Surviving the Tax Bite of RMD Withdrawals in Retirement

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FinancialDave
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Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by FinancialDave » Thu Jan 22, 2015 12:38 pm

Recently due to some unforeseen luck in a Boglehead Contest, Taylor sent me the following message:
Your winning statistics and our messages should make a good article for your website.

I hope you will post a link to your article with a new post on the Bogleheads Forum
While I saw not much appeal to anyone in trying to untangle the skill as Mauboussin would call it, in a contest that is by its nature mostly luck, I was able to work in a "lucky" reference to this forum in my 6th article in a series I have been writing on retirement.

This article is called "Surviving the Tax Bite in Retirement:"

http://seekingalpha.com/article/2837636 ... retirement

Once again as longinvest has suggested if you don't want to register for this site, and you know enough about your browser to disable your browser cookies, it seems you can read the whole article without registering.



That title is a little bit of a tease, because the longer version of that title would probably say something like:
Can someone really put a group of high growth dividend paying stocks in an IRA and expect to live off the dividends only
The results are extremely disheartening for those who actually would live to an older age of say 99 (where my study goes.) It seems that over half of that dividend income is eaten up by taxes - at least if my math is correct! The reason being, as most already know, the IRS doesn't care if you don't want or need the income, they want to get paid.

So I think the "between the lines conclusion" that I wish I had stated in the article is NOT to avoid the IRA at all costs, because truly most can get great value out of it, by deferring taxes while you are working to build a bigger retirement and then taking that money out at a much reduced tax-rate during retirement (maybe!) The "between the lines trick" is really to have the IRA "right sized" so the money you take out in RMD's is the money you need to spend. In that way you aren't paying more taxes than you need to.

Also using the RMD withdrawals as a retirement strategy is what a couple of my other articles stress as a quite efficient way to extract the maximum value from your portfolio -- in most cases even more than the typical VPW strategy discussed on this forum. Here is a link to one of those articles should you care to explore:

http://seekingalpha.com/article/2747405 ... ithdrawals


So, sometimes when you get close to retirement or during your first few years, Roth conversions can tone down the later RMD affect, but I strongly disagree with the thinking that you need to convert all your IRA money to a Roth because you are essentially afraid of taxes or the risk they add.

Personally, at 63 and retired, I am in the "toning down" (through conversions) and spending down phase of my IRA money.

fd
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Peter Foley
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Peter Foley » Thu Jan 22, 2015 1:15 pm

Interesting article - thanks for doing the work and publishing the results.

Two things come to mind, the first of which you mention.

For persons who have large deferred income accounts relative to other retirement assets, Roth conversions in the years prior to RMDs can help smooth out the tax obligation over the course of one's life in retirement. This has been well discussed on BH. You suggest this as well and while it does not work for everyone, but it works for many retirees. [Note: Because of law changes with respect to retirement accounts - Roths came about much later than traditional IRAs and 401ks, and contribution levels for Roths are much lower than those for 401k's - having more assets in a deferred account than in a Roth is par for the course for many boomers.] To do this requires some long range financial planning.

When taking RMD's, I have seen little discussion about making adjustments year by year to smooth out one's tax obligation. One would think that a 75-80 year old in good health would anticipate the tax consequences of RMD withdrawals 5 to 10 years in the future and would perhaps withdraw more than the minimum to avoid being in a high tax bracket later.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Miriam2 » Thu Jan 22, 2015 1:32 pm

Peter Foley wrote:When taking RMD's, I have seen little discussion about making adjustments year by year to smooth out one's tax obligation. One would think that a 75-80 year old in good health would anticipate the tax consequences of RMD withdrawals 5 to 10 years in the future and would perhaps withdraw more than the minimum to avoid being in a high tax bracket later.
I could not read FinancialDave's article, but when you say "to avoid being in a high tax bracket later," why would that be? Do you mean that taking out RMDs for 5-10 years puts one in a higher tax bracket?

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by The Wizard » Thu Jan 22, 2015 1:49 pm

Miriam2 wrote:
Peter Foley wrote:When taking RMD's, I have seen little discussion about making adjustments year by year to smooth out one's tax obligation. One would think that a 75-80 year old in good health would anticipate the tax consequences of RMD withdrawals 5 to 10 years in the future and would perhaps withdraw more than the minimum to avoid being in a high tax bracket later.
I could not read FinancialDave's article, but when you say "to avoid being in a high tax bracket later," why would that be? Do you mean that taking out RMDs for 5-10 years puts one in a higher tax bracket?
It could, yes, depending on how much money is in the tax-sheltered (non-Roth) fund and depending on how oblivious the person has been about RMDs prior to age 70.

But really, this is just an issue for 5% or 10% of the population, I'm guessing. Point being, if all your income is taxable would you rather be in the 15% federal tax bracket or the 28% tax bracket? I know which one I'd prefer...
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Epsilon Delta » Thu Jan 22, 2015 2:35 pm

Peter Foley wrote:When taking RMD's, I have seen little discussion about making adjustments year by year to smooth out one's tax obligation. One would think that a 75-80 year old in good health would anticipate the tax consequences of RMD withdrawals 5 to 10 years in the future and would perhaps withdraw more than the minimum to avoid being in a high tax bracket later.
If you don't want to spend the money a Roth conversion is preferable to a voluntary withdrawal.

