Steering through the shoals of IRMAA past the SS Tax Torpedo

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McQ
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Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

[If you are a Boglehead who gets bothered reading about prosperous people trying to become more prosperous by means of tax maneuvers, this thread is not for you.]

Disclaimer: “Cheryl” is not a real person but a composite intended to tease out general rules relevant to an entire group of similarly situated BH, hence the (initial) placement of this thread on the Theory board. For the record, all the characters in the dialogue below are fictional and any resemblance to persons living or dead is purely coincidental.

Background

IRMAA is a special penalty levied on moderately prosperous retirees. It is nothing the rich need worry about; once your retirement income gets up to $500,000 or so, the burden shrinks to become de minimis. The IRMAA danger zone is centered around 2023 income of $100-150,000 for singles or $200-300,000 for couples. That’s where it pinches.

Like I said, a penalty on prosperity.

The Social Security tax torpedo is aimed at the not quite so prosperous. The danger zone here is for retirees whose income would otherwise put them in the bottom half of the 22% bracket, i.e., an AGI of $50-80,000 for singles or $100-150,000 for couples. In this zone, retirees with ample social security income pay double tax on their other income (if you will allow me to round 1.85 up to 2.0).

Now to the audience for this thread: you are a retiree on Medicare and haven’t started Social Security yet. Looking ahead, you expect that a good portion of your income will come from voluntary withdrawals or Required Minimum Distributions from your Tax Deferred Account (tIRA, 401(k), 403(b), 457, or other qualified plan).

Net of Social Security, any pension, plus retirement plan distributions, you expect to enjoy a prosperous retirement. You can see IRMAA looming like an iceberg and the SS Tax Torpedo heading straight at you.

What can be done?

Type case

Meet Cheryl, never married and a practical gal with a long history of managing her personal finances to good effect. She looks forward to a Social Security payment near the maximum and has well over $1 million accumulated in her TDA. In keeping with her long history of thrift, she’s postponing SS until age 70, which she will reach in mid-2024.

Here in early 2023, not quite age 69, she perceives that she still has a good bit of flexibility for tax and income planning.

She did a Roth conversion last year up to just shy of the first IRMAA threshold; but it does not look to be enough, based on the five-year projection she made through 2027 (see below). IRMAA still threatens, and she will be high up in the torpedo range even if she manages to dodge IRMAA.

Tapping her pencil, she figures that her flexibility drains away in 2025, the first full year of Social Security, when the torpedo powers up. 2023 offers the most flexibility, but 2024 still offers some, since she’ll easily pass out the other side of the tax torpedo when there is only half a year of SS payments. By 2027, with SS and RMDs, every incremental dollar of income will potentially be taxed at a super-high rate, relative to what she is accustomed to paying.

We join her now at a holiday dinner with family.

Dinner with the family

Cheryl, tongue loosened with wine, shares her dilemma. “Why do I have to pay all that tax! I’m one of the little people.”

Her sister-in-law tells her to chill. “When RMDs kick in, you’ll be receiving tens of thousands of dollars in income above what you need to live. What do you care if a couple thousand dollars of that surplus goes to taxes? Someone has to pay for the soldiers who defend the homeland.”

Her sister Fran tries to reassure: “Aren’t you going to have to make voluntary withdrawals to cover living expenses this year and next until you have a full year of social security—won’t those cut down your TDA balance enough at least to escape IRMAA?”

Her brother Charles swirls his Scotch and shrugs. “That might get you out of IRMAA the first year, but your RMD income is going to go up and up over the first decade or two. You’ll be back into the IRMAA zone in a jiffy. I recommend you heavy up on income for the next two years. Drive your IRA withdrawals up near the top of the IRMAA range and put the surplus back into savings. Two years of multiple IRMAA is a small price to pay for avoiding any IRMAA at all for decades afterwards.”

Her nephew Peter, the CPA, tugged his chin. “I dunno Dad, I would have to see a present value analysis before ratifying that advice. Eight IRMAA payments over two years now, might be the PV equivalent of twelve to fifteen IRMMA payments later, and who knows what the tax law looks like twenty years down the road, when you’d just be breaking even?”

Turning to Cheryl, he said “You know about QCDs, right? If you find yourself $2000 over the IRMAA threshold, whatever, make a QCD of $2001 that year. It will almost pay for itself.”

Cheryl objected: “I won’t be eligible for QCDs until 2025 and they won’t do me any good before RMDs begin, it seems.” Her nephew shook his head: “once you are eligible at 70.5, QCDs reduce your TDA balance, which lowers your future RMD, which may keep you below the IRMAA threshold.”

Cheryl snorted. “Every $1000 I remove from my TDA reduces the first RMD by $37.74. At that rate I’m not charitable enough for QCDs to make a big enough dent.”

By extension, to reduce the RMD at age 73 by $1000 requires that her TDA balance somehow be made smaller by $26,500.

Cousin Celia interjects: “I don’t understand why you kept last year’s Roth conversion below the first IRMAA boundary? A dollar in Roth is worth more than a dollar in the TDA. Convert half your IRA balance this year if need be, and the rest next year. No more RMDs. IRMAA problem solved! Tax torpedo slinks away!

Cheryl’s brother nodded, “Sure, okay, but you don’t have to go full bore and convert everything, just put the heavy-up income I recommended into a Roth rather than savings. Same principle: pay now, save later.”

But her nephew was vigorously shaking his head. “Whoa Celia-- Cheryl can drive up through IRMAA #4 and still remain in the 24% bracket. But if she’s got to convert her entire $1 million+ TDA over two years, that’s going to drive her into the 32%, 35% or even 37% bracket in income tax alone, not counting IRMAA penalties. I don’t see how that strategy pencils out when her future RMDs were only going to put her into the 22% bracket.”

