Talk me out of pre-tax savings! (RMDs/contrib types)

[Admiral]

Now that I have your attention:

As most here know I am generally a fan of pre-tax retirement savings in 95% of cases. But, looking at my finances and how things seems to shape up with FI/semi-retirement in 7-8 years, I'm thinking that we may be in the 5%. I hate the thought of losing the deduction (24% marginal) but even conservative projections seem to indicate some very large RMDs. I lay out the situation below.

Ages: 49 (me) , 51 (spouse)

Current assets:
Taxable: 80k
Pre-tax: 800k (breakdown is about 700k in 403b, about 100k in spouse 457)
Roth: 160k (mix of Roth IRAs and some Roth in my employer plan, around 50k)
Vested pension value (spouse's, gov't, with survivorship) in current dollars: around $700k (more below; this is not the surrender value, this is what an annuity would cost for the payout below. For accounting purposes we use the future cash flow not the presumed value)

Current retirement savings: around $40k, pre-tax only, per year, split about $30k for me and $10k for spouse. Plan to increase in 2021 due to lower expenses w/ COVID

Marginal Fed bracket is 24%

Assumptions and expectations/projections

My age 57/58: retire from current employer with employer paid healthcare; spouse continues working for a few years at $150k/year
My age 58: spouse (60) pension begins, about $3,300/mo in todays' dollars for life. Could choose to reduce this by about 15% for me to get 100% survivor payment, will cross that bridge later

Spouse age 62, likely go part time or volunteer.

Per annum expenses in retirement:
Budgeting $120k after tax, which includes $60k in base expenses and $60k in travel etc. I'm sure there will be years where we spend much less.
Mortgage paid off at my age 60, if we don't pay it off sooner. Saves $24k per year.

Here are my income projections:
Expected SS, in current dollars
Hers at age 67, $36k
Mine at age 70, $40k
Pension, 36k and diminishing with inflation at my age 58, spouse age 60
TOTAL: $112k
Expected inheritance: $1m or more w/i 20 years

So as you can see our portfolio draw will be low from age 67 onward. However there will be 8-10 bridge years where we could do Roth conversions, assuming our income will be the pension only.

Projecting balances forward, assuming a 6% real rate of return, and no conversions, at my age 72 this is what I am seeing for balances:
Taxable: $1m (inheritance); not planning with this in mind but it's likely to be there
Roth: $583k
Pre-tax: $2.8m

RMD at age 72: $108k, taxes $21k (tax estimate is probably way low. RMD+pension+SS will likely have us in same bracket we are now)
And it goes way up from there.

Clearly, we would need to convert $100k/year or more for as long as possible before SS. But, unless we either start saving more in taxable now or receive the inheritance, basically half the pension or more will be used to pay the tax on the conversion.

It seems we are def candidates to save exclusively in Roth going forward, or possibly Roth and taxable. I just cannot bear the thought of losing a 24% tax deduction.

I welcome all thoughts and ideas.

[Admiral]

Bump!

Any thoughts much appreciated.

[sailaway]

Why are you projecting no conversions in your calculations?

[aristotelian]

If I understand correctly, you currently have saved only $40k pretax. While future contributions and growth may eventually push you into a high bracket in retirement, you are not there yet. Your next marginal contribution is likely in the 10-12% bracket at least for the years 58-6
67 or 70. I would keep doing pretax until your 401k starts approaching $1M or so. Consider delaying wife's SS also to 70.

[sailaway]

If I understand correctly, you currently have saved only $40k pretax. While future contributions and growth may eventually push you into a high bracket in retirement, you are not there yet. Your next marginal contribution is likely in the 10-12% bracket at least for the years 58-6
67 or 70. I would keep doing pretax until your 401k starts approaching $1M or so. Consider delaying wife's SS also to 70.

They said $800k in current assets in 403b and 457, it is $40k per year saved.

[Olemiss540]

State tax rate now and in planned retirement destination?

What's your income and expenses NOW?

How much above the $40k pretax are you putting into taxable and Roth accounts per year?

[aristotelian]

If I understand correctly, you currently have saved only $40k pretax. While future contributions and growth may eventually push you into a high bracket in retirement, you are not there yet. Your next marginal contribution is likely in the 10-12% bracket at least for the years 58-6
67 or 70. I would keep doing pretax until your 401k starts approaching $1M or so. Consider delaying wife's SS also to 70.