So yes to smoothing out the tax obligation, but keep it in a Roth to shelter future earnings.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Beliavsky » Thu Jan 22, 2015 2:36 pm

FinancialDave wrote:
Can someone really put a group of high growth dividend paying stocks in an IRA and expect to live off the dividends only
The results are extremely disheartening for those who actually would live to an older age of say 99 (where my study goes.) It seems that over half of that dividend income is eaten up by taxes - at least if my math is correct!
The idea that you need bonds or dividend-paying stocks for "income" does not help you make good investment decisions. What matters is volatility and total return, not whether that return comes from capital gains, dividends, or interest. (In fact, capital gains get better tax treatment.) Companies used to spend much more on dividends than buybacks. That is no longer true. Why should you not own a stock because it chooses to return capital to shareholders in a more tax-efficient way, through buybacks?

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by randomguy » Thu Jan 22, 2015 2:59 pm

Can't read the article since it is behind a pay wall but losing sleep over high RMDs is a waste of time. It means you have money. If your taxes are higher now than when you were working, odds are you are making more money than when you were working. That is a problem you can live with.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Peter Foley » Thu Jan 22, 2015 3:02 pm

Miriam2

When one first begins RMDs they average very roughly $4000/year per $100,000 for the each of the first 10 years of retirement. If you had space in the 15% tax bracket in the early years you might just fill up the bracket. If a married couple were to take only the minimum for a number of years, as the minimum grows, some couples might find that the RMD pushes them into the 25% bracket.

Example: The top of the MFJ 15% bracket is $74,900 in taxable income in 2015. If, with your current RMD you are at $70,000 in taxable income, it may be to your advantage to take out an additional $4,900 to reduce RMDs in future years. [100,000/27.4 = $3650 in year 1. Assuming approximately a 4% return for the deferred account so that its value remains constant, $100,000/18.7= $5347 in year 10]

Dave's article also includes some estimates of inflationary increases in tax brackets, exemptions and standard deductions.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by bsteiner » Thu Jan 22, 2015 3:23 pm

The Wizard wrote:... if all your income is taxable would you rather be in the 15% federal tax bracket or the 28% tax bracket? ...
I would prefer to be in the 39.6% Federal bracket.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Grt2bOutdoors » Thu Jan 22, 2015 3:34 pm

bsteiner wrote:
The Wizard wrote:... if all your income is taxable would you rather be in the 15% federal tax bracket or the 28% tax bracket? ...
I would prefer to be in the 39.6% Federal bracket.
Same here. Given the choice, I'd rather be collecting income.
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Miriam2 » Thu Jan 22, 2015 3:35 pm

Peter Foley wrote:When one first begins RMDs they average very roughly $4000/year per $100,000 for the each of the first 10 years of retirement. If you had space in the 15% tax bracket in the early years you might just fill up the bracket. If a married couple were to take only the minimum for a number of years, as the minimum grows, some couples might find that the RMD pushes them into the 25% bracket.
Would it push them into the 25% tax bracket because RMDs are counted as "income," so that increased RMD amounts would therefore increase "income," which means taxable income is higher, which means taxes are higher? (I'm not a tax wiz :wink: )
Peter Foley wrote: If, with your current RMD you are at $70,000 in taxable income, it may be to your advantage to take out an additional $4,900 to reduce RMDs in future years.
Would it reduce RMDs in future years because there is less money left in the IRA or because the IRS calculation for RMDs is different as time passes?

What about the tax deferring benefit of an IRA? How can we possibly know which is better, taking more out to fill up a tax bracket or leaving it in the IRA to grow tax deferred? It seems like if we take it out to fill up a tax bracket and we put it in a taxable account - it will grow and cause greater taxes down the road.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by ourbrooks » Thu Jan 22, 2015 4:32 pm

The required withdrawal percentage goes up as your life expectancy goes down; the first year it's about 3.65%; when you're 71, it goes up to 3.77%, and so on. Let's suppose that you're in the middle of the 15% bracket for your first withdrawal. You take out more than the required 3.65% Next year, when your rate has gone up to 3.77%, you'll be required to take out less since the 3.77% will be applied to a smaller balance. The effect is a combination of rising percentages and smaller balances.

Is it better to leave the money in and let it grow tax deferred or take it out and avoid later taxes? Hard to say, but the answer may not matter much. If you're at all near the boundary of a tax bracket, then you may not be able to accelerate withdrawals much without knocking yourself into a higher bracket.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by bsteiner » Thu Jan 22, 2015 4:35 pm

ourbrooks wrote:The required withdrawal percentage goes up as your life expectancy goes down; the first year it's about 3.65%; when you're 71, it goes up to 3.77%, and so on. Let's suppose that you're in the middle of the 15% bracket for your first withdrawal. You take out more than the required 3.65% Next year, when your rate has gone up to 3.77%, you'll be required to take out less since the 3.77% will be applied to a smaller balance. The effect is a combination of rising percentages and smaller balances.

