
celia wrote:
Thu Jun 25, 2020 7:52 am
* Keeping bonds in tax-deferred slows down growth there.
Building on the point above, here is one way to do it: In your taxable funds, Keep only 6 months living expenses (let’s say $50,000) in cash and move $200,000 into stocks. At the same time buy $200,000 of “stable value” or bond fund in your 401K accounts.

This may feel counter-intuitive, but effectively you are moving high-growth into taxable (note: that will be taxed at lower long term capital gains rate) and low-growth “cash” into 401K (which will be taxed at higher “income” rate).
Last edited by David Jay on Thu Jun 25, 2020 8:54 am, edited 1 time in total.
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Re: Am I Headed for a Retirement Tax Bomb?

Post by livesoft » Thu Jun 25, 2020 8:52 am

You can retire today as in NOW and avoid any perceived tax bomb. That is also good preparation for retirement.

Did you state your ages?

Also I'd be more concerned about avoiding taxes while working in your situation.
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CashFlo
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Re: Am I Headed for a Retirement Tax Bomb?

Post by CashFlo » Thu Jun 25, 2020 9:06 am

OP here. Thank you all for the feedback. I am intrigued by the Roth conversions after retirement and before RMDs. Hopefully the timing will work out. S/O and I are married and plan to remain that way :) for the long haul; so we will benefit from MFJ status. Someone asked about stock allocation; we have almost all index MFs and ETFs, low-cost.

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Re: Am I Headed for a Retirement Tax Bomb?

Post by dbr » Thu Jun 25, 2020 9:15 am

CashFlo wrote:
Thu Jun 25, 2020 9:06 am
OP here. Thank you all for the feedback. I am intrigued by the Roth conversions after retirement and before RMDs. Hopefully the timing will work out. S/O and I are married and plan to remain that way :) for the long haul; so we will benefit from MFJ status. Someone asked about stock allocation; we have almost all index MFs and ETFs, low-cost.
Index mutual funds and ETFs can be bond index funds.

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Watty
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Re: Am I Headed for a Retirement Tax Bomb?

Post by Watty » Thu Jun 25, 2020 10:05 am

Another way to look at this.

Keep in mind is that the RMDs start out at less than 4 percent at age 72 and you will not have to actually start drawing down your IRA until the RMD percentage is greater than the percentage that your investments are growing. If you can earn 7%, with inflation, then you will not need to actually start drawing down your IRA until the RMD is greater than 7% when you are 86.

http://www.themoneyalert.com/rmd-tables/

It would be hard to call it "good news" but most people will not live long enough and will they will not ever need to start drawing down their IRAs.

Even when you are 95 the RMD is still less than 12% so if your portfolio is still growing at 7% you will only need to draw down your IRA by 5%. At 95 you may also be living in a nursing home and have a lot of medical expenses that you can deduct so you may not be in a high tax bracket then.

You of course will end up paying taxes then but most of your money will be able to grow tax deferred for 40 years or more if you live to be 95.

RMDs may not be really as big a deal as you may be thinking.

What you should be looking at is estate planning since if you work another 10 years and your money grows for a few more decades after you retire then you will likely leave a huge estate some day. The estate tax laws are constantly changing and they are fairly generous these days but there is a good chance that the pendulum will swing the other way and there could be very low estate tax exemptions when you die. The stepped up cost bases for estates is also not engraved in stone and there have been proposals to eliminate that.

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Re: Am I Headed for a Retirement Tax Bomb?

Post by dbr » Thu Jun 25, 2020 11:09 am

I think that the idea of "retirement tax time bomb" can really only come about when the idea that deferred tax means that the tax was deferred has not been understood. The other fact, already mentioned above in replies, is that it is not really much of a time bomb in reality.

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CashFlo
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Re: Am I Headed for a Retirement Tax Bomb?

Post by CashFlo » Thu Jun 25, 2020 11:22 am

dbr wrote:
Thu Jun 25, 2020 11:09 am
I think that the idea of "retirement tax time bomb" can really only come about when the idea that deferred tax means that the tax was deferred has not been understood. The other fact, already mentioned above in replies, is that it is not really much of a time bomb in reality.
OP here again. I'm at a point in planning that I realize "I don't know what I don't know." I'd hate to get close to "calling it a career" then discover that there were things I could and should have done to prepare more thoroughly. I feel like, in some ways, we missed the boat on Roth buckets. I could blame bad advisors for that, but in the end it's really on me for not being inquisitive enough and asking questions. I find this forum far more helpful than almost all of the advice we've received from paid advisors and those who've been assigned to us at the big box investment houses. One more thing about taxes: I'll pay my fair share. I just want to avoid paying my UNfair or UNnecessary share.

Thank you all for your insight and feedback. Much to consider.

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Re: Am I Headed for a Retirement Tax Bomb?

