Retired, how to best withdraw my investments tax efficiently?

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Startin'up
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Retired, how to best withdraw my investments tax efficiently?

Post by Startin'up »

My wife and I have been living and investing the Boglehead philosophy since the 80's. As a result, we both retired at age 60 with substantial investments. We are now age 65 and just applied to start our social security benefits in November. I am completely horns-waggled as to how to start actively withdrawing/converting our investments in the most tax efficient way to avoid huge surprises down the road, and would like some helpful advice.

Here are our current circumstances:

Age 65 (soon 66)

Debt: None ($700,000 house, no mortgage)

Tax filing status: Married filing jointly, no kids

Total portfolio: $2,500,000

Portfolio breakdown: (Roughly 50/50 bond/equity)

IRAs: $1,000,000 virtually all in Vanguard Total bond index (½ of that in Inflation protected)

Taxable investments: $1,500,000 in various Vanguard Index funds plus cash plus Amer funds

$200,000 Total Bond index (Unrealized cap gains = $19,000)
$400,000 500 Index (Unrealized cap gains = $225,000)
$500,000 Total stock index (Unrealized cap gains = $315,000)
$100,000 VG Total International (Unrealized cap gains = -$9,000)

Plus $200,000 in some American funds (We've been slowly liquidating this annually by contributing it to non-profits to avoid capital gains, and plan on continuing to do so. We may simply use it to establish a Field of Interest fund with a local charitable foundation and be done with it. We have no heirs and our entire estate will go to them in the end anyway)

Emergency/living expense fund: $75,000 Vanguard money market.

Keeping it fairly simple, that is the gist of our investments.

Our living expenses generally run about $70,000 per year, Social Security income will generate $48,000 a year and our general taxable “dividend income” from investments (tax-wise) usually adds $20,000.

What a great position to be in! Except for those darned taxes.

So, here is what I would like some input on – with IRA minimum distribution looming up in a few years, what would be our best strategy now and going forward for withdrawing/liquidating/converting money from our IRAs (to Roths?) and non sheltered investments?
backpacker61
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by backpacker61 »

Startin'up wrote: Sun Oct 04, 2020 6:39 pm I am completely horns-waggled as to how to start actively withdrawing/converting our investments in the most tax efficient way to avoid huge surprises down the road, and would like some helpful advice.
You're in an incredibly awesome position.

If it were me, I would direct all of the dividends and capital gains distributions from your taxable accounts into your money market fund. If I understood you correctly, that should provide you with ~$68000 income; almost exactly your anticipated living expenses. You will pay taxes on these distributions anyway, so just send them to your emergency/living expenses money market fund.

Don't know where you hold your American Funds; if they're not at Vanguard, can you do a transfer "in kind" so that you hold them in your Vanguard brokerage account? That way, you could direct their dividends/capital gains distributions to the same money market fund.

Looks like you should have to sell very little (if anything) to support your lifestyle, and you can let your tax deferred accounts continue to appreciate until you have a need to tap them to keep up with inflation or are required to take distributions after age 72.
“Now shall I walk or shall I ride? | 'Ride,' Pleasure said; | 'Walk,' Joy replied.” | | ― W.H. Davies
sycamore
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by sycamore »

One common suggestion is to use the years before IRA Required Minimum Distribution (RMD) starts (age 72) to convert some of your Trad IRA to Roth, the idea being that if you can decrease your Trad IRA balance then your RMDs will be lower, making it easier to manage your taxable income. Whether this works depends on tax rates:
- If your tax rate when you're 72 will be higher than it is now, it makes sense to convert some now (up to the top of your current bracket)
- If you'll be in the same tax bracket, it's a wash. Although tax rates are scheduled in 2025 to revert back to 2017 rates (i.e., go up).

It's a complex question involving your dividend income, SS income, and RMDs. I'm no expert but hopefully others will chime in on whether to convert some of your Trad IRA to Roth.
BernardShakey
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by BernardShakey »

backpacker61 wrote: Sun Oct 04, 2020 7:10 pm
Startin'up wrote: Sun Oct 04, 2020 6:39 pm I am completely horns-waggled as to how to start actively withdrawing/converting our investments in the most tax efficient way to avoid huge surprises down the road, and would like some helpful advice.
You're in an incredibly awesome position.

If it were me, I would direct all of the dividends and capital gains distributions from your taxable accounts into your money market fund. If I understood you correctly, that should provide you with ~$68000 income; almost exactly your anticipated living expenses. You will pay taxes on these distributions anyway, so just send them to your emergency/living expenses money market fund.