Is it better to leave the money in and let it grow tax deferred or take it out and avoid later taxes? Hard to say, but the answer may not matter much. If you're at all near the boundary of a tax bracket, then you may not be able to accelerate withdrawals much without knocking yourself into a higher bracket.
If you're in the 15% bracket, another possibility is to do a Roth conversion up to the top of the 15% bracket (or higher, if that makes sense in the particular case).

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by randomguy » Thu Jan 22, 2015 4:58 pm

bsteiner wrote:
ourbrooks wrote:The required withdrawal percentage goes up as your life expectancy goes down; the first year it's about 3.65%; when you're 71, it goes up to 3.77%, and so on. Let's suppose that you're in the middle of the 15% bracket for your first withdrawal. You take out more than the required 3.65% Next year, when your rate has gone up to 3.77%, you'll be required to take out less since the 3.77% will be applied to a smaller balance. The effect is a combination of rising percentages and smaller balances.

Is it better to leave the money in and let it grow tax deferred or take it out and avoid later taxes? Hard to say, but the answer may not matter much. If you're at all near the boundary of a tax bracket, then you may not be able to accelerate withdrawals much without knocking yourself into a higher bracket.
If you're in the 15% bracket, another possibility is to do a Roth conversion up to the top of the 15% bracket (or higher, if that makes sense in the particular case).
If you are at the boundary, it is likely future RMDS will bump you up to the next bracket. If you are going to be paying 25% in the future, paying 25% now can make sense. It is similiar to the ROTH versus traditional debate. Are you better off investing 100k in a tax deferred account or 75k in a ROTH? If you expect lower taxes in the future (big health care expenses,less income,...) deferring makes sense. If you expect higher taxes (spouse dying so you file as an individual, big increases in income (balance or RMD % increase) it can make sense to bring income forward. Throw in the advantages of being able to undo the ROTH conversion if you don't make money in the next ~22 months and there is a pretty big incentive to convert a lot of money to a ROTH for anyone who is worried about RMDs inflating their tax burden.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by wrongfunds » Thu Jan 22, 2015 5:16 pm

I must be missing something very fundamental here. The couple starts their retirement with approximately $250K in their account and then final account balance is $9.5M (per the last spreadsheet, bottom right cell). First bar chart which talks about 1st 5 years in retirement has top of the line at $2M!

How in the world retirement account is going from $250K to $9.5M while it is being drawn down?

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Leif » Thu Jan 22, 2015 5:19 pm

Last edited by Leif on Thu Jan 22, 2015 8:33 pm, edited 1 time in total.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by bhsince87 » Thu Jan 22, 2015 5:26 pm

I've read the article through 3 times now, and I still don't understand a bunch of it.

The calculation that gives the 50% effective tax rate makes no sense to me at all.
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by wrongfunds » Thu Jan 22, 2015 5:31 pm

Also why are people treating tax bracket as if the entire income gets taxed at the higher rate? Only the income above the bracket amount gets taxed at the higher rate. So if your income goes up by $10K which puts you in to the higher bracket, only the portion of that $10K which goes in to higher bracket gets taxed at the higher rate.

I still want to know how does one start with $250K to come up with $9.5M as a retired couple :-)

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by retiredjg » Thu Jan 22, 2015 5:40 pm

randomguy wrote:Can't read the article since it is behind a pay wall but losing sleep over high RMDs is a waste of time. It means you have money. If your taxes are higher now than when you were working, odds are you are making more money than when you were working. That is a problem you can live with.
Yes, but...

Suppose a couple retires in the 15% bracket which many do. If one dies, the other can easily be pushed into the 25% bracket just by becoming single or even the 28% bracket when RMDs start. Especially if SS is delayed. There is a pretty significant difference in taxes between the 15% bracket and the 25% and 28% bracket.

I do agree there is sometimes too much ado over the RMD issue. But it is worth considering that there are lots of little old ladies and a few little old men out there who may be getting hit with higher taxes than necessary because they did not know this was coming or didn't know what to do about it if they did know it was coming. I'm sure most would have preferred the money to go to heirs or charity than to the governmental coffers.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by cherijoh » Thu Jan 22, 2015 5:41 pm

Beliavsky wrote:
FinancialDave wrote:
Can someone really put a group of high growth dividend paying stocks in an IRA and expect to live off the dividends only
The results are extremely disheartening for those who actually would live to an older age of say 99 (where my study goes.) It seems that over half of that dividend income is eaten up by taxes - at least if my math is correct!
The idea that you need bonds or dividend-paying stocks for "income" does not help you make good investment decisions. What matters is volatility and total return, not whether that return comes from capital gains, dividends, or interest. (In fact, capital gains get better tax treatment.) Companies used to spend much more on dividends than buybacks. That is no longer true. Why should you not own a stock because it chooses to return capital to shareholders in a more tax-efficient way, through buybacks?
Qualified dividends are taxed at the same rate as capital gains. Non-qualified dividends and interest are taxed at your marginal tax rate.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by celia » Thu Jan 22, 2015 5:46 pm

Can someone really put a group of high growth dividend paying stocks in an IRA and expect to live off the dividends only
I can't access the article either, but to me, the simple answer is that it depends on:
1) what your living expenses are (not covered by SS or pensions)
2) the rate of growth in the account and
3) the value of the account.
This is just a basic math problem.