Post by celia » Thu Jun 25, 2020 1:21 pm

CashFlo wrote:
Thu Jun 25, 2020 11:22 am
OP here again. I'm at a point in planning that I realize "I don't know what I don't know." I'd hate to get close to "calling it a career" then discover that there were things I could and should have done to prepare more thoroughly.
Hang around and keep reading threads whose titles interest you. Search our wiki pages for terms you don’t quite understand. No-one here knows all the topics and we have different views on many topics. This is what many of us think is great here. Even though I have been here a long time, I still learn things all the time.

A book you might like is The Tax Bomb in Your Retirement Accounts. I haven’t read it but the examples shown on the review are the kind of things we discuss here. Just be aware that it may not be up-to-date as the SECURE Act passed at the end of 2019 and it impacted IRA inheritances and moved the start of RMDs to age 72 for those who haven’t started yet.
I feel like, in some ways, we missed the boat on Roth buckets.
On the contrary, you appear to have a greater percentage of your assets in a Roth than the average Boglehead. Some of us have 90% of their assets in tax-deferred. I hope these folks check into the Roth conversion threads once in a while.
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.

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Re: Am I Headed for a Retirement Tax Bomb?

Post by 02nz » Thu Jun 25, 2020 1:25 pm

CashFlo wrote:
Thu Jun 25, 2020 9:06 am
I am intrigued by the Roth conversions after retirement and before RMDs.
For many retirees this is the single most power tax-planning or tax-optimization tool available. It can easily make a difference of hundreds of thousands of dollars in additional spendable money. Good that you're learning about it now, so you don't have to face a "tax bomb." Sometimes people in their 70s post about being pushed into a higher bracket, and by that time it's really too late to do anything about it.

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Re: Am I Headed for a Retirement Tax Bomb?

Post by Vanguard Fan 1367 » Thu Jun 25, 2020 1:31 pm

I enjoyed The Tax Bomb in Your Retirement Accounts by Josh Scandlen. It was worth the credit in my Audible account.
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Re: Am I Headed for a Retirement Tax Bomb?

Post by sergeant » Thu Jun 25, 2020 7:16 pm

celia wrote:
Thu Jun 25, 2020 1:21 pm
CashFlo wrote:
Thu Jun 25, 2020 11:22 am
OP here again. I'm at a point in planning that I realize "I don't know what I don't know." I'd hate to get close to "calling it a career" then discover that there were things I could and should have done to prepare more thoroughly.
Hang around and keep reading threads whose titles interest you. Search our wiki pages for terms you don’t quite understand. No-one here knows all the topics and we have different views on many topics. This is what many of us think is great here. Even though I have been here a long time, I still learn things all the time.

A book you might like is The Tax Bomb in Your Retirement Accounts. I haven’t read it but the examples shown on the review are the kind of things we discuss here. Just be aware that it may not be up-to-date as the SECURE Act passed at the end of 2019 and it impacted IRA inheritances and moved the start of RMDs to age 72 for those who haven’t started yet.
I feel like, in some ways, we missed the boat on Roth buckets.
On the contrary, you appear to have a greater percentage of your assets in a Roth than the average Boglehead. Some of us have 90% of their assets in tax-deferred. I hope these folks check into the Roth conversion threads once in a while.
I'm not seeing anything in their Roth accounts. Did I miss something?

OP, you say based on your projections you will have the stated amount in your various accounts. How did you come up with those numbers? What do you have now? You can take actions now to better balance tax-deferred vs. Roth.
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Re: Am I Headed for a Retirement Tax Bomb?

Post by Johnsson » Thu Jun 25, 2020 8:16 pm

You may consider looking into https://www.i-orp.com/Inflate/extended.html to determine how to maximize retirement spending, with an eye towards performing/optimizing Roth conversions.
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Re: Am I Headed for a Retirement Tax Bomb?

Post by Walkure » Thu Jun 25, 2020 8:36 pm

02nz wrote:
Thu Jun 25, 2020 1:25 pm
CashFlo wrote:
Thu Jun 25, 2020 9:06 am
I am intrigued by the Roth conversions after retirement and before RMDs.
For many retirees this is the single most power tax-planning or tax-optimization tool available. It can easily make a difference of hundreds of thousands of dollars in additional spendable money. Good that you're learning about it now, so you don't have to face a "tax bomb." Sometimes people in their 70s post about being pushed into a higher bracket, and by that time it's really too late to do anything about it.
This topic has prompted me to do a very preliminary model of my own RMDs (which are still decades off) and I'm finding that it's not really the taxes on the RMDs themselves that hurt but instead the fact that two RMDs on top of two Social Security likely winds up forcing you to recognize more income than your living expenses in the years before major medical costs are expected. The overflow invariably finds its way into taxable, and after a few years even the qualified dividends on a fairly tax efficient fund start to throw off a lot of unavoidable extra income.