Uncle Curmudgeon stirs. “She’s not going to be in the 22% bracket. I make it to be the 40.7% bracket given the social security tax torpedo, 22% * 1.85. Paying income tax of 32% now to save 40.7% later doesn’t sound so bad, and I’m warming to Celia’s point of view. And if you believe as I do that the TCJA will expire as scheduled after 2025, then she’ll be saving 46.25%.”

Her CPA nephew grew agitated. “I’ve never liked that formulation. The so-called torpedo is just a recapture of an earlier tax break, the total exemption from tax of the smaller social security payout that most people receive. If you look at the cumulative tax paid, even way up in the torpedo Cheryl is still paying less if than if she had received the same dollars in some form other than Social Security.”

Everyone flinched as Curmudgeon slammed his hand on the table. “Wrong! Gotta use the marginal tax rate. If Cheryl makes a QCD of $1000 once RMDs begin, there in the torpedo, it will save her $407 in income tax. That’s real money, and real different from $220.”

After an uncomfortable silence Cheryl’s niece Janice, on break from law school, sniffs: “You told me over and over that you’ll probably end up leaving a substantial inheritance. Let me suggest that the best strategy is the one that maximizes your after-tax bequest to heirs. FWIW, I will move to California when I graduate from law school, and by the time you pass away, hopefully decades hence, I expect to be in the 48% marginal tax bracket, Federal and State combined.”

Celia: “Gotta be Roth conversions”

Curmudgeon: “Oww…”

Nephew: “I know some good CPAs in Los Angeles.”

Her sister-in-law stood up. “Got to get started on those dishes …” Whereupon, the dinner concluded.

Leaving Cheryl with no answer to her question: What should she do, in 2023 and maybe 2024, to lower her future tax burden once RMDs kick in during 2027 and beyond?

Here are the details of Cheryl’s projected income and TDA balances if no action is taken.

Image

Notes:
A 6% return was assumed, corresponding to what one would expect from a 30/70 stock/bond blend like the Vanguard Target Retirement Income fund, given inflation of 3%.

The TDA balances shown are before any deduction for living expense or Roth conversions in 2023 or 2024, but do reflect her earlier conversion(s). Cheryl estimates that annual living expenses could be covered with a $60,000 taxable withdrawal, putting her near the top of the 12% tax bracket, where she had been before last year’s Roth conversion.

And here is her projected 2027 tax situation, showing which income falls into which bracket, the operation of the tax torpedo, and the impact of IRMAA.

Image

Notes
If she had exactly $9,295 in other income this would make $8,374 of SS taxable, giving her total income equal to the standard deduction, and a tax bill of zero. Next rows take her through the 10% and 12% brackets. With an RMD of $57, 968 she exits the SS tax torpedo: from here out, only 85% of SS will be taxable, and her marginal rate returns to being her income tax rate (22%).

For a span of about $1400, that is, after which she hits the first IRMAA. That small gap motivated the title of the thread. The first IRMAA dollar amount is typically about 4% of the dollar span until the next IRMMA, after which it becomes 5% through IRMAA #4, after which it drops to a much smaller percent, becoming vanishingly small as a proportion as income climbs above $500,000.

For reference, here are projected tax brackets and IRMAA boundaries through 2027, assuming inflation at 3%.

Image

What do you recommend Cheryl do?
1. Let QCDs handle any mild trespass into IRMAA territory?
2. Large Roth conversions, maybe all the TDA balance, during her remaining two years of flexibility?
3. Smaller Roth conversions up to just short of IRMAA #1, to at least chip away at the problem?
4. Pay whatever taxes are owed, later, and get on with her life, now?
5. Factor her heirs (nephew and niece) into the decision? (Family history suggests a life expectancy of twenty-five or more years from today’s date)
Last edited by McQ on Fri Jan 06, 2023 2:15 pm, edited 1 time in total.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
sc9182
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by sc9182 »

A distant cousin Ms. CosmicRat indicates to use paid software to convert the best amount to avoid RMDs, and/thus maximize Roth - so, nieces can benefit upon inheriting the assets. (Alas, with recent RMD rule change to 75, many folks gets delayed RMD age of 75; but, software has to evolve with this fix)

Then: Uncle Leo comes around and says - convert to Roth everything in one single year (irrespective of tax rates, IRMAA tiers etc) - might I say, bad-Uncle - he might be IRS agent or something :-)
(sorry for snitching) ..

Other-(little)-brother SC mentions: If no pensions and no LTC policies are involved - save TDA balance of 300k to 500k toward LTC/memory-care/SNF etc needs down the lane — and possibly something extra for not-so-succesful niece or two. Just-in-case keep extra buffer to take care of SORR. Then, try to Roth-convert any remaining TDA balances judiciously. Chances are Cheryl would still have decent chunk remaining in TDA - but that’s ok .. If Cheryl badly want to save on taxes - relocate to less taxed/no-tax states during retirement (or Roth-conversion) phase of life ..
Do enjoy life - along the way :-)
curmudgeon
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by curmudgeon »

The SS torpedo becomes less and less avoidable because that tax is not adjusted for inflation; this years' inflation (and SS increase) probably moved things up by 5 years or so. For someone who is single and at top age 70 SS benefit level, that one may be largely a lost cause. For someone with a relatively lower SS benefit, and/or MFJ, there may be some more room, but that's also trickling away.

The nature of other income (interest, qualified dividends/LTCG, pension, etc) can have it's own impact as well.

My inclination here would be to manage to IRMAA levels... 1) withdraw as needed for living expenses/RMDs. 2) adjust income with Roth conversions or QCDs to fit a bit under an IRMAA breakpoint. 3) assume circumstances (congress changing the rules, inherited IRAs, etc) will come along to make overly elaborate planning for naught.