They said $800k in current assets in 403b and 457, it is $40k per year saved.

Ah, in that case I see the issue! I could certainly see the case to start shifting to Roth if that is an option. I have a hard time seeing him higher than the 24% bracket but if he has limited upside from traditional, Roth would be a good hedge against tax increases etc.

[Independent George]

Can you postpone the pension payout, then draw from the tax-deferred accounts at a lower tax rate (or do a Roth conversion) during that time where you technically aren't earning any income?

[willthrill81]

If I understand correctly, you currently have saved only $40k pretax. While future contributions and growth may eventually push you into a high bracket in retirement, you are not there yet. Your next marginal contribution is likely in the 10-12% bracket at least for the years 58-6
67 or 70. I would keep doing pretax until your 401k starts approaching $1M or so. Consider delaying wife's SS also to 70.

They said $800k in current assets in 403b and 457, it is $40k per year saved.

Ah, in that case I see the issue! I could certainly see the case to start shifting to Roth if that is an option. I have a hard time seeing him higher than the 24% bracket but if he has limited upside from traditional, Roth would be a good hedge against tax increases etc.

Also, Roth avoids the 'surviving spouse is suddenly thrust into a higher tax bracket due to RMDs' issue.

Like the OP, I generally favor tax-deferred contributions, I agree that switching at least some contributions to Roth now probably makes sense. But the amount that can be converted to Roth during the 8-10 year 'bridge period' may be significant and should be taken into account when doing projections.

[Admiral]

Why are you projecting no conversions in your calculations?

I'm not skilled enough in Excel to get firm numbers on my own, but using RPM, it shows conversions of 50k/year starting at age 60 to age 67. But this still shows a pre-tax balance of $1.5-1.6m by age 72.

[Admiral]

State tax rate now and in planned retirement destination?

What's your income and expenses NOW?

How much above the $40k pretax are you putting into taxable and Roth accounts per year?

State tax rate = 3%. But PA does not tax pension income nor qualified pre-tax retirement distributions

Current gross income = $275k. However, a lot of our post-tax income goes to paying school tuition, with some to mortgage. Neither of those will be a factor in retirement. My projections are in the OP: $120k/year AT MOST in net income needed.

We are currently not adding to Roth. Taxable savings just a bit, maybe 5k/year. After expenses, taxes, and pre-tax savings there's not a lot leftover.

[Admiral]

Can you postpone the pension payout, then draw from the tax-deferred accounts at a lower tax rate (or do a Roth conversion) during that time where you technically aren't earning any income?

Not sure about that. But, we'd still need money to live on during this period. Assuming we both stopped working, with no pension income we'd need to be withdrawing in the neighborhood of $150/160k per year from pre-tax for living expenses. Which is, of course, one way to lower the balance by age 72...

[JoinToday]

What do the projections look like with 2% or 3% real? 6% real seems high (in my opinion) even if you are 100% equity in my opinion. I use 2% real for a 60:40 AA as a conservative estimate. 3% is also reasonable.

Because of tax drag and its corrosive effect on returns over the long term, after tax investing may be the worst place to put assets. Better off doing larger Roth conversions to the top of the 24% bracket now to avoid IRMAA issues at age 63 and later. Plus 3.8% NIIT if income is above $250K. The IRMAA issue is something I wish I would have thought of earlier. Note also that after the first spouse passes, SS is cut roughly in half, and tax brackets for single are more oppressive with larger RMDs (both of which you probably know).

[Admiral]

What do the projections look like with 2% or 3% real? 6% real seems high (in my opinion) even if you are 100% equity in my opinion. I use 2% real for a 60:40 AA as a conservative estimate. 3% is also reasonable.

Because of tax drag and its corrosive effect on returns over the long term, after tax investing may be the worst place to put assets. Better off doing larger Roth conversions to the top of the 24% bracket now to avoid IRMAA issues at age 63 and later. Plus 3.8% NIIT if income is above $250K. The IRMAA issue is something I wish I would have thought of earlier. Note also that after the first spouse passes, SS is cut roughly in half, and tax brackets for single are more oppressive with larger RMDs (both of which you probably know).