Fortunately, I have access to a Roth 401k option, so now the question becomes, when is the best time to fund it? Usually the advice is pretax until you have ~1.5mil then switch over, but to me this seems backwards. Shouldn't you work backward from your target retirement date, so that you fill up the pretax bucket in the highest earning mid/late career years when you're in the highest marginal bracket, and do Roth up until then in your lower earning early career?

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Re: Am I Headed for a Retirement Tax Bomb?

Post by Watty » Thu Jun 25, 2020 8:57 pm

Walkure wrote:
Thu Jun 25, 2020 8:36 pm
Shouldn't you work backward from your target retirement date, so that you fill up the pretax bucket in the highest earning mid/late career years when you're in the highest marginal bracket, and do Roth up until then in your lower earning early career?
The problem is that you don't have a crystal ball that you can use to predict what your future career and earnings will look like.

It might make sense for someone like a doctor who has lower income while they are in residency but few other people can predict their earnings that well.

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Re: Am I Headed for a Retirement Tax Bomb?

Post by JBTX » Thu Jun 25, 2020 9:45 pm

CashFlo wrote:
Thu Jun 25, 2020 11:22 am
dbr wrote:
Thu Jun 25, 2020 11:09 am
I think that the idea of "retirement tax time bomb" can really only come about when the idea that deferred tax means that the tax was deferred has not been understood. The other fact, already mentioned above in replies, is that it is not really much of a time bomb in reality.
OP here again. I'm at a point in planning that I realize "I don't know what I don't know." I'd hate to get close to "calling it a career" then discover that there were things I could and should have done to prepare more thoroughly. I feel like, in some ways, we missed the boat on Roth buckets. I could blame bad advisors for that, but in the end it's really on me for not being inquisitive enough and asking questions. I find this forum far more helpful than almost all of the advice we've received from paid advisors and those who've been assigned to us at the big box investment houses. One more thing about taxes: I'll pay my fair share. I just want to avoid paying my UNfair or UNnecessary share.

Thank you all for your insight and feedback. Much to consider.
Given how much you have saved and your current marginal rate, you probably saved quite a bit of taxes using traditional. If you had more Roth, yes you would have less future taxes but you also would have less savings. The net impact is probably mostly a wash. If you can do some pre social security post retirement Roth conversions that definitely could work to your advantage.

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Re: Am I Headed for a Retirement Tax Bomb?

Post by 02nz » Thu Jun 25, 2020 9:51 pm

Walkure wrote:
Thu Jun 25, 2020 8:36 pm
Shouldn't you work backward from your target retirement date, so that you fill up the pretax bucket in the highest earning mid/late career years when you're in the highest marginal bracket, and do Roth up until then in your lower earning early career?
Yes, it can make sense to favor Roth if one is starting out in say the 12% bracket and expects income to rise quickly. But consider this, too: viewtopic.php?f=10&t=318512

(To avoid derailing the OP's thread, if you have more questions on your situation, I recommend starting a separate thread.)

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Re: Am I Headed for a Retirement Tax Bomb?

Post by emlowe » Thu Jun 25, 2020 10:22 pm

I've always been confused by this. What is the worst thing that can happen? You have too much money?

I guess I don't understand this Tax Bomb thing.

I mean I would be more worried about the Running Out Of Money thing and just continue to save like mad.
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Re: Am I Headed for a Retirement Tax Bomb?

Post by retiredjg » Fri Jun 26, 2020 6:25 am

Walkure wrote:
Thu Jun 25, 2020 8:36 pm
Fortunately, I have access to a Roth 401k option, so now the question becomes, when is the best time to fund it? Usually the advice is pretax until you have ~1.5mil then switch over, but to me this seems backwards.
I cannot agree that this is "usually" the advice. Yes, that number has been suggested by a poster here. It may be right. It may not be right. But let's not give that number some kind of validity by considering it "usual". It is simply one person's opinion and has not found general acceptance that I'm aware of.

Shouldn't you work backward from your target retirement date, so that you fill up the pretax bucket in the highest earning mid/late career years when you're in the highest marginal bracket, and do Roth up until then in your lower earning early career?
Yes, it is backwards. If people are going to be moving up in tax brackets through their entire career, they should ideally save more in Roth early on and more in traditional later. If people are going to be staying in more or less the same bracket their entire career, they should ideally save both along the way.

This traditional vs Roth decision is also affected by the question of whether tax rate will be higher now or later. If taxes will be lower later, it is better to save more in traditional now. This factor may be more important than the one above.

The problem is that it is a balance between these two factors and most people have no idea where the balance will be. If we could see into the future, it would be a little easier. :happy

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Re: Am I Headed for a Retirement Tax Bomb?

Post by BlueCable » Fri Jun 26, 2020 7:02 am

Roth buckets may not have even been the right choice for you. They aren't for my wife and me.

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TomatoTomahto
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Re: Am I Headed for a Retirement Tax Bomb?

Post by TomatoTomahto » Fri Jun 26, 2020 7:11 am

emlowe wrote:
Thu Jun 25, 2020 10:22 pm
I've always been confused by this. What is the worst thing that can happen? You have too much money?