This general scenario is becoming very real for my wife and I. We retired a few years ago, but the factor of substantial ACA healthcare subsidies caused us to constrain taxable income and spend from savings. As we hit Medicare age, that constraint goes away, to be replaced by the higher income level (and less severe) IRMAA. We have more time, but the added complications of substantial state income tax rates and a few other life complications.
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CrazyCatLady
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by CrazyCatLady »

I find this an interesting thread because I’m Cheryl in about 15 years. I tried to work through the numbers (but tough to do 18 years out), and like Curmudgeon I have come to the conclusion that there is no way I’m going to be able to avoid the tax torpedo. I’ll do some Roth conversions in my 60’s, but large conversions don’t make sense since a large portion of my estate will go to charity. If I don’t upgrade my lifestyle, I shouldn’t have a problem staying under the first IRMAA tier most years as long as I make decent sized QCDs.

My related question is is there anything Cheryl could have done 10-15 years out to lessen the impact? If she is single, childless and in the 32% bracket (and maybe even 24% bracket) I don’t think there are a lot of options.
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Harry Livermore
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Harry Livermore »

Terrific post, McQ. I enjoyed the storytelling part!
I've always operated under the assumption that eventually SS will not only be fully taxable for us, but when creating my projections, I have also baked in a reduction in benefits... as my spouse and I will begin collecting after the SSA's projected date of not meeting obligations.
IRMAA is the lever that I really wish to pull.
I have a rough plan to continue to convert to Roth (and accelerate this if our income trends down) but I have not done any sophisticated analysis. I'll be watching this thread.
Cheers
Parkinglotracer
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Parkinglotracer »

I loved the story although It’s a little over my head - I’ll understand it better as I live it and complain after I do my taxes the next two decades lol

The good news for Cheryl and myself - lately the market decline is taking care of the projected high TDA RMDs.

I
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celia
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by celia »

McQ wrote: Thu Jan 05, 2023 5:11 pm The Social Security tax torpedo is aimed at the not quite so prosperous. The danger zone here is for retirees whose income would otherwise put them in the bottom half of the 22% bracket, i.e., an AGI of $50-80,000 for singles or $100-150,000 for couples. In this zone, retirees with ample social security income pay double tax on their other income (if you will allow me to round 1.85 up to 2.0).
Cheryl and her relatives should stop using the term “tax torpedo”. Not needing to pay taxes on SS is a benefit only for those with lower incomes. Instead, they should consider that all the income will be taxed except that only 85% of SS will be taxed. So Cheryl also benefits from having 15% of her SS not taxed. (Most states also don’t tax any of the SS.) It’s all a frame of mind on how you choose to think of it.

Here are the details of Cheryl’s projected income and TDA balances if no action is taken.

Image
Hopefully, Cheryl notices that the tax-deferred balance projections increase each year more than the RMDs. This will allow the balance to continue growing until her RMD factor increases to the same as the account growth rate. To prevent this, the earlier she converts, the better. She should withdraw AT LEAST twice the next RMD each year (to taxable, withheld for taxes, QCDs, or Roth Conversions). Once RMDs start, she needs to put at least the amount of the RMD into any of the first three choices.

And if she is willing to put in the extra effort, she should figure out how to level out her Taxable Income over all her remaining years. This will prevent having a few years of low tax brackets followed by many more years of higher-than-necessary tax brackets for all the years after that.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
Mike Scott
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Mike Scott »

"Tax Torpedo" is unhelpful click bait. Only part of SS is taxable so why not focus on the part of SS that is not taxed? People manage their income and taxes to all sorts of different targets for their own purposes.
headedwest
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by headedwest »

Thank you so much for considering scenarios for people who are likely to file their taxes as single when they retire.

If nothing else, it seems like Cheryl would benefit from breaking down the target date account into stocks and bonds so she can shift her stock allocation out with either Roth conversions or distributions beyond her living expenses and invest them in a taxable account. That would help to slow the growth of her pre-tax account.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by tibbitts »

headedwest wrote: Fri Jan 06, 2023 8:11 am Thank you so much for considering scenarios for people who are likely to file their taxes as single when they retire.

If nothing else, it seems like Cheryl would benefit from breaking down the target date account into stocks and bonds so she can shift her stock allocation out with either Roth conversions or distributions beyond her living expenses and invest them in a taxable account. That would help to slow the growth of her pre-tax account.
In theory yes, but I did exactly that and so far am worse off than I would have been by converting/spending a combination of equity and fixed income, or just fixed income. Most people have a somewhat narrow range of years between retirement and SS and RMDs so market returns during those periods will determine what order would have been best for conversions. It's sort of like the arguments over DCA: what's best in theory won't work out for everyone.
headedwest
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by headedwest »

tibbitts wrote: Fri Jan 06, 2023 8:54 am
headedwest wrote: Fri Jan 06, 2023 8:11 am If nothing else, it seems like Cheryl would benefit from breaking down the target date account into stocks and bonds so she can shift her stock allocation out with either Roth conversions or distributions beyond her living expenses and invest them in a taxable account. That would help to slow the growth of her pre-tax account.
In theory yes, but I did exactly that and so far am worse off than I would have been by converting/spending a combination of equity and fixed income, or just fixed income. Most people have a somewhat narrow range of years between retirement and SS and RMDs so market returns during those periods will determine what order would have been best for conversions. It's sort of like the arguments over DCA: what's best in theory won't work out for everyone.
No argument here. But I do think the "so far" part of your comment is important. There are so many unknowns in these types of decisions, so if the stock funds are not tapped for a considerable number of years, your decision may ultimately seem better to you. For immediate spending, no, don't take distributions that are purely stocks.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by tibbitts »