Don't know where you hold your American Funds; if they're not at Vanguard, can you do a transfer "in kind" so that you hold them in your Vanguard brokerage account? That way, you could direct their dividends/capital gains distributions to the same money market fund.

Looks like you should have to sell very little (if anything) to support your lifestyle, and you can let your tax deferred accounts continue to appreciate until you have a need to tap them to keep up with inflation or are required to take distributions after age 72.
I think OP is indicating his expenses after taxes are $70k annually. So the income requirement is somewhat higher than that to account for federal and state incomes taxes.
An important key to investing is having a well-calibrated sense of your future regret.
infotrader
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by infotrader »

I would convert at least 50% of the tIRA to Roth in the next 7 years.
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Peter Foley
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by Peter Foley »

Startin" up wrote:
Emergency/living expense fund: $75,000 Vanguard money market.

Keeping it fairly simple, that is the gist of our investments.

Our living expenses generally run about $70,000 per year, Social Security income will generate $48,000 a year and our general taxable “dividend income” from investments (tax-wise) usually adds $20,000.
Living expenses are about $70,000 per year
SS. provides $48,000.
Dividends are $20,000.

The top of the 12% bracket is $80,250 in taxable income (not gross income) for MFJ in 2020. Roth conversions to bring taxable income up to $80,250 are prudent.

However, there may be a better approach. Run your numbers through both the i-orp calculator and the Retiree Model Portfolio Calculator. While the models work slightly differently, both will provide you with a multi year plan for doing Roth conversions. Do note that if you do Roth conversions you will likely want to adjust your asset allocation in your taxable account to accommodate holding stocks in the Roth.

My recommendation is to set up a rolling 5 year plan and rerun the calculator number each year and also rerun if there is a change to the tax law.
kenbt
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by kenbt »

That a lot of taxable long term capital gains. What makes sense to me is to realize about $45,500 of those LTCG, to take you to the top of the %0 LTCG tax bracket.
Your taxes would be estimated at $1,503. Your outstanding tax bill $1,503.
This is 1.41% of your total income of $106,300. Your outstanding tax bill is estimated at $1,503. Your income puts you in the 12% tax bracket.
Sell and quickly reinvest in the same or another investment and raise your cost basis. Or spend and enjoy that money. Once your RMDs start, your LTCG rate may be 15%. For me this makes more sense then doing Roth conversions. https://www.kitces.com/blog/understandi ... -in-basis/
I used this calculator. https://www.dinkytown.net/v3/999160/Tax1040.html
No clue about your state tax.
CRTR
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by CRTR »

I was in a similar situation to you, although a couple years younger and a bit different asset distribution. I spent many, MANY hours constructing my own spreadsheets to help me figure out the "best answer" . . . . it's a complicated exercise. There are so many important variables (lifespan, future tax rates, Social Security strategies, IRMAA, NIT, etc etc). I also visited and tried a number of different websites and downloadable calculators (I-ORP, Maxifi, Emoney, NewRetirement, Fidelity, RMP, Flexible Retirement Calculator and IncomeStrategy.com . . . to name a few . . . )

When the dust settled, I liked IncomeStrategy.com the best because it effortlessly handles the various assumptions/options the best. The cost was only $20/month and I only needed one month. It took me ~1 week to learn the interface, input my data and get the answers/insight I sought. I saved the report/strategy to my computer and canceled my subscription. You enter your data, assumptions and the system spits out and ranks ~100 different withdrawal strategies. You can see a brief summary of each strategy or VERY detailed yearly results. You easily can see how changing assumptions affects the "best" recommendation. For example, in my case, aggressive Roth conversions make sense if I live to >90 but do not if I only live to 80.
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Peter Foley
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by Peter Foley »

Following up on a couple of posts: CRTR and kenbt raise valid issues.

From the Wiki part 1:
The relevant income for Social Security taxation includes all items which are normally part of your adjusted gross income, plus tax-exempt interest income, plus 50% of your Social Security benefits. (Historically, the 50% represents the fact that half of your Social Security contributions were made by your employer and thus not taxed.)[4]

There are two relevant base amounts; unlike most income limits in the tax code, they are not adjusted for inflation. The lower base is $25,000 if you are single, $32,000 if married filing jointly. The upper base is $34,000 if you are single, $44,000 if married filing jointly.[5]

If your relevant income is below the lower base, none of your benefits are taxable. For every $1 of relevant income between the lower and upper bases, 50 cents of your Social Security benefits become taxable, up to 50% of your total benefits. For every $1 of relevant income above the upper bases, 85 cents of your Social Security benefits become taxable, up to a total taxable amount of 85% of your benefits.[6]
From the Wiki part 2:
Married taxpayers:

If you are a married couple and receive $40,000 in Social Security benefits:

None of your benefits are taxable if your other income is less than $12,000.
For every dollar between $12,000 and $24,000, an additional 50 cents becomes taxable.
For every dollar over $24,000, an additional 85 cents becomes taxable, up to a total other income of $56,941, which makes the maximum $34,000 taxable.
Ballpark estimate of your RMD's at age 72 is $40,000 in gross income . This assumes little change because you are invested in bonds in traditional.