However, in an IRA, there is no distinction between "dividends", long or short term "capital gains", "interest", or anything else. Each dollar in the account or withdrawn will be taxed as ordinary income. There are no dividend or capital gain benefits, so why is that even mentioned?

wrongfunds wrote:I must be missing something very fundamental here. The couple starts their retirement with approximately $250K in their account and then final account balance is $9.5M (per the last spreadsheet, bottom right cell). First bar chart which talks about 1st 5 years in retirement has top of the line at $2M!

How in the world retirement account is going from $250K to $9.5M while it is being drawn down?
As long as you withdraw less than the growth in the account (over the long term), the value of the account will keep growing, won't it? For example, if you withdraw 4% a year from an account that is growing 5% a year, the balance is increasing. (Even more if the difference between the percentages is greater.)
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: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by The Wizard » Thu Jan 22, 2015 5:59 pm

I'm going to read the original article shortly.
But it seems obvious that once you take an RMD and reinvest the proceeds in your taxable account that capital gain and dividend taxation starts to matter increasingly each future year...
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by wrongfunds » Thu Jan 22, 2015 6:06 pm

In 5 years of taking RMD, the first chart shows total income of almost $1.8M!

The numbers are bogus or there is a huge (aka order of magnitude) error in the calculation making this entire article in suspect.

I did read the whole article. It is easy; as hinted, just disable the cookies for that site in your browser.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Peter Foley » Thu Jan 22, 2015 6:36 pm

Miriam2 wrote:
Peter Foley wrote:
When one first begins RMDs they average very roughly $4000/year per $100,000 for the each of the first 10 years of retirement. If you had space in the 15% tax bracket in the early years you might just fill up the bracket. If a married couple were to take only the minimum for a number of years, as the minimum grows, some couples might find that the RMD pushes them into the 25% bracket.

Would it push them into the 25% tax bracket because RMDs are counted as "income," so that increased RMD amounts would therefore increase "income," which means taxable income is higher, which means taxes are higher? (I'm not a tax wiz :wink: ) Yes, this is the issue. Not a big deal if you have 100k in deferred accounts, a big deal if you have 1M.
Peter Foley wrote:
If, with your current RMD you are at $70,000 in taxable income, it may be to your advantage to take out an additional $4,900 to reduce RMDs in future years.

Would it reduce RMDs in future years because there is less money left in the IRA or because the IRS calculation for RMDs is different as time passes? Less money is the bigger isssue. As you get older the distribution period very gradually gets shorter so you have to take out a slightly higher percentage each year.

What about the tax deferring benefit of an IRA? How can we possibly know which is better, taking more out to fill up a tax bracket or leaving it in the IRA to grow tax deferred? It seems like if we take it out to fill up a tax bracket and we put it in a taxable account - it will grow and cause greater taxes down the road.
Miriam2
As pointed out by an earlier poster, your could do Roth conversions of amounts in excess of your RMDs. That would keep the money tax deferred.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by randomguy » Thu Jan 22, 2015 7:03 pm

cherijoh wrote: Qualified dividends are taxed at the same rate as capital gains. Non-qualified dividends and interest are taxed at your marginal tax rate.
Not in an IRA. In there they get taxed just like everything else.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by randomguy » Thu Jan 22, 2015 7:07 pm

retiredjg wrote:
randomguy wrote:Can't read the article since it is behind a pay wall but losing sleep over high RMDs is a waste of time. It means you have money. If your taxes are higher now than when you were working, odds are you are making more money than when you were working. That is a problem you can live with.
Yes, but...

Suppose a couple retires in the 15% bracket which many do. If one dies, the other can easily be pushed into the 25% bracket just by becoming single or even the 28% bracket when RMDs start. Especially if SS is delayed. There is a pretty significant difference in taxes between the 15% bracket and the 25% and 28% bracket.

I do agree there is sometimes too much ado over the RMD issue. But it is worth considering that there are lots of little old ladies and a few little old men out there who may be getting hit with higher taxes than necessary because they did not know this was coming or didn't know what to do about it if they did know it was coming. I'm sure most would have preferred the money to go to heirs or charity than to the governmental coffers.
One dies and your living expenses are cut. Still a win:) The general point is that paying more in taxes is good. It means your making more money. You can try to optimize this number a bit (just sticking bonds in tax deferred and stocks in taxable does a pretty darn good of keeping balances from exploding. A few ROTH conversions early also reduce the size)

As far as going to heirs or charity, they are more than welcome to donate from the IRA to charity and if the money went to an heir, the hier would likely pay more in taxes (they would be doing RMDs on top of salary) so it is just a matter of when uncle sam gets paid.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by FinancialDave » Thu Jan 22, 2015 7:10 pm

randomguy wrote:Can't read the article since it is behind a pay wall but losing sleep over high RMDs is a waste of time. It means you have money. If your taxes are higher now than when you were working, odds are you are making more money than when you were working. That is a problem you can live with.
I understand that getting to the article is a pain, but I would ask you don't try to critique it without reading it.