headedwest wrote: Fri Jan 06, 2023 9:38 am
tibbitts wrote: Fri Jan 06, 2023 8:54 am
headedwest wrote: Fri Jan 06, 2023 8:11 am If nothing else, it seems like Cheryl would benefit from breaking down the target date account into stocks and bonds so she can shift her stock allocation out with either Roth conversions or distributions beyond her living expenses and invest them in a taxable account. That would help to slow the growth of her pre-tax account.
In theory yes, but I did exactly that and so far am worse off than I would have been by converting/spending a combination of equity and fixed income, or just fixed income. Most people have a somewhat narrow range of years between retirement and SS and RMDs so market returns during those periods will determine what order would have been best for conversions. It's sort of like the arguments over DCA: what's best in theory won't work out for everyone.
No argument here. But I do think the "so far" part of your comment is important. There are so many unknowns in these types of decisions, so if the stock funds are not tapped for a considerable number of years, your decision may ultimately seem better to you. For immediate spending, no, don't take distributions that are purely stocks.
Well, yes and no. You have those relatively few years between retirement and IRMAA/SS/RMDs when you're doing conversions, or at least large conversions. So you're going to go from $x in deferred at the beginning of that period to $y at the end. Maybe that's 5 years; definitely not 50 years. So I'm roughly far enough along now to know that I'll never recover from having gone with the equity-first model.
headedwest
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by headedwest »

tibbitts wrote: Fri Jan 06, 2023 10:18 am
headedwest wrote: Fri Jan 06, 2023 9:38 am
tibbitts wrote: Fri Jan 06, 2023 8:54 am
headedwest wrote: Fri Jan 06, 2023 8:11 am If nothing else, it seems like Cheryl would benefit from breaking down the target date account into stocks and bonds so she can shift her stock allocation out with either Roth conversions or distributions beyond her living expenses and invest them in a taxable account. That would help to slow the growth of her pre-tax account.
In theory yes, but I did exactly that and so far am worse off than I would have been by converting/spending a combination of equity and fixed income, or just fixed income. Most people have a somewhat narrow range of years between retirement and SS and RMDs so market returns during those periods will determine what order would have been best for conversions. It's sort of like the arguments over DCA: what's best in theory won't work out for everyone.
No argument here. But I do think the "so far" part of your comment is important. There are so many unknowns in these types of decisions, so if the stock funds are not tapped for a considerable number of years, your decision may ultimately seem better to you. For immediate spending, no, don't take distributions that are purely stocks.
Well, yes and no. You have those relatively few years between retirement and IRMAA/SS/RMDs when you're doing conversions, or at least large conversions. So you're going to go from $x in deferred at the beginning of that period to $y at the end. Maybe that's 5 years; definitely not 50 years. So I'm roughly far enough along now to know that I'll never recover from having gone with the equity-first model.
I don't question your opinion about your situation. My situation is that I'm 5-10 years before "Cheryl," so I'm glad I have a little bit more time than she does to make these decisions, but I do struggle over making them, in part because I know there are people like you who have an experience I'm hoping to avoid.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Circe »

Interesting and well-written story, thanks.

I also agree with another poster about how painful ACA can be before Medicare; my first year on it also really hurt.

$500k is probably low for memory or SNF care. I'm around the same age and plan on needing closer to $1 million for CCRC in 5-10 years. That would take precedence over leaving something for the relatives to me, especially since they'll be well into adulthood in 25 years and hopefully have done well in their careers.

"It's tough to make predictions, especially about the future" (Yogi Berra) and even harder to predict how Congress will change the tax code. Based on what we know today, she should probably move some assets to a Roth. The only good thing is that they have a reduced value today and can grow in the Roth.

There's always this:
4. Pay whatever taxes are owed, later, and get on with her life, now?

I may have additional thoughts after I work on my own tax planning over the weekend....
Last edited by Circe on Fri Jan 06, 2023 12:56 pm, edited 1 time in total.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Abe »

I appreciate the OP posting this, but I had to quit reading about half way through before my brain exploded.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by tibbitts »

headedwest wrote: Fri Jan 06, 2023 10:47 am
tibbitts wrote: Fri Jan 06, 2023 10:18 am
headedwest wrote: Fri Jan 06, 2023 9:38 am
tibbitts wrote: Fri Jan 06, 2023 8:54 am
headedwest wrote: Fri Jan 06, 2023 8:11 am If nothing else, it seems like Cheryl would benefit from breaking down the target date account into stocks and bonds so she can shift her stock allocation out with either Roth conversions or distributions beyond her living expenses and invest them in a taxable account. That would help to slow the growth of her pre-tax account.
In theory yes, but I did exactly that and so far am worse off than I would have been by converting/spending a combination of equity and fixed income, or just fixed income. Most people have a somewhat narrow range of years between retirement and SS and RMDs so market returns during those periods will determine what order would have been best for conversions. It's sort of like the arguments over DCA: what's best in theory won't work out for everyone.
No argument here. But I do think the "so far" part of your comment is important. There are so many unknowns in these types of decisions, so if the stock funds are not tapped for a considerable number of years, your decision may ultimately seem better to you. For immediate spending, no, don't take distributions that are purely stocks.
Well, yes and no. You have those relatively few years between retirement and IRMAA/SS/RMDs when you're doing conversions, or at least large conversions. So you're going to go from $x in deferred at the beginning of that period to $y at the end. Maybe that's 5 years; definitely not 50 years. So I'm roughly far enough along now to know that I'll never recover from having gone with the equity-first model.
I don't question your opinion about your situation. My situation is that I'm 5-10 years before "Cheryl," so I'm glad I have a little bit more time than she does to make these decisions, but I do struggle over making them, in part because I know there are people like you who have an experience I'm hoping to avoid.
Probably the more time you spread conversions/spending over, the greater the odds that equity-first will prove better than a balanced approach.
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Kenkat
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Kenkat »

Abe wrote: Fri Jan 06, 2023 11:43 am I appreciate the OP posting this, but I had to quit reading about half way through before my brain exploded.
I just joined brother Charles for another scotch and stayed out of it. :happy

It’s a fantastic story - boring financial stuff brought to life through creative writing!
ModifiedDuration
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by ModifiedDuration »

Circe wrote: Fri Jan 06, 2023 11:41 am Interesting and well-written story, thanks.