I tend not to agree with 3% real returns over the next 22 years for a (and my) 70-30 portfolio. But, I ran the numbers using 3% real returns for you. The pre-tax balance at age 72 is appx $2.0m at that RoR. That's with no conversions, however.

ETA: Also, I cannot do conversions now (even though we have lots of room in the 24% bracket) because I don't have the spare cash to pay the tax. (Well, I do, but I don't want to use it.) What I can do is change some pre-tax contribs to Roth, which was part of the point of my OP: whether this is a good idea.

[Olemiss540]

State tax rate now and in planned retirement destination?

What's your income and expenses NOW?

How much above the $40k pretax are you putting into taxable and Roth accounts per year?

State tax rate = 3%. But PA does not tax pension income nor qualified pre-tax retirement distributions

Current gross income = $275k. However, a lot of our post-tax income goes to paying school tuition, with some to mortgage. Neither of those will be a factor in retirement. My projections are in the OP: $120k/year AT MOST in net income needed.

We are currently not adding to Roth. Taxable savings just a bit, maybe 5k/year. After expenses, taxes, and pre-tax savings there's not a lot leftover.

Regardless of your decision on the pre/post tax, why wouldnt you be using your taxable account money to fund your Roth IRA (backdoor) contributions?

Given your huge gross income compared to small yearly savings I would stick with pretax so as to not reduce the gross amount saved any further since you are getting to your last 10 years of employement. I personally like to error on the side of having TOO much money when given the two alternatives.

Maybe revisit if your projections hold and your pretax accounts get into the 1.5M-1.75M range IMO. Obviously this is extremely personal decision and the RIGHT answer is available only in hindsight.

[foo.c]

The easiest argument to make, but difficult to prove: taxes could go up.

[Olemiss540]

What do the projections look like with 2% or 3% real? 6% real seems high (in my opinion) even if you are 100% equity in my opinion. I use 2% real for a 60:40 AA as a conservative estimate. 3% is also reasonable.

Because of tax drag and its corrosive effect on returns over the long term, after tax investing may be the worst place to put assets. Better off doing larger Roth conversions to the top of the 24% bracket now to avoid IRMAA issues at age 63 and later. Plus 3.8% NIIT if income is above $250K. The IRMAA issue is something I wish I would have thought of earlier. Note also that after the first spouse passes, SS is cut roughly in half, and tax brackets for single are more oppressive with larger RMDs (both of which you probably know).

I tend not to agree with 3% real returns over the next 22 years for a (and my) 70-30 portfolio. But, I ran the numbers using 3% real returns for you. The pre-tax balance at age 72 is appx $2.0m at that RoR. That's with no conversions, however.

ETA: Also, I cannot do conversions now (even though we have lots of room in the 24% bracket) because I don't have the spare cash to pay the tax. (Well, I do, but I don't want to use it.) What I can do is change some pre-tax contribs to Roth, which was part of the point of my OP: whether this is a good idea.

Wont you also have 90k (+ tax) in living expense withdrawals per year from age 62ish to age 70?

[Admiral]

State tax rate now and in planned retirement destination?

What's your income and expenses NOW?

How much above the $40k pretax are you putting into taxable and Roth accounts per year?

State tax rate = 3%. But PA does not tax pension income nor qualified pre-tax retirement distributions

Current gross income = $275k. However, a lot of our post-tax income goes to paying school tuition, with some to mortgage. Neither of those will be a factor in retirement. My projections are in the OP: $120k/year AT MOST in net income needed.

We are currently not adding to Roth. Taxable savings just a bit, maybe 5k/year. After expenses, taxes, and pre-tax savings there's not a lot leftover.

Regardless of your decision on the pre/post tax, why wouldnt you be using your taxable account money to fund your Roth IRA (backdoor) contributions?

Given your huge gross income compared to small yearly savings I would stick with pretax so as to not reduce the gross amount saved any further since you are getting to your last 10 years of employement. I personally like to error on the side of having TOO much money when given the two alternatives.

Maybe revisit if your projections hold and your pretax accounts get into the 1.5M-1.75M range IMO. Obviously this is extremely personal decision and the RIGHT answer is available only in hindsight.

