Why ORP-I suggests you spending down aft-tax saving 1st?

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WhiteMaxima
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Why ORP-I suggests you spending down aft-tax saving 1st?

Post by WhiteMaxima » Tue Dec 05, 2017 2:06 pm

To me , it seems good to spend down tax-deferred to reduce the future RMD. Plus Roth conversion if the total withdraw plus conversion is below certain tax bracket. Leave aft-tax asset alone for emergency or some other purpose.

Chuck
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by Chuck » Tue Dec 05, 2017 2:12 pm

ORP probably wants to keep your tax-deferred/tax-free accounts growing in a tax-deferred/tax-free manner.

livesoft
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by livesoft » Tue Dec 05, 2017 2:14 pm

I think ORP will try to keep the account that you have said will have the highest return the longest. So be sure to tell ORP that all your accounts will have the same expected annualized return.
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user5027
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by user5027 » Tue Dec 05, 2017 3:32 pm

If gains are involved, selling and spending down taxable investments in low income years before pensions, social security and/or rmd's kick in could incur lower capital gains tax.

smitcat
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by smitcat » Tue Dec 05, 2017 3:36 pm

livesoft wrote:
Tue Dec 05, 2017 2:14 pm
I think ORP will try to keep the account that you have said will have the highest return the longest. So be sure to tell ORP that all your accounts will have the same expected annualized return.
This is very likely the answer - folks set up these calculators with various income %'s and then they wonder why they are putting out data telling them to spend one accounts first or take SS a certain year.
They are calculators so if you tell them that tax deferred earns more than after tax it will protect that account over time.
Same when making choices for Roth conversions and when to take SS.

The Wizard
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by The Wizard » Tue Dec 05, 2017 3:52 pm

The correct reason that i-ORP does this is to free up space to do Roth conversions early in retirement.
Say you have $400k in your taxable account and want $60k per year. Then take $60k from taxable for 6 or 7 years and do Roth conversions of at least $60k each year to get that money totally sheltered.
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WhiteMaxima
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by WhiteMaxima » Tue Dec 05, 2017 4:04 pm

So it is necessary to have aft-tax account to cover the expense while doing the Roth conversion. From this point of view, pre-pay mortgage will reduce the aft-tax asset. Let say someone choose to take SS at 70.5. Let say he will 80k need for living expense. He is now X years old. So he would need (70-X) *80k saved in secure aft-account (50/50 AA presume). Roth covert to the target maginal rate.

munemaker
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by munemaker » Tue Dec 05, 2017 4:18 pm

WhiteMaxima wrote:
Tue Dec 05, 2017 2:06 pm
To me , it seems good to spend down tax-deferred to reduce the future RMD. Plus Roth conversion if the total withdraw plus conversion is below certain tax bracket. Leave aft-tax asset alone for emergency or some other purpose.
The advantage of tax deferred is the money you would have spent on taxes continues to compound and grow. You generally want to spend your taxable money first, and let the tax deferred and tax free grow as long as possible.

To reduce the RMD, you make Roth conversions and pay the taxes with your after-tax account.

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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by The Wizard » Tue Dec 05, 2017 4:24 pm

WhiteMaxima wrote:
Tue Dec 05, 2017 4:04 pm
So it is necessary to have aft-tax account to cover the expense while doing the Roth conversion. From this point of view, pre-pay mortgage will reduce the aft-tax asset. Let say someone choose to take SS at 70.5. Let say he will 80k need for living expense. He is now X years old. So he would need (70-X) *80k saved in secure aft-account (50/50 AA presume). Roth covert to the target maginal rate.
No it's not "necessary".
Having a large taxable account simply allows much more to be Roth converted while keeping AGI level to increasing slightly each year to mid 70s.

I, for example, had essentially zero taxable account at start of retirement in 2013. So I do rather modest Roth conversions each year in the 28% bracket, on top of regular income from tax-deferred...
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randomguy
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by randomguy » Tue Dec 05, 2017 6:23 pm

munemaker wrote:
Tue Dec 05, 2017 4:18 pm
WhiteMaxima wrote:
Tue Dec 05, 2017 2:06 pm
To me , it seems good to spend down tax-deferred to reduce the future RMD. Plus Roth conversion if the total withdraw plus conversion is below certain tax bracket. Leave aft-tax asset alone for emergency or some other purpose.
The advantage of tax deferred is the money you would have spent on taxes continues to compound and grow. You generally want to spend your taxable money first, and let the tax deferred and tax free grow as long as possible.