I hope that someone notices the IRMAA problem in Congress, or perhaps Yellen might notice and bring it to their attention. Obviously it should be inflation-indexed. With lower rates of inflation, not a huge issue but with higher rates it hurts especially over time.

I also agree with another poster about how painful ACA can be before Medicare; my first year on it also really hurt.

$500k is probably low for memory or SNF care. I'm around the same age and plan on needing closer to $1 million for CCRC in 5-10 years. That would take precedence over leaving something for the relatives to me, especially since they'll be well into adulthood in 25 years and hopefully have done well in their careers.

"It's tough to make predictions, especially about the future" (Yogi Berra) and even harder to predict how Congress will change the tax code. Based on what we know today, she should probably move some assets to a Roth. The only good thing is that they have a reduced value today and can grow in the Roth.

There's always this:
4. Pay whatever taxes are owed, later, and get on with her life, now?

I may have additional thoughts after I work on my own tax planning over the weekend....
IRMAA is indexed for inflation.
technovelist
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by technovelist »

Maybe she should get married.
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McQ
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

CrazyCatLady wrote: Thu Jan 05, 2023 10:35 pm I find this an interesting thread because I’m Cheryl in about 15 years. I tried to work through the numbers (but tough to do 18 years out), and like Curmudgeon I have come to the conclusion that there is no way I’m going to be able to avoid the tax torpedo. I’ll do some Roth conversions in my 60’s, but large conversions don’t make sense since a large portion of my estate will go to charity. If I don’t upgrade my lifestyle, I shouldn’t have a problem staying under the first IRMAA tier most years as long as I make decent sized QCDs.

My related question is is there anything Cheryl could have done 10-15 years out to lessen the impact? If she is single, childless and in the 32% bracket (and maybe even 24% bracket) I don’t think there are a lot of options.
Although you are not in my bulls-eye target audience, you are part of my larger target audience (4-5 more posts scheduled as I offer my solutions to the questions posed in the OP). I will be curious to hear your takeaway as you digest the next few posts and comments by others.

My short answer for someone in your situation is to consider retiring as early as possible and living as well as possible by voluntary withdrawals until Social Security begins. You may also be heartened several posts out, when I demonstrate the power of QCDs, so that you can engage in the desired charity while still alive.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Circe »

ModifiedDuration wrote: Fri Jan 06, 2023 11:55 am
IRMAA is indexed for inflation.
Thanks, fixed it. I guess that I misunderstood something that I had read a few years ago. I am not yet taking distributions so haven't yet had to deal with it.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by LadyGeek »

This thread has been moved to the Personal Finance (Not Investing) forum. It started as a general discussion, but is focused on taxes. Also, the replies are personally actionable.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

LadyGeek wrote: Fri Jan 06, 2023 1:42 pm This thread has been moved to the Personal Finance (Not Investing) forum. It started as a general discussion, but is focused on taxes. Also, the replies are personally actionable.
Thanks. Last time I started a thread like this in Personal Finance, it got locked as non-actionable, and unlocked only after a request that it be moved to the Theory board. Please forgive my confusion.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by LadyGeek »

It depended on the situation at that time.

Acronym decoder:

- IRMAA - Income-Related Monthly Adjustment Amount

- QCD - Qualified charitable distribution

What is TDA in your first post? Please expand the acronym, as it doesn't appear to be commonly used.

Additional info that will help understand the "Social Security Tax Torpedo": How Retirees Can Avoid the "Tax Torpedo" | Morningstar

The wiki has a calculator: Social Security tax impact calculator
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by tibbitts »

McQ wrote: Fri Jan 06, 2023 12:46 pm You may also be heartened several posts out, when I demonstrate the power of QCDs, so that you can engage in the desired charity while still alive.
Well, yes but it seems like on a average single people without kids may have greater need (especially per-person) for medical and related expenses, some of which may qualify for deductions. So early-stage QCDs might not be the best plan for everyone.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

What Cheryl could do

I proceed through the family suggestions one by one. Here is a simplified income projection for Cheryl out through ten years. In this image, nothing is done (sister-in-law recommendation).

Image

As indicated earlier, on this no-action branch Cheryl will exceed the IRMAA #1 threshold as soon as RMDs begin. RMDs, given the 6% expected return on the TDA, will rise faster than the IRMAA boundary, which goes up with inflation at the assumed 3% rate. If nothing is done, Cheryl will never escape IRMAA until, maybe, late in her 90s; and she may even begin to surpass IRMAA #2 in her late 80s, especially if her TDA investments enjoy a good run.

First attempt at remediation: subtract living expenses

But something can be done: Cheryl needs money to live, this year and next. Having spent all her taxable account on living expenses and paying tax on Roth conversions up to this point, there are only two possible sources of income for her in 2023: 1) stop deferring social security; and 2) start voluntary withdrawals from the TDA. The first is silly, leaving the second option. Voluntary withdrawals reduce future RMDs the same as Roth conversions do. BTW, her Roth balances will be ignored in the first few iterations, since they don’t affect her tax situation, and she has so much surplus income from RMDs alone that she is unlikely ever to tap her Roth.

How much does Cheryl need for expenses? Call it $60,000 in 2023, to cover taxes, and increase that amount by inflation each year. Not coincidentally, this will take her to the top of the 12% bracket. In 2024, the voluntary withdrawal will be reduced, as six months of SS income is booked; and once RMDs start, she’ll blow right past her income needs and have no more occasion for voluntary withdrawals. Here is the impact:

Image

Good news: her age 73 income in 2027 now falls short of triggering IRMAA. Likewise, her age 74 income, age 75 income and age 76 income; she does not hit IRMAA until age 77 in 2031. Voluntary withdrawals proved to be powerful!