Hmm. Not sure I'd agree that 14.5% savings rate is "small yearly savings" but you need to understand that the pension contribution is another $9k per year. So in effect we are saving about 18% of gross. Lower than in the past, but with the pension I don't feel a need to have $3m in order to retire. My target is $2.0m.

That said, yes, we have done backdoor Roth contributions in the past. However the taxable account is partially an emergency fund and is also used for things like vacations, big purchases, r.e. tax etc that we cannot make from cashflow.

[Admiral]

What do the projections look like with 2% or 3% real? 6% real seems high (in my opinion) even if you are 100% equity in my opinion. I use 2% real for a 60:40 AA as a conservative estimate. 3% is also reasonable.

Because of tax drag and its corrosive effect on returns over the long term, after tax investing may be the worst place to put assets. Better off doing larger Roth conversions to the top of the 24% bracket now to avoid IRMAA issues at age 63 and later. Plus 3.8% NIIT if income is above $250K. The IRMAA issue is something I wish I would have thought of earlier. Note also that after the first spouse passes, SS is cut roughly in half, and tax brackets for single are more oppressive with larger RMDs (both of which you probably know).

I tend not to agree with 3% real returns over the next 22 years for a (and my) 70-30 portfolio. But, I ran the numbers using 3% real returns for you. The pre-tax balance at age 72 is appx $2.0m at that RoR. That's with no conversions, however.

ETA: Also, I cannot do conversions now (even though we have lots of room in the 24% bracket) because I don't have the spare cash to pay the tax. (Well, I do, but I don't want to use it.) What I can do is change some pre-tax contribs to Roth, which was part of the point of my OP: whether this is a good idea.

Wont you also have 90k (+ tax) in living expense withdrawals per year from age 62ish to age 70?

Yes, sort of. Depends when my spouse stops working, and when she takes SS. She is two years older so she could claim at my age 65. Or, of course, delay to my age 68. If she works to age 62, then it could be as few as 5 years.

[PhrugalPhan]

My situation is somewhat similar and I came to this conclusion a few years ago. I have turned up my Roth 457 to 95% of my contributions for the past three years. My analysis for going forward is I will have to slip into the 24% marginal bracket in the last two years of employment due to Roth contributions and the 3 years before I turn 64 while doing Roth conversions to keep my pre-tax balance out of the runaway growth zone (that is - always 24% + tax bracket) that can't be stopped. Thankfully I have been putting some into Roth for years and it has kept this situation from getting totally out of hand.

For my analysis I used 5% real growth. If I use 2% I can probably stay in the 22% bracket but I think that is being optimistic.

Anyway, to your question, I came to the same realization and have gone up reluctantly to the next tax bracket (24%) for a small amount of my earnings, and will do so for conversions. I think its the right choice, and I think you have already realized the same for you.

[Admiral]

My situation is somewhat similar and I came to this conclusion a few years ago. I have turned up my Roth 457 to 95% of my contributions for the past three years. My analysis for going forward is I will have to slip into the 24% marginal bracket in the last two years of employment due to Roth contributions and the 3 years before I turn 64 while doing Roth conversions to keep my pre-tax balance out of the runaway growth zone (that is - always 24% + tax bracket) that can't be stopped. Thankfully I have been putting some into Roth for years and it has kept this situation from getting totally out of hand.

For my analysis I used 5% real growth. If I use 2% I can probably stay in the 22% bracket but I think that is being optimistic.

Anyway, to your question, I came to the same realization and have gone up reluctantly to the next tax bracket (24%) for a small amount of my earnings, and will do so for conversions. I think its the right choice, and I think you have already realized the same for you.

Thanks. Yeah we are already well into 24% and could not get down to 22% even with two full contributions plus catch up. But, the good news is that we are far from 32%. It just pains me to give up such a large tax deduction, which is partially why I am kind of hanging my hat on the dream of big conversions at low income. Just not sure what the right choice is. I may be able to delay the move to Roth for another few years. Assuming that the brackets revert, paying at 24% now is likely the better choice. It's just hard to pull the trigger.

[willthrill81]

My situation is somewhat similar and I came to this conclusion a few years ago. I have turned up my Roth 457 to 95% of my contributions for the past three years. My analysis for going forward is I will have to slip into the 24% marginal bracket in the last two years of employment due to Roth contributions and the 3 years before I turn 64 while doing Roth conversions to keep my pre-tax balance out of the runaway growth zone (that is - always 24% + tax bracket) that can't be stopped. Thankfully I have been putting some into Roth for years and it has kept this situation from getting totally out of hand.

