Decumulation Sequencing

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willyd123
Posts: 36
Joined: Mon Feb 19, 2018 7:23 am

Decumulation Sequencing

Post by willyd123 » Sun Jul 22, 2018 8:03 am

Bogleheads:

Situation:
Age 56, Spouse 53
Plan to retire 2019
After Tax Assets: $4.3 mil
Retirement Assets: $1.6 mil
Roth Assets: $140K
Home Equity: $1.0 mil
No debt.
Typically earn about $55K annually in dividends ($50,000 are qualified) from mutual funds and individual stocks on which I have to pay taxes. Receive $12,000 in taxable pension income annually, And have about $4,400 in taxable interest and $8,400 in non-taxable interest. I suspect all of this income to be pretty consistent going forward.
Plan to commence Soc Sec at age 70 and 67, myself and wife, respectively.

Question: I have read that I should consider doing Roth conversions beginning after I retire up through the point I have to commence RMDs in 2032 when I turn 70 1/2 (God willing!) to reduce the RMDs and to reduce overall taxes so I thought I should test this.

According to Dinkytown.net's tax calculator, I would owe zero in Federal taxes with $55,000 in dividends, $12,000 in pension income, $4,400 in taxable income and $8,400 in non-taxable interest (I live in a no income tax state). If I took an early distribution from an IRA of $25,000, I'd owe $2,307 (9% of the IRA distribution) in Federal taxes, if I took $50,000, I'd owe $8,337 (16.7%), if I took $75,000, I'd owe $15,087 (20%), if I took $100,000, I'd owe $20,807 (21%) and if I took $150,000, I'd owe $31,807 (21.2%). The new tax rates are pretty bunched between $77,400 and $315,000 in taxable income where the marginal rates are 22% and 24% so for distributions above $150,000 are taxes at similar rates.

If I look at the RMD tables, the factor I would use is 27.4 so with $1.6 mil, my RMD distribution would be $58,394 in today's dollars if I waited until 2032 to dip into my IRA with my RMD. So my question is does it really make sense for me to do Roth conversions of more than maybe $50,000 between the time I retire and when I turn 70 1/2 or should I not bother? I suppose doing Roth conversions would help mitigate the risk of tax rates going up which is certainly possible.

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dwickenh
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Location: Illinois

Re: Decumulation Sequencing

Post by dwickenh » Sun Jul 22, 2018 8:36 am

You have a complicated question that will require assistance from complex calculations available at I-orp. Try plugging your numbers into the

model including possible conversions. Unless they update the brkts for SS being taxable(very unlikely), you will be hit hard on taxes at RMD time.

https://www.i-orp.com/GuarInc/extended.html

Try out this free planner and see if it helps.

Best to you,

Dan
The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” | — Warren Buffett

willift
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Re: Decumulation Sequencing

Post by willift » Sun Jul 22, 2018 8:42 am

One of the things that I think needs to be considered concerning RMDs and the taxes associated with them is the likelihood that a number of couples Married Filing Jointly today will be unfortunately Widowed/Widowers filing Single by the time RMDs kick in. The tax consequences of that life event change seems to be dismissed or ignored in a lot of these discussions. Your brackets obviously change, the tax rate increases and most likely the Qualified Dividends taxed like Capital Gains at 0% start to drift into the 15% tax area.

I'm not sure I follow my own thoughts because my wife hates to pay any taxes before they are due and her financial savvy and saving ethics got us to this point. We are definitely "Kick the Can Down the Roaders"

Anybody else see the impact of the eventual Single Taxpayer tax trap?

Chip
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Re: Decumulation Sequencing

Post by Chip » Sun Jul 22, 2018 8:50 am

Your current income profile puts you close to the "phantom" 27% bracket. That is, once your taxable income reaches the 77,200 limit for 0% QDI/LTCG tax rates, any additional ordinary income (such as Roth conversions) will by itself be taxed at 12%, PLUS it will cause an equal amount of QDI/LTCG to be taxed at 15%. 12+15=27. This rate continues until you have taxable ordinary income over 77,200. At that point your marginal tax rate drops to 22% for ordinary income until you exceed the limits for that bracket. All of your QDI/LTCG will be taxed at 15% while in the 22% bracket.