To reduce the RMD, you make Roth conversions and pay the taxes with your after-tax account.
You generally want to spend your money in the way that gives you the maximal amount of spendable money. That is rarely selling taxable first. It is also rarely selling taxable deferred first. In general it is some blend between both taxable and tax deferred that depends on current and future income expectations.

I agree with other people in that you have to make sure the returns are the same in all the accounts (same AA and expected returns) or i-ORP will just resort to spending the account with the lowest return first in most cases. I have made that mistake more than once:)
Last edited by randomguy on Tue Dec 05, 2017 8:26 pm, edited 1 time in total.

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David Jay
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by David Jay » Tue Dec 05, 2017 6:46 pm

WhiteMaxima wrote:
Tue Dec 05, 2017 4:04 pm
Let say someone choose to take SS at 70.5
Then he has lost 6 months worth of SS payments - there is no benefit to delay past age 70
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smitcat
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by smitcat » Tue Dec 05, 2017 7:29 pm

WhiteMaxima wrote:
Tue Dec 05, 2017 4:04 pm
So it is necessary to have aft-tax account to cover the expense while doing the Roth conversion. From this point of view, pre-pay mortgage will reduce the aft-tax asset. Let say someone choose to take SS at 70.5. Let say he will 80k need for living expense. He is now X years old. So he would need (70-X) *80k saved in secure aft-account (50/50 AA presume). Roth covert to the target maginal rate.
Perhaps read this and review the charts for some thoughts....
https://www.kitces.com/blog/tax-efficie ... ing-needs/

munemaker
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by munemaker » Tue Dec 05, 2017 7:32 pm

randomguy wrote:
Tue Dec 05, 2017 6:23 pm


You generally want to spend your money in the way that gives you the maximal amount of spendable money. That is rarely selling taxable first. It is also rarely selling taxable first. In general it is some blend between both taxable and tax deferred that depends on current and future income expectations.
Not sure where you are getting your information.

Working with BigFoot's spreadsheet and iOrp, spending the taxable first while making heavy Roth conversions gave me the best results, and I experimented with it quite a bit.

Here's some supporting information:
If you have any of your retirement savings invested in an ordinary, taxable brokerage account, you should use this money first in retirement. By doing this, you allow the money you have saved in your tax-advantaged accounts to continue to grow on a tax-deferred or tax-free basis as you spend the money that is subject to capital gains and dividend taxes.
reference: https://www.fool.com/retirement/general ... first.aspx

randomguy
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by randomguy » Tue Dec 05, 2017 7:52 pm

munemaker wrote:
Tue Dec 05, 2017 7:32 pm

If you have any of your retirement savings invested in an ordinary, taxable brokerage account, you should use this money first in retirement. By doing this, you allow the money you have saved in your tax-advantaged accounts to continue to grow on a tax-deferred or tax-free basis as you spend the money that is subject to capital gains and dividend taxes.
reference: https://www.fool.com/retirement/general ... first.aspx
Run the math on
a) 150k LTGC for 10 years, 150k of OI for 10 years
and compare it to
b) 75k of LTGC/75k of OI for 20 years.

The graduated tax system we have today favores b over a.

Obviously your spendable income isn't quite the same but it doesn't help a to look any better. And of course if you are lucky that tax defer will result in you having 300k RMDS.:) You don't want to waste the 0%/10% income brackets on LTGC when you can be filling them up with OI. It is hard to overcome the graduated tax system.

smitcat
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by smitcat » Tue Dec 05, 2017 8:16 pm

munemaker wrote:
Tue Dec 05, 2017 7:32 pm
randomguy wrote:
Tue Dec 05, 2017 6:23 pm


You generally want to spend your money in the way that gives you the maximal amount of spendable money. That is rarely selling taxable first. It is also rarely selling taxable first. In general it is some blend between both taxable and tax deferred that depends on current and future income expectations.
Not sure where you are getting your information.

Working with BigFoot's spreadsheet and iOrp, spending the taxable first while making heavy Roth conversions gave me the best results, and I experimented with it quite a bit.

Here's some supporting information:
If you have any of your retirement savings invested in an ordinary, taxable brokerage account, you should use this money first in retirement. By doing this, you allow the money you have saved in your tax-advantaged accounts to continue to grow on a tax-deferred or tax-free basis as you spend the money that is subject to capital gains and dividend taxes.
reference: https://www.fool.com/retirement/general ... first.aspx

Yes, agreed - I see significant gains following your model with RPM.
We end up with about 9% higher spendable dollars over the lifetime and equally but lower gains over shorter periods.
It is important to note that spendable dollars are different than the totals in each account at any one point in time.
With modeling It is also possible to increase your tax deferred accounts higher still but generate tax liabilities that are not yet realized.
Of course modeling different rates of returns and various ages of demise for each partner will also be eye opening with 'spendable' dollars.