I start with the beneficial effect of voluntary withdrawals for a reason. The literature on Roth conversions sometimes forgets that 60-something retirees may indeed be (temporarily) in a low tax bracket before SS and RMDs kick in; but typically tax brackets up through 12% (at least) will have to be filled if living expenses must be covered from income. These voluntary withdrawals taken from the TDA reduce future RMDs by just as much as a Roth conversion would—but of course, being spent, don’t build after-tax wealth as a Roth conversion can.

Returning to this first iteration, the math of RMD reduction is quite daunting. As noted upthread, to reduce the age 73 RMD by $1000 requires the future TDA balance to be smaller by about $26,500. Cheryl took out over $100,000 in living expenses ; it was only enough to pull income below the IRMAA threshold for four years. The withdrawals scarcely dented her TDA balance; withdrawals were less than the annual appreciation.

Second attempt: Continue Roth conversions up just short of IRMAA #1

Although her living expenses exhaust the 12% tax bracket, Cheryl has room under the first IRMAA threshold for continued small Roth conversions of some tens of thousands of dollars per year. These could continue until the first RMD, but will have to shrink a bit after a full year’s social security is in hand, lest they be taxed in the nose cone of the tax torpedo, at 40.7%.

Really not a good idea to do Roth conversions at 40.7%, IMHO.

Here is the effect:

Image

Good news: these continued small conversions, amounting to almost $150,000 over four years, have a measurable effect: now the first IRMAA will not be triggered until age 80, twelve years out, and three years further than withdrawals for living expenses were able to achieve.

Bad news: because RMDs increase faster than inflation, IRMAA could be postponed a few years but still not permanently put off. RMDs increase faster than inflation during these early years because the TDA is still growing even after taking the RMD, and the RMD withdrawal percentage is going up steadily.

More good news: in the first few years some of the RMD reduction from these conversions occurs within the 40.7% tax torpedo range. Cheryl converts at 22%, saves 40.7% in tax on part of the reduction in RMD, and averts IRMAA for a few more years. Not too shabby.

Cheryl should definitely make these under-IRMAA Roth conversions.

Pause for evaluation

A rational person in Cheryl’s situation could stop at this point. She might reason: who knows what the tax code will look like in a dozen years? Maybe I’ll worry about IRMAA later. Thinking again about what her sister-in-law said, Cheryl realizes that at age 80 in 2034, after withdrawals and conversions:

1. The IRMAA penalty will be about 1% of her total income
2. And less than 0.1% of her TDA wealth

“Whatever” is surely a rational response to an annual penalty of that magnitude.

There is another good argument for calling a halt to obsessing about IRMAA, now that it has been pushed out so far into the future. IRMAA is scary because it functions as a cliff edge tax: go one dollar over, and you owe the full amount of the penalty, over a thousand dollars to start in Cheryl’s case. That’s an astronomical marginal rate on that first dollar, alarming even the most phlegmatic.

But there’s a flip side to that cliff edge: fall one dollar short, and you don’t pay a cent. Because the IRMAA threshold changes each year with inflation, errors in projected future inflation can budge the predicted threshold up or down by thousands of dollars. For instance: suppose these projections had been prepared before 2021 and 2022. Inflation in the first two years would then have been 7% and 7%, not 3%. How much difference would that make to the 2034 IRMAA threshold, which Cheryl is on track to breach by a few hundred dollars?

In the current projection the value for IRMAA threshold #1 in 2023, of $97,000, increases to $134,271, i.e., by 1.03 to the 11th power. If for the first two years the increase were to be 7%, then the 2034 threshold would $144,901, up $10,000. Cheryl would not hit the first IRMAA threshold until 2038, when she is 84.

Continuing to draw out the implications of the cliff edge:
Q: Why is Cheryl going to hit the IRMAA threshold sooner or later?
A: Because she has large RMDs growing larger each year.
Q: Why is that?
A: Because she started this illustrative example with a million dollar plus TDA balance growing at a moderate rate of 6%.
Q: Is it possible that annual returns might be volatile, even if their geometric (annualized) mean comes in at 6%?
A: Of course; what’s your point?

The point: the TDA might be flat in 2033. That means it will be about $90,000 lower than in the illustration. And that means the following year RMD might be lower by about $4500. Which is more than enough to keep Cheryl out of the first IRMAA, maybe for more than one year if markets are slow to recover.

Of course, this cuts the other way too. Since almost all of Cheryl’s future RMDs look to be surplus, she might consider moving to a more aggressive investment strategy than the 30/70 mix shown. If so, she might have one or two or three hundred thousand dollars more in the TDA by 2027, driving her RMDs right back up into IRMAA territory.

Trick question (for some): which is better, A or B

A. $100,000s more wealth and have to pay IRMAA?
B. $100,000s less wealth and don’t have to pay IRMAA?

I hope you answered ‘A’.

Back to Cheryl. She was about to close her laptop when she remembered her nephew’s comments about QCDs. Looking again at her spreadsheet she sees that her RMDs only barely trigger IRMAA in 2034, and are only a couple thousand dollars over the threshold the following year.

She rubs her hands. “If QCDs were to allow me to push the first IRMAA out to several years past age 80, I will definitely not worry about it until then!”

Next up: the comforting math of QCDs in the face of IRMAA.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by celia »

LadyGeek wrote: Fri Jan 06, 2023 2:20 pm Acronym decoder:

- IRMAA - Income-Related Monthly Adjustment Amount

- QCD - Qualified charitable distribution

What is TDA in your first post? Please expand the acronym, as it doesn't appear to be commonly used.
TDA always makes me think of TDAmeritrade (where I had to monitor accounts for a relative). Looking it up in a financial list of acronyms gives me “Time Deposit Account”. Neither makes sense in the current context. I think McQ made it up himself as there doesn’t seem to be another financial term that is often capitalized and needs to be abbreviated.
Last edited by celia on Fri Jan 06, 2023 4:28 pm, edited 1 time in total.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by ModifiedDuration »

celia wrote: Fri Jan 06, 2023 4:25 pm
LadyGeek wrote: Fri Jan 06, 2023 2:20 pm Acronym decoder:

- IRMAA - Income-Related Monthly Adjustment Amount

- QCD - Qualified charitable distribution

What is TDA in your first post? Please expand the acronym, as it doesn't appear to be commonly used.
TDA always makes me think of TDAmeritrade (where I had to monitor accounts for a relative). Looking it up in a financial list of acronyms gives me “Time Deposit Account”. Neither make sense in the current context. I think McQ made it up himself.
Or Tax Deferred Accounts.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by celia »

ModifiedDuration wrote: Fri Jan 06, 2023 4:28 pm Or Tax Deferred Accounts.
Grammatically, this should be “Tax-deferred Accounts”.