By the way it is not a pay site it just asks that you register, just like (almost) you have to do to converse here and there are ways around the register process (according to some) if you think it is worthwhile.

fd
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by FinancialDave » Thu Jan 22, 2015 7:20 pm

Beliavsky wrote:
FinancialDave wrote:
Can someone really put a group of high growth dividend paying stocks in an IRA and expect to live off the dividends only
The results are extremely disheartening for those who actually would live to an older age of say 99 (where my study goes.) It seems that over half of that dividend income is eaten up by taxes - at least if my math is correct!
The idea that you need bonds or dividend-paying stocks for "income" does not help you make good investment decisions. What matters is volatility and total return, not whether that return comes from capital gains, dividends, or interest. (In fact, capital gains get better tax treatment.) Companies used to spend much more on dividends than buybacks. That is no longer true. Why should you not own a stock because it chooses to return capital to shareholders in a more tax-efficient way, through buybacks?
Capital gains get exactly the same treatment as Qualified dividends.

I agree completely with your other statements, but the article was not really about that --- though it is a major thorn in the side of those thinking they can only live off the dividend income inside an IRA.

It was more about basically having a "bunch" (you define bunch) of money inside the IRA that you don't plan to spend and want to pass on -- if you live to 99 you may be surprised how much the tax man gets back.

fd
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FinancialDave
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by FinancialDave » Thu Jan 22, 2015 7:29 pm

randomguy wrote:
cherijoh wrote: Qualified dividends are taxed at the same rate as capital gains. Non-qualified dividends and interest are taxed at your marginal tax rate.
Not in an IRA. In there they get taxed just like everything else.
In the article, for those who didn't read it, the investor who wanted to take the RMD's and not spend them, the money ended up in a taxable account, where the qualified dividend rate comes very much into play.

By the way the starting account value was around $244k and it grew to well over a million (in fact in the taxable account "overflow" it was over $7 million), so the 33% tax rate did come into play -- but sorry for those who wanted the 39.6% tax rate -- it was just short of that tax rate by some $50k, which essentially put you there without having to pay the extra taxes.

:beer

fd
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by hulburt1 » Thu Jan 22, 2015 7:47 pm

State tax can hurt. We in Oregon have a 9%. I might move before I hit 70. In Oregon if you make 100000 you would pay $9000 then close to $20000 fed. Bob Brinker says that you should not pay tax's until you have too. Keep your tax money invested. Hope I'm not off topic but I have run the numbers and I'll be in the 25% at 70 but 15% now.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Pizzasteve510 » Thu Jan 22, 2015 7:49 pm

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Carl53
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Carl53 » Thu Jan 22, 2015 7:53 pm

Take a look at the wiki on taxation of social security benefits.
https://www.bogleheads.org/wiki/Taxatio ... y_benefits

From the tables, you will see taxation at rates of up to 46.25%. Large RMDs could put you in that bad spot. We are converting to the top of the 15% bracket prior to taking SS to avoid the higher taxation levels that otherwise we were headed for.

Here is a link to a several year old thread that has some interesting graphics that depict the interaction between RMDs, SS and taxation described in the WIKI. The data presented is a couple of years old but standard deductions and exemptions and brackets have not changed significantly to void the point the graphics make.

viewtopic.php?f=1&t=70229
Note that there are two sets of graphs, one pair for 2010 and one for 2034 (or some date where inflation adjustments have doubled SS, tax brackets, exemptions etc. but the SS taxation threshholds remain unchanged consistent with current tax law).

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by bhsince87 » Thu Jan 22, 2015 8:12 pm

Carl53 wrote:Take a look at the wiki on taxation of social security benefits.
https://www.bogleheads.org/wiki/Taxatio ... y_benefits

From the tables, you will see taxation at rates of up to 46.25%. Large RMDs could put you in that bad spot. We are converting to the top of the 15% bracket prior to taking SS to avoid the higher taxation levels that otherwise we were headed for.

.
Yes, but that's a MARGINAL rate of 46.25%. If it understand it correctly, Dave is coming up with an EFFECTIVE rate of 49.7% somehow.
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by randomguy » Thu Jan 22, 2015 8:35 pm

bhsince87 wrote:
Carl53 wrote:Take a look at the wiki on taxation of social security benefits.
https://www.bogleheads.org/wiki/Taxatio ... y_benefits

From the tables, you will see taxation at rates of up to 46.25%. Large RMDs could put you in that bad spot. We are converting to the top of the 15% bracket prior to taking SS to avoid the higher taxation levels that otherwise we were headed for.

.
Yes, but that's a MARGINAL rate of 46.25%. If it understand it correctly, Dave is coming up with an EFFECTIVE rate of 49.7% somehow.
Large RMDs will blow you right past those 46.25% in SS and back to the normal marginal rates:) Sort of like high enough income solves the amt issue.

I am curious were the tax brackets adjusted for inflation? I don't see how you turn 250k into 8 million without assuming high return (10% nominal is possible. 10% real is really optimistic) and long time period (35+ years). In 35 years at 3% inflation (historical normal) you are talking something like 500k of income to get into the 33% bracket for a single. You need to be like 108 for the RMDs on 1 million to be that big. It also seems unlikely that the account will continue to grow much past 90 (25 years). Once you start taking out 10%+/yr, you account will start to drop in real money.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Sagenick48 » Thu Jan 22, 2015 8:37 pm

Financial Dave

Thank you for a very good article addressing an issue few anticipate.