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Peter Foley
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by Peter Foley » Tue Dec 05, 2017 10:04 pm

munemaker wrote:
Working with BigFoot's spreadsheet and iOrp, spending the taxable first while making heavy Roth conversions gave me the best results, and I experimented with it quite a bit.
I've commented on both the RPM and I-ORP calculators before. I have run a number of scenarios in both programs and would agree with munemaker's statement.

I also concluded that the ratio of one's tax deferred savings to taxable savings was a significant factor. Generally speaking, the higher the ratio of tax deferred to taxable the more beneficial the Roth conversions were.

I understood randomguy's comment differently. I understood it to mean be conscious of your current and future tax brackets. It has been often commented here that filling the 15% tax bracket makes a lot of sense when SS and RMD's later in retirement ensure one that he/she will be in the 25% bracket or higher.
Last edited by Peter Foley on Wed Dec 06, 2017 4:39 pm, edited 1 time in total.

randomguy
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by randomguy » Wed Dec 06, 2017 1:12 am

Peter Foley wrote:
Tue Dec 05, 2017 10:04 pm
munemaker wrote:
Working with BigFoot's spreadsheet and iOrp, spending the taxable first while making heavy Roth conversions gave me the best results, and I experimented with it quite a bit.
I've commented on both the RMP and I-ORP calculators before. I have run a number of scenarios in both programs and would agree with munemaker's statement.

I also concluded that the ratio of one's tax deferred savings to taxable savings was a significant factor. Generally speaking, the higher the ratio of tax deferred to taxable the more beneficial the Roth conversions were.

I understood randomguy's comment differently. I understood it to mean be conscious of your current and future tax brackets. It has been often commented here that filling the 15% tax bracket makes a lot of sense when SS and RMD's later in retirement ensure one that he/she will be in the 25% bracket or higher.
Doing roth conversions is a way to spend down tax deferred which is exactly what I stated is the optimal path. You are just choosing to put the money in a ROTH instead of taxable.

Roth conversions have the same math as picking which one to put your money in in the first place. You need to guess if your tax rates will be lower or higher in the future and pick which one works. Now figuring out those rates is hard with SS taxation, Medicare, and the potential lose of spouse.

The benefit of tax deferral drops a lot when you are spending the money:)

2comma
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by 2comma » Wed Dec 06, 2017 1:32 am

Could someone tell me what OI and RMP stand for?

Ok, I'm guessing OI is ordinary income...
If I am stupid I will pay.

smitcat
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by smitcat » Wed Dec 06, 2017 10:01 am

randomguy wrote:
Wed Dec 06, 2017 1:12 am
Peter Foley wrote:
Tue Dec 05, 2017 10:04 pm
munemaker wrote:
Working with BigFoot's spreadsheet and iOrp, spending the taxable first while making heavy Roth conversions gave me the best results, and I experimented with it quite a bit.
I've commented on both the RMP and I-ORP calculators before. I have run a number of scenarios in both programs and would agree with munemaker's statement.

I also concluded that the ratio of one's tax deferred savings to taxable savings was a significant factor. Generally speaking, the higher the ratio of tax deferred to taxable the more beneficial the Roth conversions were.

I understood randomguy's comment differently. I understood it to mean be conscious of your current and future tax brackets. It has been often commented here that filling the 15% tax bracket makes a lot of sense when SS and RMD's later in retirement ensure one that he/she will be in the 25% bracket or higher.
Doing roth conversions is a way to spend down tax deferred which is exactly what I stated is the optimal path. You are just choosing to put the money in a ROTH instead of taxable.

Roth conversions have the same math as picking which one to put your money in in the first place. You need to guess if your tax rates will be lower or higher in the future and pick which one works. Now figuring out those rates is hard with SS taxation, Medicare, and the potential lose of spouse.

The benefit of tax deferral drops a lot when you are spending the money:)
Yes agreed - but the benefits are more easily seen when you move from a higher tax state to a lower tax state when utilizing the funds. Most of our 401K went in with a marginal deduction at 6.65% or more state and 35% or more Fed - about 42%.
Easier to figure out the spending strategy with those differences to work with.

smitcat
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by smitcat » Wed Dec 06, 2017 10:04 am

2comma wrote:
Wed Dec 06, 2017 1:32 am
Could someone tell me what OI and RMP stand for?