I guess I don't understand this Tax Bomb thing.

I mean I would be more worried about the Running Out Of Money thing and just continue to save like mad.
Let me try to help you clear up some of the confusion.

The tax bomb situation is for people who don’t have to worry about running out of money; they are well beyond that. However, they’d really like to leave as much as possible for heirs or charity.

So, they expect RMDs, pensions, SS, deferred compensation, 2% of taxable accounts, etc. to throw them (or often, their surviving spouse) into the highest tax bracket, which might well be higher than today’s brackets. Their income will be a few hundred thousand per year.

Please don’t reply with the infuriating “first world problem,” as though it’s an insight that has escaped us.
Okay, I get it; I won't be political or controversial. The Earth is flat.

j0e0r7
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Re: Am I Headed for a Retirement Tax Bomb?

Post by j0e0r7 » Fri Jun 26, 2020 7:44 am

TomatoTomahto wrote:
Fri Jun 26, 2020 7:11 am
emlowe wrote:
Thu Jun 25, 2020 10:22 pm
I've always been confused by this. What is the worst thing that can happen? You have too much money?

I guess I don't understand this Tax Bomb thing.

I mean I would be more worried about the Running Out Of Money thing and just continue to save like mad.
Let me try to help you clear up some of the confusion.

The tax bomb situation is for people who don’t have to worry about running out of money; they are well beyond that. However, they’d really like to leave as much as possible for heirs or charity.

So, they expect RMDs, pensions, SS, deferred compensation, 2% of taxable accounts, etc. to throw them (or often, their surviving spouse) into the highest tax bracket, which might well be higher than today’s brackets. Their income will be a few hundred thousand per year.

Please don’t reply with the infuriating “first world problem,” as though it’s an insight that has escaped us.
People appear to be worrying about it to an irrational degree though. I see that some advice given above is to stop contributing to tax-deferred accounts, so as to "not make the problem worse."

This reminds me a little of (possibly apocryphal) stories of people refusing their bonuses so they don't move into the next tax bracket.

RMDs are a tiny percentage of one's account, which has never been taxed in the first place. I would agree with the above poster that it's very low on the things that are worth worrying about.

reln
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Re: Am I Headed for a Retirement Tax Bomb?

Post by reln » Fri Jun 26, 2020 7:55 am

CashFlo wrote:
Wed Jun 24, 2020 8:23 pm
My S/O and I are approximately 10-12 years away from retirement.

Here are our current projections at full retirement:
$1.5m in pre-tax 401k's
$750k invested in stocks in post-tax brokerage account
$250k in cash reserves
~ $6k per month combined SS draw beginning at 70
We are currently barely hitting the 24% tax bracket.

I'M THINKING A LOT ABOUT TAXES IN RETIREMENT!
I've just started looking into RMD's.
Are walking into a tax bomb?
What should we consider doing now, if anything, to prepare?

We've been very disciplined to get where we are. I don't want tax ignorance to screw us up when we start accessing the fruits of our labor.

CF
Nope. Research the tax torpedo. You'll be fine.

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TomatoTomahto
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Re: Am I Headed for a Retirement Tax Bomb?

Post by TomatoTomahto » Fri Jun 26, 2020 8:10 am

j0e0r7 wrote:
Fri Jun 26, 2020 7:44 am
TomatoTomahto wrote:
Fri Jun 26, 2020 7:11 am
emlowe wrote:
Thu Jun 25, 2020 10:22 pm
I've always been confused by this. What is the worst thing that can happen? You have too much money?

I guess I don't understand this Tax Bomb thing.

I mean I would be more worried about the Running Out Of Money thing and just continue to save like mad.
Let me try to help you clear up some of the confusion.

The tax bomb situation is for people who don’t have to worry about running out of money; they are well beyond that. However, they’d really like to leave as much as possible for heirs or charity.

So, they expect RMDs, pensions, SS, deferred compensation, 2% of taxable accounts, etc. to throw them (or often, their surviving spouse) into the highest tax bracket, which might well be higher than today’s brackets. Their income will be a few hundred thousand per year.

Please don’t reply with the infuriating “first world problem,” as though it’s an insight that has escaped us.
People appear to be worrying about it to an irrational degree though. I see that some advice given above is to stop contributing to tax-deferred accounts, so as to "not make the problem worse."

This reminds me a little of (possibly apocryphal) stories of people refusing their bonuses so they don't move into the next tax bracket.

RMDs are a tiny percentage of one's account, which has never been taxed in the first place. I would agree with the above poster that it's very low on the things that are worth worrying about.
I’ve never worked with anyone who refused a bonus, but I have worked with people who didn’t want overtime or a raise because ... they just didn’t understand how marginal rates work. :oops:

I don’t know if RMDs are a tiny percentage of one’s account. My wife, for example, has 401k of around $3M, and might be $4M by the time she retires in a few years. RMD percentages start small, but they increase inexorably, year after year.