First, I am still trying to get off the Seeking Alpha mailing list, I registered for the site back when Larry Swedroe was posting there and still get 10 emails a day even though I asked to be removed and have put them in my junk mail/spam folder box. Errgh!!!!

Second, the concern you point out may only apply to the top 20% of the 1%. So most folks don't care. However of that 20% of the 1% there are very few of them who are BHs so they aren't here to hear your cautionary tale.

I agree with what you are saying and two years ago started the process, which will take 5 to 10 years, of addressing the growing tax bracket creep of RMDs which will be afflicting me about the same time that my cognitive abilities to handle my financial affairs will begin to materially decline.

Again thank you for reminding us of this issue and concern which is one of those which will affect those folks many of whom are least able to protect themselves.
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by grabiner » Thu Jan 22, 2015 10:28 pm

I don't see the RMDs themselves as a major tax problem. If you are in a 25% tax bracket, the IRS owns 25% of your IRA, and will take that 25% somehow. If you have a $1.2M traditional IRA, you own $900K of it tax-free.

If the RMDs are more than you need, you can move the money to your taxable account, where it will lose very little to taxes if it is invested in stocks which pay qualified dividends and which your heirs will inherit with a stepped-up basis. Alternatively, you can convert your traditional IRA to a Roth IRA up to the top of the same tax bracket, using the unneeded RMDs to pay the taxes; this will reduce future RMDs.
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by wrongfunds » Fri Jan 23, 2015 10:26 am

wrongfunds wrote:In 5 years of taking RMD, the first chart shows total income of almost $1.8M!

The numbers are bogus or there is a huge (aka order of magnitude) error in the calculation making this entire article in suspect.

I did read the whole article. It is easy; as hinted, just disable the cookies for that site in your browser.
I think this need to be addressed. There is just no way $245K becomes $1.8M in 5 years *after* taking RMD (i.e. reducing the base every year) unless the market returns are astronomical! You have to be doubling your investment every single year for that to happen.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by earlyout » Fri Jan 23, 2015 10:32 am

Sagenick48 wrote:Financial Dave
...
Second, the concern you point out may only apply to the top 20% of the 1%. So most folks don't care. However of that 20% of the 1% there are very few of them who are BHs so they aren't here to hear your cautionary tale.
...
Again thank you for reminding us of this issue and concern which is one of those which will affect those folks many of whom are least able to protect themselves.
Could someone explain this for me? If the top 0.2 % can't take care of themselves, who can?

Thanks.
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by teacher » Fri Jan 23, 2015 12:04 pm

To access the article in a backdoor kind of way, go to:
http://www.bullfax.com/?q=node-survivin ... retirement

Then go to the right top corner and click where it says, "Original article".

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by celia » Fri Jan 23, 2015 1:15 pm

teacher wrote:To access the article in a backdoor kind of way, go to:
http://www.bullfax.com/?q=node-survivin ... retirement

Then go to the right top corner and click where it says, "Original article".
I tried this, but it still requires me to register.

FinancialDave wrote:
randomguy wrote:
cherijoh wrote: Qualified dividends are taxed at the same rate as capital gains. Non-qualified dividends and interest are taxed at your marginal tax rate.
Not in an IRA. In there they get taxed just like everything else.
In the article, for those who didn't read it, the investor who wanted to take the RMD's and not spend them, the money ended up in a taxable account, where the qualified dividend rate comes very much into play.

By the way the starting account value was around $244k and it grew to well over a million (in fact in the taxable account "overflow" it was over $7 million), so the 33% tax rate did come into play -- but sorry for those who wanted the 39.6% tax rate -- it was just short of that tax rate by some $50k, which essentially put you there without having to pay the extra taxes.
grabiner wrote:If the RMDs are more than you need, you can move the money to your taxable account, where it will lose very little to taxes if it is invested in stocks which pay qualified dividends and which your heirs will inherit with a stepped-up basis. Alternatively, you can convert your traditional IRA to a Roth IRA up to the top of the same tax bracket, using the unneeded RMDs to pay the taxes; this will reduce future RMDs.
The underlining in the two above quotes is mine. Again, any withdrawal (taking, moving, transferring, converting) from the traditional IRA is taxed as ordinary income for the year of withdrawal. This amount can become quite large as the value of the account grows AND the percent that must be removed grows each year. I think this is the tax that is being discussed, not the tax on the growth/dividends after it is invested in a taxable account. That will also be taxed, but that is not the big issue I believe we are discussing. [article not read]
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: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Sagenick48 » Fri Jan 23, 2015 5:23 pm

To early out,

My point was a recent article that I read on the Center for Retirement Research of Boston College its title was

How Does Aging Affect Financial Decision Making?

by Keith Jacks Gamble,Patricia A. Boyle,Lei Yu and David A. Bennett.

I would give you a hot link but I am typing this on my ipad and my c&p abilities are next to nil.

The point of the article was that of a very select set of retirees, all college educated, there was a marked decline in their cognitive abilities to handle their financial affairs as they reached age 80 or so. In addition, they didn't think that they were losing any of their abilities.