Ok, I'm guessing OI is ordinary income...
RPM - a spreadsheet calculator developed by a sharing bogle that we find to be really great tool.
It is a little difficult to load and get correct but IMO is very much worth it as it can supply all kinds of good inputs for planning.
Thank you Bigfoot...

https://www.bogleheads.org/wiki/Retiree_Portfolio_Model

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Peter Foley
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by Peter Foley » Thu Dec 07, 2017 11:59 am

randomguy wrote:
I agree with other people in that you have to make sure the returns are the same in all the accounts (same AA and expected returns) or i-ORP will just resort to spending the account with the lowest return first in most cases. I have made that mistake more than once:)
I have struggled with this myself when running scenarios. I understand that in theory making the returns the same in accounts makes for a better comparison. But how does one then take into account the common practice of holding most bonds in tax deferred and holding mostly, if not exclusively, stocks in a Roth? Our tax deferred accounts are about 40/60 and our Roths are 100/0. Together they approximately achieve the our 50/50 AA goal.

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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by 2pedals » Thu Dec 07, 2017 12:20 pm

Peter Foley wrote:
Thu Dec 07, 2017 11:59 am
randomguy wrote:
I agree with other people in that you have to make sure the returns are the same in all the accounts (same AA and expected returns) or i-ORP will just resort to spending the account with the lowest return first in most cases. I have made that mistake more than once:)
I have struggled with this myself when running scenarios. I understand that in theory making the returns the same in accounts makes for a better comparison. But how does one then take into account the common practice of holding most bonds in tax deferred and holding mostly, if not exclusively, stocks in a Roth? Our tax deferred accounts are about 40/60 and our Roths are 100/0. Together they approximately achieve the our 50/50 AA goal.
Since most investors look to use an overall AA to limit taxes, I-ORP should have a way to use a overall AA not an overriding individual AA for each account. I-ORP could then attempt to optimize the AA within each account type.

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TimeRunner
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by TimeRunner » Thu Dec 07, 2017 12:34 pm

I'm confused by this thread.

You would set the AA the same in each account if you didn't want I-ORP to spend money from the account that had the lowest returns first, and you just wanted to see what the recommendation would be if the AA is the same.

But most people don't have the same AA in each account, therefore optimizing spending would need to account for the AA in order to optimize spending. Ultimately that's what you want.

There's no conflict here that I see. I would enable Roth IRA Conversions, and consider capping the tax bracket to stay out of highest brackets. Set the AA the same if you want to see recommendations without regard to AA across your accounts, then set AA to actual if you want to see optimized spending based on your actual AA.

I would think this approach would work for most people; of course there's always edge cases.
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by smitcat » Thu Dec 07, 2017 12:47 pm

TimeRunner wrote:
Thu Dec 07, 2017 12:34 pm
I'm confused by this thread.

You would set the AA the same in each account if you didn't want I-ORP to spend money from the account that had the lowest returns first, and you just wanted to see what the recommendation would be if the AA is the same.

But most people don't have the same AA in each account, therefore optimizing spending would need to account for the AA in order to optimize spending. Ultimately that's what you want.

There's no conflict here that I see. I would enable Roth IRA Conversions, and consider capping the tax bracket to stay out of highest brackets. Set the AA the same if you want to see recommendations without regard to AA across your accounts, then set AA to actual if you want to see optimized spending based on your actual AA.

I would think this approach would work for most people; of course there's always edge cases.
Yes - agreed on all. Plus that fact that the real returns by both market type and AA in each account will not be close to the flat xx% you have previously loaded into the calculator so each year you will adjust the inputs and re-run getting an updated plan.
Best fit plan will be updated each year, overall strategy will be closer than the actual details.

2pedals
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by 2pedals » Thu Dec 07, 2017 1:11 pm

TimeRunner wrote:
Thu Dec 07, 2017 12:34 pm
I'm confused by this thread.

You would set the AA the same in each account if you didn't want I-ORP to spend money from the account that had the lowest returns first, and you just wanted to see what the recommendation would be if the AA is the same.
agreed
TimeRunner wrote:
Thu Dec 07, 2017 12:34 pm
But most people don't have the same AA in each account, therefore optimizing spending would need to account for the AA in order to optimize spending. Ultimately that's what you want.
yes most people don't have the same AA in each account. Over the years I-ORP will grow each account based on the AA so the overall AA will change overtime and favor taking money from the low growth account. That is not what I want. I want to take money, grow and re-balance to get my overall AA.
TimeRunner wrote:
Thu Dec 07, 2017 12:34 pm
There's no conflict here that I see. I would enable Roth IRA Conversions, and consider capping the tax bracket to stay out of highest brackets. Set the AA the same if you want to see recommendations without regard to AA across your accounts, then set AA to actual if you want to see optimized spending based on your actual AA.

