Retiring now, thank you, Bogleheads! And tax question

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2marshmallow
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Retiring now, thank you, Bogleheads! And tax question

Post by 2marshmallow »

About 10 years ago I started wondering how the whole retirement finance thing was going to work. DW, now 64, and I,now 61, had been saving regularly into 401k's and had started to accumulate a reasonable amount of money, despite some really knuckleaded investment choices I made early on. I started modeling the retirement period with sequences of inflation adjusted withdrawals and assumptions of constant returns for stocks, bonds, etc. There were articles on bucket approaches that sounded promising, and something called the CORI index. Then about 3-4 years ago I happened to read something about the 3-fund portfolio, which led me to the Bogleheads forum. I read through the basic (and long!) thread on the 3-fund portfolio with increasing interest. I drank the kool-aid and it tasted good! Add my voice to the loud chorus saying, "I wish I had found the BH forum sooner". It was like the fog cleared and I could see the path. We are now 50% US stock/5% Int Stock/45% bond, all low cost, broad index funds, mainly at Fidelity. The BH forum also led me to Bernstein's book on asset allocation and McClung's book on retirement finance strategies, both adding to our confidence in being able to be the stewards of our own financial future.

For the record, our retirement kitty is $2.6M of which $2.1M is tax deferred and will generate a starting income of $84K (4%). Combined with SS taken at full retirement age or later, we should have an after tax income of $125K or so, which matches our expenses when we include allocations for entertainment, travel, etc. We will use some kind of variable withdrawal strategy, not sure yet which one, noting that we can absorb about a $40K/yr decrease in income if really needed. The house is not paid off yet, but a rental unit on the property covers the small mortgage principal and interest (rental income not included in the $125K above and the PI is not included in our expenses). The other $500k is post-tax savings and will go into the bridge funding needed to get us to SS age ($225K) and some left over for "fun money" ($275K).

My workplace very recently shook up and when the dust settled I was given a promotion but, planning to retire later in the year, I didn't want to start a new job only to exit shortly after. So I decided to retire now and my employer is happy that I did that so they don't have to install a new person so soon. Today in fact is day two of my retirement and DW will retire in a few short weeks.

Tax question: DW and I have always paid taxes via our employer. When we start taking distributions from a traditional IRA, they are taxable. What are the mechanics of paying the taxes due? Somehow calculate what amounts will be due and pay them at the time of withdrawal? Wait until tax time the following year and write a check for the whole amount (it seems to me there might be a penalty for that ?).

Thank you in advance for any tax advice and also for the huge amount of general knowledge available in the BH forum!

2marshmallow
livesoft
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by livesoft »

When you take a withdrawal from your IRAs you can specify a tax withholding rate. That should get you started. However, you should run a "What if?" tax return a few times during the year to see how much taxes you will end up paying. Perhaps you won't have to pay any income taxes? I know some folks use a withdrawal in December to pay taxes with 100% withholding. There are other methods of paying taxes, too. IRS Direct Pay is convenient and easy.
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retiredjg
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by retiredjg »

I'd use withholding when you take money from the IRA and/or from SS when you start that.

The first year is hard to guess because your expenses change so much - so just withhold some extra to be sure. After the first year, unless you expect expenses to be very different, you will know what a good guess is.

I currently just withhold as much as the previous year's total tax amount - it's a safe harbor. For me it ends up being pretty close.
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WoodSpinner
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by WoodSpinner »

OP,

Are you planning on any Roth Conversions?

At 2.1MM you might consider it as apart if your tax planning.

Lots of threads on it, plus a good Wiki article.

This was one of my biggest surprises in Retirement planning.

WoodSpinner
sofarsogood
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by sofarsogood »

am i correct to say upon retirement that one should withdraw from a tax deferred account to pay for living expenses and sell shares in a brokerage account to pay for the taxes?

thanks
retiredjg
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by retiredjg »

sofarsogood wrote: Wed Jan 13, 2021 3:19 pm am i correct to say upon retirement that one should withdraw from a tax deferred account to pay for living expenses and sell shares in a brokerage account to pay for the taxes?

thanks
There is no "should" answer for your question. :happy. Depends on the circumstances. Some people do not have a taxable account. Some would rather draw down the IRA. Some would like what you suggest.
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telemark
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by telemark »

retiredjg wrote: Wed Jan 13, 2021 4:41 pm
sofarsogood wrote: Wed Jan 13, 2021 3:19 pm am i correct to say upon retirement that one should withdraw from a tax deferred account to pay for living expenses and sell shares in a brokerage account to pay for the taxes?

thanks
There is no "should" answer for your question. :happy. Depends on the circumstances. Some people do not have a taxable account. Some would rather draw down the IRA. Some would like what you suggest.
I would think not. At this point, taxable or better yet Roth money is preferable to tax deferred, because withdrawals are taxed at a lower rate and because they give you more flexibility when you make withdrawals: if you want to make a large purchase or have an unexpected expense, you don't face pushing your taxes into a higher bracket. There may be reasons I'm overlooking.

In general, the point of deferring taxes is the expectation of a lower rate in the future. But once you are retired you are already there.

For the original poster, I like

http://www.moneychimp.com/features/tax_calculator.htm

as a quick way to get a ballpark tax estimate. Just make sure you select the right year.
lstone19
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by lstone19 »

sofarsogood wrote: Wed Jan 13, 2021 3:19 pm am i correct to say upon retirement that one should withdraw from a tax deferred account to pay for living expenses and sell shares in a brokerage account to pay for the taxes?
I think people get too hung up on source of funds. It's situation and age specific. One of the reasons for the strong suggestion that other funds be used to pay taxes on a Roth conversion is the penalty for pre-59.5 distributions. Once north of 59.5 like the OP, that's no longer a concern and all funds are available for whatever is needed.