Investment and other forms of fraud are targeted to the elder. AARP writes about that just about every month. Examples include the phone scams to grandma to send money, or even the harmless and not fraudulent example in the recent
movie "Nebraska"

Most of the BHs are in, or aspire to be in at least the 1%.

My family has a history of dementia. An Ivy League education wouldn't stop that from happening. I will become a vulnerable senior. I will not be able to protect myself. I will not know that it is happening.

Therefore, those least able to protect themselves, will be at risk. The consolation is that (1) I wouldn't know what is happening and (2) all my nursing home costs will, at least under current law and subject to the caps, be deductible.

I treat my son well since he will be picking out my nursing home.

If I am lucky I will be as sharp as Taylor when I am 80, but genetically the odds are against me. It doesn't matter how many dollars you have you can still be a vulnerable adult, taken advantage of by those you trust, without your realizing it.
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by FinancialDave » Fri Jan 23, 2015 6:04 pm

wrongfunds wrote:
I still want to know how does one start with $250K to come up with $9.5M as a retired couple :-)
Because the modern Roth did not come into existence until the tax relief act of 1997, what I am going to say is just an example, but because I have been questioned on how does one get paid dividends of over $2 million and still end up with $9.5 million this is quite easy to explain, though I do not suggest anyone try this --- the purpose of the example I use (of JNJ stock) was to only illustrate two methods of withdrawing money from - in one case dividends only, and the other case from essentially a total return methodology where the investments are sold and money spent.

Note: the $9.5 ending balance was the tax-free Roth example -so if you exclude taxes it goes like this

Dec. 31 1979 the investor buys 3091 shares of JNJ stock -- price then was $79.25 = $244961.75

First stock split is a triple in 1981 --- now has 9273 shares

then 4 more stock splits where the shares double in years 1989, 1992 1996, 2001.

If you want to see this data for yourself here is the link to JNJ div history:

http://www.investor.jnj.com/divhistory.cfm

So ending share balance is now 9273 x2 x2 x2 x2 = 148368 shares.

The above, 148368, times the ending share price of $64.25 on Dec 8, 2009, last day of the study = $9.533 million! Of course if you still had the account today it would be worth over $15 million ($102.2 ending price of JNJ).

Dave
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by wrongfunds » Fri Jan 23, 2015 6:20 pm

Oh I see; you chose JNJ because of that particular timeframe! I was wondering why you did not select say Google or Apple!!

Come on, you know how unrealistic your example is. If you had selected GM, the numbers would be vastly different.

If you had at least picked S&P or Vanguard Index, it would have been at least somewhat realistic.

No BH is going to buy single stock as his retirement investment.

Oh well, why am I the only one who is saying emperor has no clothes?

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by FinancialDave » Fri Jan 23, 2015 6:44 pm

bhsince87 wrote:I've read the article through 3 times now, and I still don't understand a bunch of it.

The calculation that gives the 50% effective tax rate makes no sense to me at all.
Let's start by translating my statement in the article into maybe something that is a little clearer:
The effective tax rate is computed by dividing the total taxes paid by the total income received (Social Security income plus RMD income) for the one account; and dividing the total taxes paid by the Social Security income plus dividend income for the income-only account.
In the strictest sense of the definition of effective tax rate, each investor would have the same effective tax rate because with the same balance they are forced to withdraw the same amount, but what I wanted to do was compare tax rates on what each investor considered their "spendable income." So looking at the second half of the sentence in the second case I am using the lessor amount - DIVIDEND ONLY income, not the full RMD withdrawal.

So knowing the above and focusing on the first two bar charts that show the tax and income components separately the explanation goes something like this:

The person who decides they are going to limit their spendable income to dividends only and put the excess in the taxable account, maybe by doing a direct transfer of the JNJ shares (doesn't really matter, taxes still must be paid on them) has a much higher proportionate tax burden on their "spendable income." Furthermore you might notice in the later years, the taxes paid by this investor are even greater than the RMD strategy investor because they are now paying taxes on even the qualified dividends.

Hope that helps.

Hope some were not offended by my "redefinition" of effective tax rate -- maybe I just should have called it something else??

Dave
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by livesoft » Fri Jan 23, 2015 6:48 pm

wrongfunds wrote:Oh I see; you chose JNJ because of that particular timeframe! I was wondering why you did not select say Google or Apple!!
I thought he picked JNJ because he used to work for JNJ.
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by FinancialDave » Fri Jan 23, 2015 6:59 pm

wrongfunds wrote:Also why are people treating tax bracket as if the entire income gets taxed at the higher rate? Only the income above the bracket amount gets taxed at the higher rate. So if your income goes up by $10K which puts you in to the higher bracket, only the portion of that $10K which goes in to higher bracket gets taxed at the higher rate.
I don't know about other people but in my article I built a very elaborate table that calculated the actual tax in each bracket and added them up each year for the total I used. I also inflated the tax brackets by 2% each year to give them some reality. So for example in year 30 of the study the top end of the 28% tax bracket was almost $403,000. The taxes on the qualified dividends in the taxable account were much easier - they were either zero or 15% based on the marginal tax bracket of the investors income.

fd
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Christine_NM » Fri Jan 23, 2015 7:57 pm

Hi fd -

Could only read the first page before the Register popup appeared and the second page faded out. Can you not make the article easily accessible? I am not going to screw up my browser just because Seeking Alpha is too aggressive about collecting email addresses.