So, we split the baby by having new contributions go to Roth 401k (and the match perforce go to traditional). I didn’t have the strength of character to continue doing Roth conversions; it was just too painful.

Is it worth worrying about? I guess it depends on how much one worries.
Okay, I get it; I won't be political or controversial. The Earth is flat.

sd323232
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Re: Am I Headed for a Retirement Tax Bomb?

Post by sd323232 » Fri Jun 26, 2020 8:32 am

CashFlo wrote:
Wed Jun 24, 2020 8:23 pm
My S/O and I are approximately 10-12 years away from retirement.

Here are our current projections at full retirement:
$1.5m in pre-tax 401k's
$750k invested in stocks in post-tax brokerage account
$250k in cash reserves
~ $6k per month combined SS draw beginning at 70
We are currently barely hitting the 24% tax bracket.

I'M THINKING A LOT ABOUT TAXES IN RETIREMENT!
I've just started looking into RMD's.
Are walking into a tax bomb?
What should we consider doing now, if anything, to prepare?

We've been very disciplined to get where we are. I don't want tax ignorance to screw us up when we start accessing the fruits of our labor.

CF
Thats why Roth is so important, so people dont have problem like this. Roth is way to go

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celia
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Re: Am I Headed for a Retirement Tax Bomb?

Post by celia » Fri Jun 26, 2020 11:00 am

sergeant wrote:
Thu Jun 25, 2020 7:16 pm
I'm not seeing anything in their Roth accounts. Did I miss something?
CashFlo wrote:
Wed Jun 24, 2020 8:23 pm
Here are our current projections at full retirement:
$1.5m in pre-tax 401k's
$750k invested in stocks in post-tax brokerage account
I read the post-tax as being Roth. However, if it is a post-tax 401K (as opposed to a Roth 401k), the OP should consider moving the post-tax assets to a Roth IRA (assuming the plan allows in-service rollovers) where only the growth, and not the contributions, will be taxed.

Note: Some 401Ks have a Roth component, while others have a post-tax component. In both cases, employee contributions can be contributed there or pre-tax 401k contributions and growth can be converted to there. The two types differ in that the Roth component has the growth also being tax-free whereas in the post-tax component, the growth within that part is still subject to being taxed.

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Re: Am I Headed for a Retirement Tax Bomb?

Post by geerhardusvos » Fri Jun 26, 2020 11:07 am

CashFlo wrote:
Wed Jun 24, 2020 8:23 pm
My S/O and I are approximately 10-12 years away from retirement.

Here are our current projections at full retirement:
$1.5m in pre-tax 401k's
$750k invested in stocks in post-tax brokerage account
$250k in cash reserves
~ $6k per month combined SS draw beginning at 70
We are currently barely hitting the 24% tax bracket.

I'M THINKING A LOT ABOUT TAXES IN RETIREMENT!
I've just started looking into RMD's.
Are walking into a tax bomb?
What should we consider doing now, if anything, to prepare?

We've been very disciplined to get where we are. I don't want tax ignorance to screw us up when we start accessing the fruits of our labor.

CF
Deleted
Last edited by geerhardusvos on Fri Jun 26, 2020 5:51 pm, edited 1 time in total.
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Walkure
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Re: Am I Headed for a Retirement Tax Bomb?

Post by Walkure » Fri Jun 26, 2020 11:26 am

celia wrote:
Fri Jun 26, 2020 11:00 am
sergeant wrote:
Thu Jun 25, 2020 7:16 pm
I'm not seeing anything in their Roth accounts. Did I miss something?
CashFlo wrote:
Wed Jun 24, 2020 8:23 pm
Here are our current projections at full retirement:
$1.5m in pre-tax 401k's
$750k invested in stocks in post-tax brokerage account
I read the post-tax as being Roth. However, if it is a post-tax 401K (as opposed to a Roth 401k), the OP should consider moving the post-tax assets to a Roth IRA (assuming the plan allows in-service rollovers) where only the growth, and not the contributions, will be taxed.

Note: Some 401Ks have a Roth component, while others have a post-tax component. In both cases, employee contributions can be contributed there or pre-tax 401k contributions and growth can be converted to there. The two types differ in that the Roth component has the growth also being tax-free whereas in the post-tax component, the growth within that part is still subject to being taxed.
I would naturally read that as referring to an ordinary, taxable brokerage account where they have already paid income taxes on the take home wages before investing them, but are still subject to capital gains and dividends rates on any future income it generates.

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celia
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Re: Am I Headed for a Retirement Tax Bomb?

Post by celia » Fri Jun 26, 2020 11:56 am

TomatoTomahto wrote:
Fri Jun 26, 2020 7:11 am
emlowe wrote:
Thu Jun 25, 2020 10:22 pm
I've always been confused by this. What is the worst thing that can happen? You have too much money?

I guess I don't understand this Tax Bomb thing.