And right now there is another thread about a Treasury Direct Account.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by sandramjet »

For what it's worth I assumed it was Tax Deferred Account. That abbreviation seems to be seen frequently on the web
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by sandramjet »

For what it's worth I assumed it was Tax Deferred Account. That abbreviation seems to be seen frequently on the web
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by teen persuasion »

Cheryl estimates that annual living expenses could be covered with a $60,000 taxable withdrawal, putting her near the top of the 12% tax bracket, where she had been before last year’s Roth conversion.
But something can be done: Cheryl needs money to live, this year and next. Having spent all her taxable account on living expenses and paying tax on Roth conversions up to this point, there are only two possible sources of income for her in 2023: 1) stop deferring social security; and 2) start voluntary withdrawals from the TDA. The first is silly, leaving the second option. Voluntary withdrawals reduce future RMDs the same as Roth conversions do. BTW, her Roth balances will be ignored in the first few iterations, since they don’t affect her tax situation, and she has so much surplus income from RMDs alone that she is unlikely ever to tap her Roth.
Cheryl should have been doing Roth conversions BEFORE last year, and/or living on withdrawals from her TDA instead of on taxable $$. It isn't clear how long ago she retired, but it's obviously not *just* last year. If she realized RMDs would push her into the 22% bracket, she should not have tried to stay in the 12% bracket so long, only compounding the growth in the TDA.

Since you mentioned that she turns 70 mid-year, I wonder if she could utilize a trick other bogleheads have mentioned, to get a bit more time for more conversions: delay SS until age 70.5 into 2025, then get the back 6 months payment + the normal annual payout. No SS in 2024, more conversions. Total SS is higher in 2025, but that might be somewhat advantageous in the calculation of taxable SS (using half of SS to start the calculation) with a reduced TDA withdrawal/conversion.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by RetiredAL »

McQ wrote: Fri Jan 06, 2023 3:53 pm
Good news: these continued small conversions, amounting to almost $150,000 over four years, have a measurable effect: now the first IRMAA will not be triggered until age 80, twelve years out, and three years further than withdrawals for living expenses were able to achieve.
I retired in 2016 at age 66 with $1M in IRA's and did similar modeling relating to what happens to the last person standing. I needed a 2.5% withdrawal from my IRA on top of our SS to cover for spending. At that time, the starting RMD at age 70 would have been right at 4%. I came to the conclusion that taking the remainder of that 4% as a conversion would likely keep the last standing in a better position both tax-wise and IRMAA-wise. So across 5 years, I converted $120K.

This year is my first RMD year. My IPS (Investing Policy Statement) has a section about doing conversions on top the RMD if the IRA's exceeded a certain number. 12 month's ago, it looked like I would exceed that threshold 2022. Mr Bear took care of that.

I fully funded Wife's and my Roth's, since the year after after Roth's were created, instead of maximizing the 401K. If I had not done the Roth's, the last standing between us could have easily been your poster person. Did I understand those factors 20+ years ago? No!
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by WoodSpinner »

McQ,

So far I am following the story and thought process — interesting case study.

A couple of points resonated with our plans:
  1. Using the TDA account to cover the Cashflow needs is a solid strategy, especially since she only has a TDA, Roth or SS for the funding.
  2. It may have been implied in your Case Study, but we are also doing the same for our Federal and State Taxes — paid via TDA distributions in December, with 100% withheld for taxes.
  3. Interestingly enough, our plan starting 2023 is to cover our Cashflow needs from TDA withdrawals and STOP further Roth Conversions. By targeting our income to the top of the 22% bracket (this should take care of our planned Cashflow), we are also at a Tax equilibrium point (at least as best we can model).
  4. The costs for hitting the IRMAA-Tier1 are really quite low so I am much more focused on the impact of changes to the Marginal Brackets.
  5. The primary driver for our previous years Roth conversions was to improve the Resilience of our Retirement Finances by growing our Roth accounts. We started in Retirement with 95/0/5 (TDA, Roth, Taxable) and are now (75/25/0).
What I think is missing from the Case Study so far:
  • We have little insight into her priorities and Retirement Goals.
  • Does she plan larger expenses now so she can take advantage of her GoGo years?
  • Is she pretty settled down?
  • How important are charity and bequeaths to her?
  • How is she planning for LTC needs? This may affect the amount she should LEAVE in the TDA since a majority of those expenses are Deductible.
  • We don’t know the size of her current Roth. It was implied (at least I think so) that her Taxable accounts are close to Zero.
  • Her Retirement Financing seems very Fragile since she has to tap her TDA for Emergencies or other unexpected expenses. Resilience is an underrated driver for conversions for many of us who do not have a well balanced asset location across IRA, Roth or Taxable.
  • What I haven’t seen (yet) are her Tax projections (Fed + State) . A good general metric is to try balancing taxes paid across Retirement in order to optimize one’s Finances.
  • If tax Savings are a key Conversion driver for Cheryl then she also needs to understand the Breakeven point of not doing Conversions versus other options. A breakeven point close to expected mortality is NOT a strong driver for paying taxes early to save on them later.
Looking forward to seeing how this study evolves….