I've never reviewed the Dinkytown calculator so I don't know how accurate it is. You should verify it.

In addition to what your joint tax return at age 70.5 will look like, consider what sort of tax rates the survivor might face when one of you passes. Also consider that if one of you should need long term care the associated medical deductions could substantially reduce your tax rate. Plus, as you mention, there is a chance tax rates will go up. In fact, it's the law that current rates will revert in 2025. And don't forget about Medicare income-related premium adjustments (IRMAA). Your tax returns starting at age 63 will affect them.

I think it's a no-brainer for you to convert up to the beginning of that phantom 27% bracket. But that won't be a lot in the way of conversions. Above that it's more of a guess. But if you do convert into that bracket you should probably blow through it in any given year and convert at least to the top of the 22% bracket.

There have been many previous discussions on these issues. A search should turn up some of them.

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#Cruncher
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Re: Decumulation Sequencing

Post by #Cruncher » Sun Jul 22, 2018 4:01 pm

Chip wrote:
Sun Jul 22, 2018 8:50 am
I think it's a no-brainer for you to convert up to the beginning of that phantom 27% bracket.
I agree except that I'd say "marginal 27% rate" instead of "phantom 27% bracket". There is nothing phantom about this; it's real money the tax man takes out of your pocket. Using the figures from the original post, the 27% marginal rate would apply to Roth conversions from $29,800 to $79,800, as shown in columns 4 and 5 of the following table:

Code: Select all

Floor: 10% ord income bracket          0  --------------------------------------------------->
Floor: 12% ord income bracket     19,050  --------------------------------------------------->
Floor: 22% ord income bracket     77,400  --------------------------------------------------->
Floor: 24% ord income bracket    165,000  --------------------------------------------------->
Floor:  0% LTCG & QDI bracket          0  --------------------------------------------------->
Floor: 15% LTCG & QDI bracket     77,200  --------------------------------------------------->
                                   Col 1    Col 2    Col 3    Col 4    Col 5    Col 6    Col 7

Code: Select all

Roth conversions                      -     2,600   21,650   29,800   79,800   80,000  167,600 
Other ordinary income             21,400   21,400   21,400   21,400   21,400   21,400   21,400
LTCG & QDI                        50,000   50,000   50,000   50,000   50,000   50,000   50,000
Adjusted gross income             71,400   74,000   93,050  101,200  151,200  151,400  239,000
Deductions plus Exemptions        24,000   24,000   24,000   24,000   24,000   24,000   24,000
Taxable Income                    47,400   50,000   69,050   77,200  127,200  127,400  215,000
LTCG & QDI Taxable                47,400   50,000   50,000   50,000   50,000   50,000   50,000
Ordinary income taxable              -        -     19,050   27,200   77,200   77,400  165,000
Taxable: 22% ord income bracket      -        -        -        -        -        -     87,600
Taxable: 12% ord income bracket      -        -        -      8,150   58,150   58,350   58,350
Taxable: 10% ord income bracket      -        -     19,050   19,050   19,050   19,050   19,050
Taxable: 15% LTCG & QDI bracket      -        -        -        -     50,000   50,000   50,000
Taxable:  0% LTCG & QDI bracket   47,400   50,000   50,000   50,000      -        -        -

Code: Select all

Tax: 22% ord income bracket          -        -        -        -        -        -     19,272
Tax: 12% ord income bracket          -        -        -        978    6,978    7,002    7,002
Tax: 10% ord income bracket          -        -      1,905    1,905    1,905    1,905    1,905
Tax: 15% LTCG & QDI bracket          -        -        -        -      7,500    7,500    7,500
Total tax                            -        -      1,905    2,883   16,383   16,407   35,679

