Tax Questions

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sparky123
Posts: 19
Joined: Mon Nov 20, 2017 9:14 am

Tax Questions

Post by sparky123 » Wed Oct 10, 2018 10:27 am

If I were to retire early in the year, I would try to max out my retirement accounts before then.
Let's say I worked 4 months, made 30k, put 18.5k + 6k into the 401k, put 3.5k into a HSA, and had pretty much no taxable earned income.
I could transfer 6k into a Roth from a savings account and so max out all the retirement accounts for that year.
Should I fill up the 12% bracket with roth conversions(50k = 38k + 12k standard deduction)? Then take about 80k in capital gains for living expenses, and so still be under the roth income limit (38k + 80k <120k for single)?
Does it matter that the 6k in roth contributions were earned the previous year?

cas
Posts: 374
Joined: Wed Apr 26, 2017 8:41 am

Re: Tax Questions

Post by cas » Wed Oct 10, 2018 11:24 am

Careful. Do you really mean "take 80 k in capital gains for living expenses"? Or would part of that be cost basis and part of it be long term capital gains, obtained by selling an asset in a taxable account?

Assuming you really meant "take 80 k in capital gains" (or at least significant capital gains) (and assuming filing single), I see a couple of things you may not have considered.

1. $80k in long term capital gains, if that is what you really mean, would transform your nominal 0%, 10%, and 12% tax brackets into 15%, 25%, and 27% marginal "shadow" tax brackets. Looks like you would end up paying a much higher marginal rate on the Roth conversion than you were intending to pay.

(The 15%, 25%, and 27% "shadow" brackets come about because every $1 of your Roth conversion (taxed at 0%,10%, or 12%) would also push $1 of LTCG from the 0% special QDiv/LTCG tax bracket into the 15% special QDiv/LTCG tax bracket. 0% ordinary income tax + 15% LTCG tax = 15% marginal tax. 10% ordinary + 15% LTCG = 25% marginal. 12% ordinary + 15% LTCG = 27% marginal)

For more information, see Boglehead's wiki "Common Examples of High Marginal Tax Rates", 2nd paragraph: https://www.bogleheads.org/wiki/Margina ... inal_rates )

2. IRMAA (Income Related Monthly Adjustment Amount for Medicare Pt B and D premiums). If you are 63 or older in the year you do this, the $130 in AGI (50K roth conversion + 80 K LTCG) will put you near the top of the 3rd IRMAA bracket 2 years afterwards. This will lead to your Medicare B premiums having an annual cost (using 2018 figures) about $1600 higher than if you kept your AGI under $85,000. Medicare D premiums will also be increased. It can be debated whether knowingly pushing oneself into a higher IRMAA bracket is "worth it" to achieve certain other financial goals (e.g. Roth conversions), but one should be very aware that one is going to do it.

sparky123
Posts: 19
Joined: Mon Nov 20, 2017 9:14 am

Re: Tax Questions

Post by sparky123 » Wed Oct 10, 2018 12:03 pm

Thanks CAS, that shadow tax bracket info was exactly what I was afraid of.
The 80k capital gains was actually 120k total redeemed, 80k LTCG.
Not old enough for IRMAA yet.

kaneohe
Posts: 5148
Joined: Mon Sep 22, 2008 12:38 pm

Re: Tax Questions

Post by kaneohe » Wed Oct 10, 2018 1:04 pm

If you contribute 24.5K to 401K and 3.5K to HSA , that is a total of 28K of your 30K earnings. Assuming the HSA
contribution was a pre-tax deduction, your W2 would show 2K for taxable compensation which seems like it would limit your Roth contribution to 2K for the year.

Dottie57
Posts: 4790
Joined: Thu May 19, 2016 5:43 pm

Re: Tax Questions

Post by Dottie57 » Wed Oct 10, 2018 1:12 pm

You may not be able to max 401k. My employer’s plan limited contributions to 50% of gross paycheck. Read you plan summary document.

sparky123
Posts: 19
Joined: Mon Nov 20, 2017 9:14 am

Re: Tax Questions

Post by sparky123 » Thu Oct 11, 2018 6:48 am

Dottie57 wrote:
You may not be able to max 401k. My employer’s plan limited contributions to 50% of gross paycheck. Read you plan summary document.

Mine is 75% not counting the catch up.

Kaneohe wrote:
If you contribute 24.5K to 401K and 3.5K to HSA , that is a total of 28K of your 30K earnings. Assuming the HSA
contribution was a pre-tax deduction, your W2 would show 2K for taxable compensation which seems like it would limit your Roth contribution to 2K for the year.

Maybe I'll stay on another month. Hmm.

Thanks for the replies.

cas
Posts: 374
Joined: Wed Apr 26, 2017 8:41 am

Re: Tax Questions

Post by cas » Thu Oct 11, 2018 7:28 am

sparky123 wrote:
Wed Oct 10, 2018 10:27 am
If I were to retire early in the year, I would try to max out my retirement accounts before then.
Let's say I worked 4 months . . . put 3.5k into a HSA,
This is a more minor point, but, for completeness...

You didn't say what your plans for health insurance were after retiring, but the total amount you are eligible to contribute to an HSA in a year is prorated by the number of months in the year you have HSA-eligible HDHP health insurance. Whatever IRS publication it is that covers HSAs has a worksheet to fill out to determine how much you are eligible to contribute to the HSA if you have less than 12 months of HSA-eligible HDHP coverage.

So, if, after retiring early in the year, you were to switch to health insurance that was not HSA-eligible HDHP health insurance, you would not be eligible to contribute the whole $3.5k-ish (individual coverage, age less than 55) into an HSA. (And if you did, you'd need to be searching these forums for threads on how to back out the excess contribution.)

If your insurance after retirement remained some version of an HSA-eligible HDHP for the rest of the year, there is no problem making the full 3.5k contribution to the HSA.

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