I mean I would be more worried about the Running Out Of Money thing and just continue to save like mad.
Let me try to help you clear up some of the confusion.

The tax bomb situation is for people who don’t have to worry about running out of money; they are well beyond that. However, they’d really like to leave as much as possible for heirs or charity.

So, they expect RMDs, pensions, SS, deferred compensation, 2% of taxable accounts, etc. to throw them (or often, their surviving spouse) into the highest tax bracket, which might well be higher than today’s brackets. Their income will be a few hundred thousand per year.

Please don’t reply with the infuriating “first world problem,” as though it’s an insight that has escaped us.
I don't see the "Tax Bomb" situation as having to be that extreme. To me, it is just when one's taxes jump unexpectedly due to RMDs. It could be as simple as a couple having enough SS to meet their living expenses during their 60s. If they don't have any income from taxable sources, such as distributions or capital gains, they don't owe any tax. If they have taxable distributions or capital gains, that starts to make some of their SS be taxed until 85% of it is taxed. They still might not owe any taxes, if the calculated amount is less than the standard deduction. They get used to this until age 70 or 72. Then RMDs start and not only the amount withdrawn is added to their income, but up to 85% of their SS is also taxed! They were not expecting this to happen. That's what I would also call a "Tax Bomb". Then the percentage to withdraw each year increases while the tax-deferred year-end balance also increases, until one year they bump into a higher tax bracket. Another "Tax Bomb"! OK, they get used to it, but one year one spouse dies. Taxes for that year are pretty much the same, but when the survivor files as Single the following year, although she is only collecting one SS, the same RMD would still need to be taken, but the space in the tax brackets for Singles is only half as much as for MFJ. So another "Tax Bomb" pushes her up to another tax bracket!

Part of this surprise may be due to the account owner having always considered the tax-deferred account as just "theirs", when it actually belonged to them, the IRS, and possibly the state. Several years ago, this perception was quite prevalent, when our accounts were smaller and people who retired 15, 20, 30 years ago, hardly had anything in their accounts (since many tax-deferred accounts hadn't been in existence very long and the contribution limit started at $1,500 in the early years). Now it is common to see a million dollars in an account for someone who contributed for 30 years. It was easy to think of the account as just "yours" since your name was the only one listed at the top of the statements. But it wasn't all "yours" because the taxes hadn't yet been paid.

And even if you think you'll die before it impacts you that much, your heirs will have to withdraw and pay the taxes within 10 years of your death. That may be a "Tax Bomb" for them if they are still working and have to add this on top of their other income!
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.

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celia
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Re: Am I Headed for a Retirement Tax Bomb?

Post by celia » Fri Jun 26, 2020 12:04 pm

geerhardusvos wrote:
Fri Jun 26, 2020 11:07 am
CashFlo wrote:
Wed Jun 24, 2020 8:23 pm
My S/O and I are approximately 10-12 years away from retirement.

Here are our current projections at full retirement:
$1.5m in pre-tax 401k's
$750k invested in stocks in post-tax brokerage account
$250k in cash reserves
~ $6k per month combined SS draw beginning at 70
We are currently barely hitting the 24% tax bracket.
Depending on your goals, it really looks like you could just retire in the next couple years, or right now and live a tax efficient future. With that amount of Social Security, I would not work another day in your position. Depends on your budget and financial goals obviously. Nice work!
That projected SS is more than 20 years away for both of them. If they retire now, that is 10-12 years of not contributing to SS so their upcoming years will have $0 contributions into the SS system. The years from age 67 to 70 include a 8% automatic increase, but that would be applied to a much lower base SS if they retire now.
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.

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sergeant
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Re: Am I Headed for a Retirement Tax Bomb?

Post by sergeant » Fri Jun 26, 2020 3:56 pm

geerhardusvos wrote:
Fri Jun 26, 2020 11:07 am
CashFlo wrote:
Wed Jun 24, 2020 8:23 pm
My S/O and I are approximately 10-12 years away from retirement.

Here are our current projections at full retirement:
$1.5m in pre-tax 401k's
$750k invested in stocks in post-tax brokerage account
$250k in cash reserves
~ $6k per month combined SS draw beginning at 70
We are currently barely hitting the 24% tax bracket.

I'M THINKING A LOT ABOUT TAXES IN RETIREMENT!
I've just started looking into RMD's.
Are walking into a tax bomb?
What should we consider doing now, if anything, to prepare?

We've been very disciplined to get where we are. I don't want tax ignorance to screw us up when we start accessing the fruits of our labor.

CF
Depending on your goals, it really looks like you could just retire in the next couple years, or right now and live a tax efficient future. With that amount of Social Security, I would not work another day in your position. Depends on your budget and financial goals obviously. Nice work!
I think that you missed that this is their PROJECTED portfolio 12 years from now. I don't think they should stop working now as I have no idea what their portfolio is right now nor their expenses right now.
AA- 20+ Years of Expenses Fixed Income/The remainder in Equities.