I would think this approach would work for most people; of course there's always edge cases.
Some possible issues with that two model approach that I see are:
I believe the first model would disfavor Roth conversions if your stock AA are actually higher in the taxable accounts or tax deferred accounts.
I believe the second model would create a higher overall AA due to growth of the account with the highest AA, favoring to take money from the low stock AA.

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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by CnC » Thu Dec 07, 2017 2:27 pm

Well one good thing about selling taxable first is that you can potentially keep your agi under 15% and pay no long term capital gains.

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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by smitcat » Thu Dec 07, 2017 3:11 pm

TimeRunner wrote:
Thu Dec 07, 2017 12:34 pm
There's no conflict here that I see. I would enable Roth IRA Conversions, and consider capping the tax bracket to stay out of highest brackets. Set the AA the same if you want to see recommendations without regard to AA across your accounts, then set AA to actual if you want to see optimized spending based on your actual AA.

I would think this approach would work for most people; of course there's always edge cases.
Some possible issues with that two model approach that I see are:
I believe the first model would disfavor Roth conversions if your stock AA are actually higher in the taxable accounts or tax deferred accounts.
I believe the second model would create a higher overall AA due to growth of the account with the highest AA, favoring to take money from the low stock AA.
[/quote]

We use the IORP to narrow down the options quickly and then populate the RPM to do details like the Roth decisions.
The RPM will give you a great comparison between base and full Roth conversions on the same page.
The RPM takes longer to understand and to load so best to learn on the IORP for the easier stuff.

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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by randomguy » Thu Dec 07, 2017 3:17 pm

2pedals wrote:
Thu Dec 07, 2017 1:11 pm
TimeRunner wrote:
Thu Dec 07, 2017 12:34 pm
I'm confused by this thread.

You would set the AA the same in each account if you didn't want I-ORP to spend money from the account that had the lowest returns first, and you just wanted to see what the recommendation would be if the AA is the same.
agreed
TimeRunner wrote:
Thu Dec 07, 2017 12:34 pm
But most people don't have the same AA in each account, therefore optimizing spending would need to account for the AA in order to optimize spending. Ultimately that's what you want.
yes most people don't have the same AA in each account. Over the years I-ORP will grow each account based on the AA so the overall AA will change overtime and favor taking money from the low growth account. That is not what I want. I want to take money, grow and re-balance to get my overall AA.

Yep that is the problem. If you are 100% stocks in the ROTH and 100% bonds in the IRA and the stock returns are 10% and bonds are 3%, it is worthwhile to pay a ton of taxes to get the money into the ROTH ASAP. The obviously issue is your risk goes way up as you go from a quasi 50/50 allocation to a 100% stocks.

If they had an option to maintain an overall AA while saying where to put higher return assets, you would run into the issue of how to account for different (i.e. do you discount the tax deferred by 24% and taxable by 10%?) value of money in each account.

In the end you have to remember you can't really optimize this problem. There are too many unknowns. If stocks return 15% for the next 20 years, you would make different choices than if they return 5. Or if the market is going to crash and stay down for 10 years. i-Orp gets you in the rough ballpark (and it is a great tool) and you just have to accept that you can't get accurate to the nearest thousand dollars.

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TimeRunner
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by TimeRunner » Thu Dec 07, 2017 3:31 pm

Also, you really need to run I-ORP every year to see current year recommendations, and if your AA changed from previous year, you would either put in the new resulting AA numbers or you would rebalance your accounts as needed to get back to your desired AA and then run I-ORP.
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Re: Why ORP-I suggests you spending down aft-tax saving 1st?

Post by gneeby » Fri Dec 08, 2017 10:18 am

2pedals wrote:
Thu Dec 07, 2017 12:20 pm
Peter Foley wrote:
Thu Dec 07, 2017 11:59 am
randomguy wrote:

Since most investors look to use an overall AA to limit taxes, I-ORP should have a way to use a overall AA not an overriding individual AA for each account. I-ORP could then attempt to optimize the AA within each account type.
This suggestion has been explored and it didn't work out at all well. The big problem is that ORP makes withdrawals based on multiple factors, not just solely on asset returns. These factors include taxes, the RMD, and down stream requirements for funds. Thus, overall AA gets out of whack very quickly and trying to enforce overall AA makes the model go infeasible.

This worthy suggestion needs a clearer definition of what overall AA looks like.

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