Please don't frighten old folks into doing something they need not do, or make them regret decisions that can't be changed now.

My mind just turns off with that kind of tax-horror language. I know my situation and I deal with it. I have been investing for retirement since the 70's.

It was always obvious to me that it is possible to either overpay or underpay taxes during working years, so one should neither avoid tax-deferred accounts nor neglect taxable accounts. I didn't always contribute to my TIRA and never maxed out my 401(k). I am very glad that my taxable account ended up larger than my tax-deferred IRA (which is 401k+traditional IRA).
17% cash 47% stock 36% bond. Retired, w/d rate 2.85%

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by FinancialDave » Fri Jan 23, 2015 8:05 pm

wrongfunds wrote:Oh I see; you chose JNJ because of that particular timeframe! I was wondering why you did not select say Google or Apple!!

Come on, you know how unrealistic your example is. If you had selected GM, the numbers would be vastly different.

If you had at least picked S&P or Vanguard Index, it would have been at least somewhat realistic.

No BH is going to buy single stock as his retirement investment.
All of what you say is pretty much true, but before you ride through the street declaring something that has nothing to do with the point, consider what is the point (which of course I realize I could have made clearer - but you are helping me with that :happy :

One investment that can simulate two variables for two different types of investors that are sometimes at odds against each other (both the variables and the investors!) These variables are dividend income and total return. Now I don't want a big discussion on the merits of one vs the other as we have had many of these, but if you read through my other 5 articles leading up to this (each article has a link to the previous) you will notice the story has been developing between these two investors, who in one article I called Mr. TR and Mr. IO (total return, or income only) . If you like stories you can check it out:

http://seekingalpha.com/article/2791855 ... tal-return

Back to the portfolio characteristic I was looking for --- one investment with good total return growth and also a good long term dividend profile -- a type of profile that might be representative of the growth (for the total return investor) or the dividend income (for the dividend investor.) JNJ fills BOTH of these characteristics -- beyond that my criteria was also to use absolute REAL market data on whatever investments I choose - this has been one of my complaints of other articles, that they just splice together 10 years of data or simulate something that grows at a constant CAGR of 8% and call that good. This later criteria is the reason I only wanted to use ONE stock. While I could use a mutual fund, most fall a little short on the dividend income range of things and very few actually existed back in 1980 with the two characteristics I mentioned. Most dividend investors like very much if their dividend income increases every year with a yield of 2-3%, most TR investors are very happy if their total returns beat the SP500 index - this one investment does BOTH of these things. The only drawback, which does make the simulation unrealistic is the fact that JNJ over these 30 years has trounced the SP500. In fact the numbers over the range of my study go something like this - VFINX 10.7%, JNJ 15.4%. So I give you the fact, that an index or even a diversified stock portfolio would "tone down" the growth of this example, but if you don't like the totals just cut them in half - or you choose. If you want try doing this with 10 stocks. I don't have that much time and to be honest I have used JNJ in most of my examples, so I have real data going back to 1972. Previously I published data on 3 start dates for JNJ and compared the results (1973, 1975, 1980) -- '73 & '75 were two classic years to show how sequence of returns risks affects you -- as it turns out the data I used was sort of the "middle of the road example of portfolio growth - I could have chose lessor or greater total return growth - but admittedly still high by most standards -- but it is "comparable" to much of my other work, and I didn't have to "reinvent the wheel" as many Engineers like to say.

So if it makes you feel better, call the investment "XYZ Super Mutual Fund" that pays a 2-3% dividend and has a CAGR over the last 30 years of 15.4% and sign me up for it!

Hopefully that explains the why of the JNJ and the timeframe - it was not to get any particular "super result" but to compare two strategies - total return and dividends only -- and not to imply that either is good or bad, but let you contrast the results for yourself.

:sharebeer

fd
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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by randomguy » Fri Jan 23, 2015 9:15 pm

FinancialDave wrote:In fact the numbers over the range of my study go something like this - VFINX 10.7%, JNJ 15.4%. So I give you the fact, that an index or even a diversified stock portfolio would "tone down" the growth of this example, but if you don't like the totals just cut them in half - or you choose.

fd
how much money will be in the account with different returns in 30 years

10%:4.3million
15%: 16 million
20% (Hey someone bough microsoft when it went public): 59 million

Cut your numbers by 75% and how much do RMDs matter (note the account balances would be about half with RMDs)? What about if you put any bonds in there and only make 8%. Getting 15% isn't impossible. But it isn't very likely. Planning for that case doesn't seem to be very useful.

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Re: Surviving the Tax Bite of RMD Withdrawals in Retirement

Post by Christine_NM » Fri Jan 23, 2015 9:21 pm

Dave -

You might want to gin up a chart of AAPL and JNJ 1981-present. JNJ is good but not that great. Sorry, I know that distracts from your point, but since I really don't get your point I wander off into distractions.

Any chance on another source for that article? You can say no, but please at least answer the question.
17% cash 47% stock 36% bond. Retired, w/d rate 2.85%

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