For my analysis I used 5% real growth. If I use 2% I can probably stay in the 22% bracket but I think that is being optimistic.

Anyway, to your question, I came to the same realization and have gone up reluctantly to the next tax bracket (24%) for a small amount of my earnings, and will do so for conversions. I think its the right choice, and I think you have already realized the same for you.

Thanks. Yeah we are already well into 24% and could not get down to 22% even with two full contributions plus catch up. But, the good news is that we are far from 32%. It just pains me to give up such a large tax deduction, which is partially why I am kind of hanging my hat on the dream of big conversions at low income. Just not sure what the right choice is. I may be able to delay the move to Roth for another few years. Assuming that the brackets revert, paying at 24% now is likely the better choice. It's just hard to pull the trigger.

Don't forget that you can use tax-deferred funds to pay for medical expenses exceeding 7.5% of your AGI, including long-term care, with no income tax.

[PhrugalPhan]

My situation is somewhat similar and I came to this conclusion a few years ago. I have turned up my Roth 457 to 95% of my contributions for the past three years. My analysis for going forward is I will have to slip into the 24% marginal bracket in the last two years of employment due to Roth contributions and the 3 years before I turn 64 while doing Roth conversions to keep my pre-tax balance out of the runaway growth zone (that is - always 24% + tax bracket) that can't be stopped. Thankfully I have been putting some into Roth for years and it has kept this situation from getting totally out of hand.

For my analysis I used 5% real growth. If I use 2% I can probably stay in the 22% bracket but I think that is being optimistic.

Anyway, to your question, I came to the same realization and have gone up reluctantly to the next tax bracket (24%) for a small amount of my earnings, and will do so for conversions. I think its the right choice, and I think you have already realized the same for you.

Thanks. Yeah we are already well into 24% and could not get down to 22% even with two full contributions plus catch up. But, the good news is that we are far from 32%. It just pains me to give up such a large tax deduction, which is partially why I am kind of hanging my hat on the dream of big conversions at low income. Just not sure what the right choice is. I may be able to delay the move to Roth for another few years. Assuming that the brackets revert, paying at 24% now is likely the better choice. It's just hard to pull the trigger.

Don't forget that you can use tax-deferred funds to pay for medical expenses exceeding 7.5% of your AGI, including long-term care, with no income tax.

In my case I am not forgetting this, as I want to keep a good amount in my 457 for those situations. Even holding money to account for those situations, I'm still going to get into a runaway 24% bracket situation without major Roth conversions or a major market correction.

[Olemiss540]

State tax rate now and in planned retirement destination?

What's your income and expenses NOW?

How much above the $40k pretax are you putting into taxable and Roth accounts per year?

State tax rate = 3%. But PA does not tax pension income nor qualified pre-tax retirement distributions

Current gross income = $275k. However, a lot of our post-tax income goes to paying school tuition, with some to mortgage. Neither of those will be a factor in retirement. My projections are in the OP: $120k/year AT MOST in net income needed.

We are currently not adding to Roth. Taxable savings just a bit, maybe 5k/year. After expenses, taxes, and pre-tax savings there's not a lot leftover.

Regardless of your decision on the pre/post tax, why wouldnt you be using your taxable account money to fund your Roth IRA (backdoor) contributions?

Given your huge gross income compared to small yearly savings I would stick with pretax so as to not reduce the gross amount saved any further since you are getting to your last 10 years of employement. I personally like to error on the side of having TOO much money when given the two alternatives.

Maybe revisit if your projections hold and your pretax accounts get into the 1.5M-1.75M range IMO. Obviously this is extremely personal decision and the RIGHT answer is available only in hindsight.

Hmm. Not sure I'd agree that 14.5% savings rate is "small yearly savings" but you need to understand that the pension contribution is another $9k per year. So in effect we are saving about 18% of gross. Lower than in the past, but with the pension I don't feel a need to have $3m in order to retire. My target is $2.0m.