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David Jay
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Re: Am I Headed for a Retirement Tax Bomb?

Post by David Jay » Fri Jun 26, 2020 4:10 pm

j0e0r7 wrote:
Fri Jun 26, 2020 7:44 am
RMDs are a tiny percentage of one's account...
You do realize that RMDs are based on remaining life expectancy and the percentage goes up every year, right?

For instance, your RMD at age 95 is 12%. Now imagine having a couple of million in tax deferred and the surviving spouse is filing taxes "single". That's a lot of green.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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Re: Am I Headed for a Retirement Tax Bomb?

Post by geerhardusvos » Fri Jun 26, 2020 5:54 pm

sergeant wrote:
Fri Jun 26, 2020 3:56 pm
geerhardusvos wrote:
Fri Jun 26, 2020 11:07 am
CashFlo wrote:
Wed Jun 24, 2020 8:23 pm
My S/O and I are approximately 10-12 years away from retirement.

Here are our current projections at full retirement:
$1.5m in pre-tax 401k's
$750k invested in stocks in post-tax brokerage account
$250k in cash reserves
~ $6k per month combined SS draw beginning at 70
We are currently barely hitting the 24% tax bracket.

I'M THINKING A LOT ABOUT TAXES IN RETIREMENT!
I've just started looking into RMD's.
Are walking into a tax bomb?
What should we consider doing now, if anything, to prepare?

We've been very disciplined to get where we are. I don't want tax ignorance to screw us up when we start accessing the fruits of our labor.

CF
Depending on your goals....
I think that you missed that this is their PROJECTED portfolio 12 years from now. I don't think they should stop working now as I have no idea what their portfolio is right now nor their expenses right now.
:oops:
VTSAX and chill

LeeMKE
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Re: Am I Headed for a Retirement Tax Bomb?

Post by LeeMKE » Fri Jun 26, 2020 8:18 pm

It has been mentioned before, but once again, this question is answered best by running your situation through the FREE tool at I-Orp.com (use the extended tool).

I am a poster child for the importance of running this analysis early and heeding the advice. Fidelity first pointed out the problem, then the Fidelity RIP showed a big bubble of expenditures in my 80s, the bubble was taxes, throwing me into the 33% bracket for about 5 years.

I needed to convert IRA to Roth, using my early retirement years to pay taxes on IRA conversions. And I had to move ALOT of money, so I needed time to spread the tax burden out.

Now, I'm safely in the 12-15% bracket for the rest of my life. AND I don't have a problem that would have popped up in my 80s when I don't want any financial drama.

Some people find that they don't have a big problem. And if that turns out to be you, that's great. But you sound like you'd rather be sure than guessing.
The mightiest Oak is just a nut who stayed the course.

drzzzzz
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Re: Am I Headed for a Retirement Tax Bomb?

Post by drzzzzz » Sat Jun 27, 2020 6:14 am

LeeMKE wrote:
Fri Jun 26, 2020 8:18 pm
It has been mentioned before, but once again, this question is answered best by running your situation through the FREE tool at I-Orp.com (use the extended tool).

I am a poster child for the importance of running this analysis early and heeding the advice. Fidelity first pointed out the problem, then the Fidelity RIP showed a big bubble of expenditures in my 80s, the bubble was taxes, throwing me into the 33% bracket for about 5 years.

I needed to convert IRA to Roth, using my early retirement years to pay taxes on IRA conversions. And I had to move ALOT of money, so I needed time to spread the tax burden out.

Now, I'm safely in the 12-15% bracket for the rest of my life. AND I don't have a problem that would have popped up in my 80s when I don't want any financial drama.

Some people find that they don't have a big problem. And if that turns out to be you, that's great. But you sound like you'd rather be sure than guessing.
Just curious about your interaction with Fidelity about pointing out the future tax issue and Roth conversions. How did you find or use the Fidelity person - was it from a private management group, an office rep, or someone in their back offices assigned to these types of issues? Or did you primarily use I-orp to figure this out for yourself thanks

mikemartin82
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Re: Am I Headed for a Retirement Tax Bomb?

Post by mikemartin82 » Sat Jun 27, 2020 9:12 am

I am about 5 years away from retirement and started shifting my thinking from "saving", to thinking about a drawdown strategy to get the most out of what we saved.

I've learned that coming up with a withdrawal strategy - is complicated. For instance, I found out about things like IRMAA and NIIT and that the order of withdrawing (taxable/tax deferred/tax free) matters.

Since I love software tools, I started using a $20/month service called Income Strategy. (I cancelled after a few months, but I learned a lot from it) https://incomestrategy.com/howitworks/

For me, at the current tax rates from the TCJA, it makes sense for me to convert my traditional retirement savings to ROTH over the next 10 years. I also stopped contributing to any tax deferred retirement accounts. I'm convinced that tax rates will likely go back up in future, so I am trying to take advantage of lower tax rates now, and the low income I will have in my early retirement years.