So the questions become: 1. What will my tax rate be at age 72? 2. To what extent should I keep my tax rates low now? (i.e., pay now or pay later)

CRTR lists the variables that make this a difficult calculation. I've run many scenarios with the calculators and have concluded that I will only know the best scenario in retrospect. I think as kenbt states, that taking some long term capital gains now is part of the equation.

My approach was to try to keep my marginal tax rate relatively level as I transitioned from pre RMD's to RMD's. I felt it was a good approach but admit it may not have been the best. The Roth conversion strategy that I recommended was based on that. The ratios of one's holdings relative to taxable, tax deferred, and tax free are also important. My ratios were much different than yours so in retrospect I'm leaning a bit more toward kenbt's approach.

If you run the numbers using a calculator it would be interesting to hear your conclusions. I'll stay tuned.
sycamore
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by sycamore »

Another good read is a BH thread on Kitces on Roth Conversions vs. Harvesting Capital Gains. There are various considerations and pros/cons to each approach. As noted above, the best approach will only be known in retrospect. If, after running the numbers, it's not clear that one is best, just do some of each in a given year, and then re-run the numbers the next.
Buckrodgerz
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by Buckrodgerz »

Recommendations:
1. If you do not need the immediate income, delay taking SS until age 67 to 70. The monthly check goes up substantially.
2. In the taxable accounts, use tax managed funds, muni's, MLP's, only low yield bonds, low interest cash or CDs, S-corp stock, index equity funds, and
long term (over one year) individual traded stocks.
3. In the tax deferred accounts, use Life Style funds, Target funds, TIPs, ETF commodities, bond ETFs, and REITs, Index Bond funds, individual bonds,
short term traded individual stocks, and non-tax efficient managed funds.
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galawdawg
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by galawdawg »

Just a few observations/comments...

Did you run a social security calculator to determine the optimal strategy for claiming social security? If not, this one is recommended: https://opensocialsecurity.com/

Doing some back of the envelope calculations based upon the information you provided indicates that it might be advisable to consider waiting to claim SS until age 70. Assuming you defer SS to age 70, you would need to withdraw $50k from your portfolio in addition to your $20k dividends to cover your $70k annual expenses. In the meantime, you may be able to do Roth conversions of about $65k per year and incur a total federal tax liability of only about $4400. So including your taxes, that would bump your needed income to $75k which I accounted for below. Here are the numbers I used:

Qualified dividend income $20k
Long-term capital gains $22k (assuming you withdraw $55k per year from taxable with the average LT gains as noted in your OP)
Roth conversions $65k

Adjusted gross income $107k
Standard deduction $27k
Taxable income $80k
Federal income tax $4375

So in five (5) years, you would be able to move $325,000 to Roth accounts which reduces your overall tax liability when you reach age 72 and have both social security and required minimum distributions.

Again, those were very simple and quick calculations assuming MFJ with no income other than dividends and LT capital gains, taking the standard deduction, and no other tax considerations, like tax credits and such. If I overlooked something or if my calculations are off, I'm sure a smarter BH than me will point it out! :happy

Food for thought...
InMyDreams
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by InMyDreams »

CRTR wrote: Mon Oct 05, 2020 7:58 am When the dust settled, I liked IncomeStrategy.com the best because it effortlessly handles the various assumptions/options the best. The cost was only $20/month and I only needed one month. It took me ~1 week to learn the interface, input my data and get the answers/insight I sought. I saved the report/strategy to my computer and canceled my subscription. You enter your data, assumptions and the system spits out and ranks ~100 different withdrawal strategies. You can see a brief summary of each strategy or VERY detailed yearly results. You easily can see how changing assumptions affects the "best" recommendation. For example, in my case, aggressive Roth conversions make sense if I live to >90 but do not if I only live to 80.
Does IncomeStrategy address asset allocation in the $20/mo subscription? How does it handle "other" investments, say TIAA Trad?