That said, yes, we have done backdoor Roth contributions in the past. However the taxable account is partially an emergency fund and is also used for things like vacations, big purchases, r.e. tax etc that we cannot make from cashflow.

Didn't think you were posting to get folks to agree with you but to provide their perspective on your situation.

You know you can pull your Roth IRA contributions out in case of emergency with no penalty? As I said, the really is zero reason to add to a taxable account without funding your Roth IRAs.

Seems like you have a good idea what you want and are looking for validation. I am certain you will be fine either way and this will all be a matter of a few unimportant percentages at the end of your days.

[Fishing50]

My situation is somewhat similar and I came to this conclusion a few years ago. I have turned up my Roth 457 to 95% of my contributions for the past three years. My analysis for going forward is I will have to slip into the 24% marginal bracket in the last two years of employment due to Roth contributions and the 3 years before I turn 64 while doing Roth conversions to keep my pre-tax balance out of the runaway growth zone (that is - always 24% + tax bracket) that can't be stopped. Thankfully I have been putting some into Roth for years and it has kept this situation from getting totally out of hand.

For my analysis I used 5% real growth. If I use 2% I can probably stay in the 22% bracket but I think that is being optimistic.

Anyway, to your question, I came to the same realization and have gone up reluctantly to the next tax bracket (24%) for a small amount of my earnings, and will do so for conversions. I think its the right choice, and I think you have already realized the same for you.

Thanks. Yeah we are already well into 24% and could not get down to 22% even with two full contributions plus catch up. But, the good news is that we are far from 32%. It just pains me to give up such a large tax deduction, which is partially why I am kind of hanging my hat on the dream of big conversions at low income. Just not sure what the right choice is. I may be able to delay the move to Roth for another few years. Assuming that the brackets revert, paying at 24% now is likely the better choice. It's just hard to pull the trigger.

We came to the realization Roth TSP contributions in the 22% tax bracket is the right choice for us closing in on retirement. I’m considering large conversations after retirement, before tax rates return to 2016 levels in 2026. We might just avoid the pain of large tax bills on future conversions in the 22% tax bracket.

[scifilover]

I don't think there is a single right answer to this problem. If you retire at 55 with $1.3M in tax deferred less than a 5% compound growth rate will produce $3.5M by age 75. However, the future growth rate could be 3% or it could be 7%. This is the dilemma we all face. If we tilt the direction of savings more to taxable we may find the rate of return to be lower and thus not meet our future needs. If we tilt more to tax deferred, the growth rate might be larger creating larger tax deferred balances than is ideal. And, even if you work at Roth conversions, the future rate of investment growth can undo much of what you hope to accomplish.

[Admiral]

I don't think there is a single right answer to this problem. If you retire at 55 with $1.3M in tax deferred less than a 5% compound growth rate will produce $3.5M by age 75. However, the future growth rate could be 3% or it could be 7%. This is the dilemma we all face. If we tilt the direction of savings more to taxable we may find the rate of return to be lower and thus not meet our future needs. If we tilt more to tax deferred, the growth rate might be larger creating larger tax deferred balances than is ideal. And, even if you work at Roth conversions, the future rate of investment growth can undo much of what you hope to accomplish.

Well said. Right now, the conundrum (even putting aside potential growth) is that contribs in pretax capture the 24% deduction, but converting as much as possible from age 58 on, if rates revert, we would likely be at 28% as follows:

40k pension + 90-100k withdrawal for living expenses (so, already into "old" 25% bracket)... and then add in another $50k to convert (so $180k) which would have us mostly in 25% with some at 28%. We could convert a bit more to max out that bracket (which will have risen due to inflation), but that's still saving at 24% and paying tax at 28%. Not great tax strategy.

Interestingly, i-ORP recommends all savings in taxable only!

[MathWizard]

In the 12% bracket, I'd go for ROTH.

In the 24% ,I'd have a hard time not going for tax deferred.

[willthrill81]

In the 12% bracket, I'd go for ROTH.

In the 24% ,I'd have a hard time not going for tax deferred.

But in the OP's case, there will be a substantial pension. It's almost certain that the OP will at least be in the 22% bracket, and if the OP or spouse passes away, the survivor will be in a much higher bracket.

[anon_investor]

OP should go 100% Roth at this point. The 24% tax bracket is set to disappear in 2026 under current law.