Our plan is to set a target AGI to keep us south of the first IRMAA point. Whatever of that target AGI not used by other taxable income will be taken up by Roth conversions. Given that, it's simple in TT to come up with the approximate tax due on that target AGI. We then take 92% of it (to keep us a little above the 90% safe-harbor) and pay it as quarterly estimated tax payments with the balance due with the 1040 (that number will probably be a little high since no allowance is made at that point for qualified dividends, etc.).

Any money not available from cash on hand will be taken from IRAs (reducing conversions). While we do have some money in taxable accounts, we're letting that sit for two reasons:
1) Lots of gains, some of which might be donated in the future
2) As we currently live in Illinois but are contemplating moving to California, perhaps in 2023, for now, our goal is to have as much of our income be things that are not taxed in Illinois (like Roth conversions) but are taxed in California. Things that have the same tax treatment in both states, like SS (taxed in neither) or capital gains (taxed in both), are being avoided for now.
angelescrest
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by angelescrest »

Congratulations, and big respect for your thoughtful approach with your employer. :beer
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celia
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by celia »

2marshmallow wrote: Wed Jan 13, 2021 12:52 pm $2.1M is tax deferred and will generate a starting income of $84K (4%).
Oh, oh. I see a red flag here. Is this today's value or the expected value of tax-deferred at age 72? If it is today's value, it is possible for it to double, or at least reach $3M by the time you start RMDs. What will that do to your taxes and tax bracket at that time? Are you planning to start Roth conversions now?

To give you something to think about, look at the year-end value of your tax-deferred accounts for the last 4 years. Mentally subtract out any new contributions that were made each year. Then subtract the 2019 ending value from the 2020 ending value to see how much the account grew in 2020. Repeat for the other years. If you don't remove/convert the amount of yearly growth each year, the accounts will just continue to grow.
Bigfish
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by Bigfish »

I withdraw part of my expected living expenses from my traditional IRA that is with Vanguard. I have the option of withholding a dollar amount or a percentage of the withdrawal for both federal and stated taxes. I chose the percentage according to my state and federal tax bracket which is 7% and 12% respectively. I like having it done all at once and not having to bother with it the rest of the year. The amount taken from the IRA this year is 3%, which the amount after taxes plus SS is more than enough to cover our budget, particularly with the effect of COVID on our spending habits.
Topic Author
2marshmallow
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by 2marshmallow »

I want to thank everyone for their thoughtful replies! They have given me more to think about than anticipated. I’m going to have to look into Roth conversions now.

Cheers!
2marshmallow
esteen
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by esteen »

Congrats!!

+1 to exploring Roth conversions.

Boglehead Wiki Roth IRA Conversion Page
Some Calculators
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Tim_in_GA
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by Tim_in_GA »

How does the withholding work from a tax deferred account? They withhold a certain amount, do they pay direct to the IRS or is the money just sitting there until we do our taxes?
Roadhog
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by Roadhog »

Sounds like a thoughtful approach. Just curious - what are planning to do for medical insurance before you are eligible for Medicare. Your wife is a year away but you have several years to go. Always interested in how early retirees solve this problem.
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22twain
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by 22twain »

Tim_in_GA wrote: Thu Jan 14, 2021 7:25 am How does the withholding work from a tax deferred account? They withhold a certain amount, do they pay direct to the IRS or is the money just sitting there until we do our taxes?
It goes straight to the IRS, same as when you're working and have taxes withheld from your salary. Your brokerage or 401(k) / IRA custodian will report the amount to you on a form 1099 at tax time, so you can in turn enter it on your tax return, when calculating your refund or amount to pay.
Last edited by 22twain on Thu Jan 14, 2021 8:38 am, edited 1 time in total.
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markcoop
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by markcoop »

2marshmallow wrote: Thu Jan 14, 2021 12:31 am I want to thank everyone for their thoughtful replies! They have given me more to think about than anticipated. I’m going to have to look into Roth conversions now.
I am a few years behind you, but my projected numbers are pretty close to where you are now. I am still working. This past year I have given myself a crash course on the desirability for Roth conversions. As a rough number, I would say if you can get the tax-deferred part below $1 million before you hit SS, you'd be in a much better position. Some of the considerations are SS taxation, IRMAA levels and what happens with all the numbers when one spouse passes away in the future.

Good luck and congratulations on retiring.
Mark
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2marshmallow
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by 2marshmallow »

Roadhog wrote: Thu Jan 14, 2021 7:38 am Sounds like a thoughtful approach. Just curious - what are planning to do for medical insurance before you are eligible for Medicare. Your wife is a year away but you have several years to go. Always interested in how early retirees solve this problem.
Yes, as you point out, we discovered that medical coverage is something to be reckoned with. We have budgeted $700 each per month for COBRA coverage, which lasts 18 months. DW will go on Medicare in about a year, which will reduce her cost to $400-ish (I think). When I go off Cobra I will have a couple of years on the ACA, so maybe $1100 or $1200 per month (?). So the overall cost shouldn't change too much from the $1400/mo total in our budget for medical.

2marshmallow
Topic Author
2marshmallow
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Re: Retiring now, thank you, Bogleheads! And tax question

Post by 2marshmallow »

angelescrest wrote: Wed Jan 13, 2021 6:48 pm Congratulations, and big respect for your thoughtful approach with your employer. :beer
Yes, we parted on really good terms. Online celebration, virtual high-fives all around, expensive bottles of wine gifted to me, etc. I did not realize this before, but that is important to me. It forms that last impression I have of my working career, and I will carry it for the rest of my life.

:sharebeer

2marshmallow
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