Has anyone else used it and liked it?
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Peter Foley
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by Peter Foley »

A suggestion if you are inclined to sell some your mutual fund holdings with capital gains in taxable and then reinvest them. Note which of your stock mutual funds in taxable is most tax efficient. Sell funds that are less tax efficient and reinvest in those that are more tax efficient. Those that more tax efficient are likely to have less in capital gains each year.

Also, just to make sure you are not selling some funds with a mix of long term and short term capital gains, turn off the reinvestment of capital gains and dividends in your taxable accounts.
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grabiner
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by grabiner »

If you can do this consistent with your asset allocation, it is better to sell taxable bond funds and keep taxable stock index funds. The taxable bond funds have little or no capital gain when sold, and the income you get out of the taxable stock funds is taxed at a lower rate than the income you get out of the taxable bond funds.

A further advantage is that you may leave some of those taxable stock funds to your heirs or to charity, so that the tax on the capital gains is never paid.

Thus, in your situation, I would continue to use the tax-inefficient American funds for charity, and sell the Total Bond Market Index for living expenses if needed. If that gives you too much stock, move some of the IRA from bonds to stock.

Once you turn 70-1/2, you can make Qualified Charitable Distributions from your IRA. This is a particularly good use of the RMDs, as the money isn't counted in your income at all; for example, it won't count towards the IRMAA limits which can make Medicare Part B more expensive.
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CRTR
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by CRTR »

InMyDreams wrote: Mon Oct 05, 2020 5:24 pm
CRTR wrote: Mon Oct 05, 2020 7:58 am When the dust settled, I liked IncomeStrategy.com the best because it effortlessly handles the various assumptions/options the best. The cost was only $20/month and I only needed one month. It took me ~1 week to learn the interface, input my data and get the answers/insight I sought. I saved the report/strategy to my computer and canceled my subscription. You enter your data, assumptions and the system spits out and ranks ~100 different withdrawal strategies. You can see a brief summary of each strategy or VERY detailed yearly results. You easily can see how changing assumptions affects the "best" recommendation. For example, in my case, aggressive Roth conversions make sense if I live to >90 but do not if I only live to 80.
Does IncomeStrategy address asset allocation in the $20/mo subscription? How does it handle "other" investments, say TIAA Trad?

Has anyone else used it and liked it?
I know there are people on here who have used it. I first heard about it in the WSJ and then looked it up here, on BH. If you search for IncomeStrategy, you'll find some previous threads.

If memory serves me correctly, I was able to enter my info and do a trial use but I don't know if they still allow that. To me, a single, $20 fee was not a big risk.

I found this link from Google: https://incomestrategy.com/#challenge -- I think this is for the free trial run but don't quote me on that . . .

Apropos to asset allocation, they do take that into account. You can choose a custom allocation or go with one of their recommended portfolios. Not exactly sure what you mean by "other" investments nor am I sure what TIAA Trad is. I do know when setting up your profile, you can model real estate, insurance products, pensions and annuities and they have a social security optimizer. They run Monte Carlo analysis of each plan as well.

For me, the biggest issue with the site was profile set up and data entry was not intuitive to me. It was a bit of a work to learn the system. On the other hand, once I learned how to use it and manipulate it, it was extremely useful.
Old Sage(brush)
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by Old Sage(brush) »

Interesting thread, great comments. I can easily agree that a $20 one time fee is fairly low risk :happy . To me, there are so many variables that all you can do is take a fairly high level macro analysis to guide you and continue to review it as you go forward. I think the level of contingencies is so great that granular planning years out is of limited use. Not that planning should not be done, but I wouldn't sweat it too much. Bottom line is OP is in a great position and if the withdrawal execution does not fully optimize things as a matter of tax efficiency, barring the end of the world as we know it (which is not a no-risk proposition), all will be ok. More than ok.
GMT-8
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Re: Retired, how to best withdraw my investments tax efficiently?

Post by GMT-8 »

I would suggest you spend an hour or two (free) with i-orp (optimal retirement planner) which is fairly easy to use and quite sophisticated with calculations of when and how much to draw from
  • Tax advantaged accounts IRA, 401(k), etc
  • Taxable accounts
  • Illiquid investments home, land, etc
And also takes into account your
  • Pensions
  • Annuities
and calculates your potential taxes, all while showing your maximum annual income depending on how much you wish to leave at the end.

There are lots of options to tailor your inquiries and best of all it’s not a sales portal or way for someone to hook you in for expensive advice/assistance.

GMT
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