Increased ordinary income               2,600   19,050    8,150   50,000      200   87,600
Increased tax                             -      1,905      978   13,500       24   19,272
Marginal tax rate                       0.00%   10.00%   12.00%   27.00%   12.00%   22.00%
The bottom row of the table shows the marginal rates of 0%, 10%, 12%, 27%, 12% (briefly), and 22% as Roth conversions increase from $0 to $167,600 where, assuming a $24,000 standard deduction, ordinary taxable income reaches $165,000 and the 24% bracket. I prepared the table with the Compare sheet of my Marginal Tax Rates spreadsheet. The Main sheet displays the marginal rates graphically.

Assuming a 2% real growth rate, converting $29,800 annually will keep the traditional retirement account balance about the same at $1,600K and cause the Roth balance to increase from $140K to $660K over the 14 years from age 56 to 70. Using the Excel FV function:

Code: Select all

1,635 = FV(2%, 14,  29.8, -1600, 0)
  661 = FV(2%, 14, -29.8,  -140, 0)

Chip
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Re: Decumulation Sequencing

Post by Chip » Sun Jul 22, 2018 4:10 pm

#Cruncher wrote:
Sun Jul 22, 2018 4:01 pm
I agree except that I'd say "marginal 27% rate" instead of "phantom 27% bracket". There is nothing phantom about this; it's real money the tax man takes out of your pocket.
Tomato, tomahto. Sure it's a real marginal rate. I called it phantom because it doesn't appear on any official tax rate schedule.

Nice exposition on the tax details for the OP!

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munemaker
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Re: Decumulation Sequencing

Post by munemaker » Sun Jul 22, 2018 5:13 pm

With the kind of assets you are talking about, I would use the RPM spreadsheet to do a detailed analysis; then you will know.

https://www.bogleheads.org/wiki/Retiree_Portfolio_Model
viewtopic.php?t=97352

MikeG62
Posts: 1131
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Location: New Jersey

Re: Decumulation Sequencing

Post by MikeG62 » Mon Jul 23, 2018 6:05 am

willyd123 wrote:
Sun Jul 22, 2018 8:03 am
Bogleheads:

...So my question is does it really make sense for me to do Roth conversions of more than maybe $50,000 between the time I retire and when I turn 70 1/2 or should I not bother? I suppose doing Roth conversions would help mitigate the risk of tax rates going up which is certainly possible.
I think it makes a lot of sense to Roth convert to the top of the 12% Federal income tax bracket - that is somewhere around $50,000 using your numbers. Your Federal tax rate once you turn 70 will almost certainly be higher than 12% (given your numbers).

If you do more such that some of your dividends become taxable, your marginal tax rate will be 27% on that incremental income (as has already been pointed out).

FWIW, I am going precisely this. I am 56 and DW is 53 are we are retired three years now.
Real Knowledge Comes Only From Experience

carolinaman
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Location: North Carolina

Re: Decumulation Sequencing

Post by carolinaman » Mon Jul 23, 2018 8:09 am

willift wrote:
Sun Jul 22, 2018 8:42 am
One of the things that I think needs to be considered concerning RMDs and the taxes associated with them is the likelihood that a number of couples Married Filing Jointly today will be unfortunately Widowed/Widowers filing Single by the time RMDs kick in. The tax consequences of that life event change seems to be dismissed or ignored in a lot of these discussions. Your brackets obviously change, the tax rate increases and most likely the Qualified Dividends taxed like Capital Gains at 0% start to drift into the 15% tax area.

I'm not sure I follow my own thoughts because my wife hates to pay any taxes before they are due and her financial savvy and saving ethics got us to this point. We are definitely "Kick the Can Down the Roaders"

Anybody else see the impact of the eventual Single Taxpayer tax trap?
Yes, IMO the eventual single taxpayer status for one of you needs to be considered in your planning. If doing a Roth is a close call, then this should be considered. Also, if you anticipate most or all of the Roth to eventually be inherited, you should consider the pros and cons of inherited Roth for beneficiaries.

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