One of my goals is to leave enough money for my kids to make them more comfortable in their retirement years.

Mike
Last edited by mikemartin82 on Sat Jun 27, 2020 10:26 am, edited 1 time in total.

LeeMKE
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Re: Am I Headed for a Retirement Tax Bomb?

Post by LeeMKE » Sat Jun 27, 2020 9:35 am

Just curious about your interaction with Fidelity about pointing out the future tax issue and Roth conversions. How did you find or use the Fidelity person - was it from a private management group, an office rep, or someone in their back offices assigned to these types of issues? Or did you primarily use I-orp to figure this out for yourself thanks
The Fidelity Rep assigned to me first pointed out the problem during a routine financial checkup. Then a few months later, I realized it was showing up in the Retirement Income Planner as a big hump in my 80s. I asked if that was what the rep was referring to, and he confirmed it was. I went into table mode, added up the dollars in the hump (about $250,000), converted to present value and converted that amount in the next 3 years. The hump dissappeared from the RIP and I thought I was done.

But then I was searching for the answer to when to start Social Security. All the other calculators said to wait to age 68 or 70. But I would have to draw down from my savings during the waiting period, and that didn't seem to be accounted for. That is when I found I-ORP, and sure enough, that draw down was included in the I-ORP calculations and confirmed my sense that the other calculators were making assumptions that I would continue working, which did not apply in my case.

Then I used I-ORP extended to look at my IRA to Roth conversions. I-ORP suggested a much more aggressive conversion, and pointed out the opportunity to lower my tax rate throughout retirement. The result was much better than any other calculators, so I did it. But I needed to convert quite a bit, so it took me several more years to complete.

Now that the conversions are complete, all of my monitors are in agreement: I-ORP, Fidelity Retirement Planner, and my worksheet from Living Off Your Money.
The mightiest Oak is just a nut who stayed the course.

bearwithbear
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Re: Am I Headed for a Retirement Tax Bomb?

Post by bearwithbear » Sat Jun 27, 2020 9:40 am

LeeMKE,

About how much did you save in total taxes?
Which meant that you spent how much on taxes now to save how much later?

Thanks,
Bear

Topic Author
CashFlo
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Re: Am I Headed for a Retirement Tax Bomb?

Post by CashFlo » Sat Jun 27, 2020 11:43 am

OP here. I appreciate all of the comments about things I should consider. It is all helpful.

What spoke to me most is the idea of doing Roth conversions during the time between retirement and drawing on SS -- when earned income is lower. I am going to continue to research that possibility and discuss it with my financial planner. I am focused on the tax ramifications of a surviving spouse when it comes to pre-tax investments (401k's, IRA's). As I said earlier, I have no problem paying my fair share of taxes, but want to avoid paying an unfair share that can come from poor planning. I have many years of runway left to make adjustments.

On a side note, there was some confusion about Roths. We have none. All of our funds are in 401k's, IRA's and cash (post-tax brokerage) accounts. The entire portfolio is 80/20 stocks/cash or cash equivalents. The equities are all in low-cost index funds ranging from S&P 500, total stock market, and a few sector indexes. The brokerage account is 90% total stock market indexes. It's a fairly aggressive portfolio given our age. We have enough cash/cash equivalents to ride out market downturns.

02nz
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Re: Am I Headed for a Retirement Tax Bomb?

Post by 02nz » Sat Jun 27, 2020 11:57 am

CashFlo wrote:
Sat Jun 27, 2020 11:43 am
OP here. I appreciate all of the comments about things I should consider. It is all helpful.

What spoke to me most is the idea of doing Roth conversions during the time between retirement and drawing on SS -- when earned income is lower. I am going to continue to research that possibility and discuss it with my financial planner. I am focused on the tax ramifications of a surviving spouse when it comes to pre-tax investments (401k's, IRA's). As I said earlier, I have no problem paying my fair share of taxes, but want to avoid paying an unfair share that can come from poor planning. I have many years of runway left to make adjustments.

On a side note, there was some confusion about Roths. We have none. All of our funds are in 401k's, IRA's and cash (post-tax brokerage) accounts. The entire portfolio is 80/20 stocks/cash or cash equivalents. The equities are all in low-cost index funds ranging from S&P 500, total stock market, and a few sector indexes. The brokerage account is 90% total stock market indexes. It's a fairly aggressive portfolio given our age. We have enough cash/cash equivalents to ride out market downturns.
As other posters have already suggested, why not also contribute to Roth IRAs? You may be near the phaseout range for direct contributions to Roth IRA, but you can do the backdoor Roth IRA (https://www.bogleheads.org/wiki/Backdoor_Roth), as long as you don't have traditional IRAs with tax-deferred balances (i.e. that $1.5 M is actually in 401k's and have not been rolled over to IRAs). You should fund Roth IRAs ahead of taxable accounts, as Roth IRAs are advantageous in almost every respect.

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