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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by privateID »

I have found this thread quite interesting. Anyone who has done similar planning with their own spreadsheet or a software product has pondered these questions. In my case, I am 56 and plan to retire in 3.5 years. I an MFJ, so big difference to this case but I always have an eye on the eventual single survivor case. I have TDA accounts and Roth accounts and practically no taxable account. In my projections, from age 60 to 70 I am doing what is being proposed - I first withdraw from my TDA up to the the point of my needed expenses (at some point I may get a small inheritance that will cover expenses for a few years). After TDA withdrawals for expenses, I next do Roth conversions up to the top of the 12% (future 15%) tax bracket. My spreadsheet has the ability to withdraw/convert to the lower IRMAA limit or top of the 25% tax bracket, but for now I don't think that is necessary. My projections show I will remain in the 15% tax bracket for as long as we are MFJ up to age 100. So, for now I am expecting only to withdraw/convert to the top of the 15% bracket. Part of that plan was influenced by some of Dr McQ's past conversations. But I am still pondering if I should withdraw/convert more between 60-70 (also pondering TDA vs Roth for the next 3.5 years). Now, when I change some input variables, I can hit the next tax bracket and even IRMAA. For example, when I don't use static returns (I can do Monte Carlo runs in my spreadsheet), sometimes I see cases where I jump a tax bracket here and there or even hit IRMAA. If I increase my rate of return (I use 6% stock returns), that also affects things. Inflation, with everything that is tied to it, also changes the equation. And, of course, the single survivor case changes everything. So my dilemma is finding a sweet spot where I can change these variables and still come out on top (whatever that means) most of the time.

One other point. The age between SS (70.5) and RMDs (now 75) is also really interesting time. For now, I plan on withdraw/convert to the top of 10% tax bracket, but that may change.

The big elephant in the room, in my opinion, is SS taxation. Given that the SS taxation equation is the only thing in my spreadsheet not tied to inflation, and also given potential SS funding issues, I have to believe that things will change.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by JoinToday »

WoodSpinner wrote: Fri Jan 06, 2023 7:48 pm ........
[*]What I haven’t seen (yet) are her Tax projections (Fed + State) . A good general metric is to try balancing taxes paid across Retirement in order to optimize one’s Finances.
[*]If tax Savings are a key Conversion driver for Cheryl then she also needs to understand the Breakeven point of not doing Conversions versus other options. A breakeven point close to expected mortality is NOT a strong driver for paying taxes early to save on them later.

[/list]

Looking forward to seeing how this study evolves….

WoodSpinner
I agree with the tax projections (Fed + State). Balancing taxes + IRMAA + other fees paid across retirement is a good general starting point/guideline. But there are lots of uncertainties.

What is the break even point you are referring to? The decision to do Roth conversions is almost all based on "tax rates" (current vs future). Tax rates include IRMAA, etc. I think McQ had a previous posting where this was discussed. If there is some sort of break even point, I would argue that the decision to do Roth conversions would be acceptable even if the break even point was later than the expected lifespan (but it probably doesn't make too much difference one way or the other, so I agree with you that it is NOT a strong driver).

The argument is similar to the decision when to take social security: break even analysis says it doesn't matter too much. But waiting to take SS addresses the tail risk of living a long time. If you wait until age 70 to take SS, and die at 75, that is unfortunate. If you take SS at 62/65, and live to 95 barely getting by. One needs to look at not only the likelihood, but also the impact of the choice. In this case, the impact of Roth conversions is probably not too meaningful. As you stated, her retirement financing seems fragile.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

LadyGeek wrote: Fri Jan 06, 2023 2:20 pm It depended on the situation at that time.

Acronym decoder:

- IRMAA - Income-Related Monthly Adjustment Amount

- QCD - Qualified charitable distribution

What is TDA in your first post? Please expand the acronym, as it doesn't appear to be commonly used.

Additional info that will help understand the "Social Security Tax Torpedo": How Retirees Can Avoid the "Tax Torpedo" | Morningstar

The wiki has a calculator: Social Security tax impact calculator
You and I worked through this issue in a thread some months ago, after which you graciously added TDA to the list of acronyms on the wiki: tax-deferred account.

As to whether or not it is in common use, per Celia: William Reichenstein uses it in his Journal of Financial Planning articles on Roth conversions. I don't know of a more prominent writer in this space, or a more prestigious journal outlet devoted to financial planning issues. I hope you will allow me to continue using TDA here at Bogleheads.

It's so much more compact than the expansion I gave in the 5th paragraph of the OP: "...Required Minimum Distributions from your Tax Deferred Account (tIRA, 401(k), 403(b), 457, or other qualified plan)."
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by busdriver »

McQ wrote: Sat Jan 07, 2023 4:12 pm
LadyGeek wrote: Fri Jan 06, 2023 2:20 pm It depended on the situation at that time.

Acronym decoder:

- IRMAA - Income-Related Monthly Adjustment Amount

- QCD - Qualified charitable distribution

What is TDA in your first post? Please expand the acronym, as it doesn't appear to be commonly used.

Additional info that will help understand the "Social Security Tax Torpedo": How Retirees Can Avoid the "Tax Torpedo" | Morningstar

The wiki has a calculator: Social Security tax impact calculator
You and I worked through this issue in a thread some months ago, after which you graciously added TDA to the list of acronyms on the wiki: tax-deferred account.

As to whether or not it is in common use, per Celia: William Reichenstein uses it in his Journal of Financial Planning articles on Roth conversions. I don't know of a more prominent writer in this space, or a more prestigious journal outlet devoted to financial planning issues. I hope you will allow me to continue using TDA here at Bogleheads.

It's so much more compact than the expansion I gave in the 5th paragraph of the OP: "...Required Minimum Distributions from your Tax Deferred Account (tIRA, 401(k), 403(b), 457, or other qualified plan)."
I wonder what recommendations Dr. Reichenstein's software, (Income Strategy), would come up with for your original post? It was certainly of value for coming up with a plan how to solve my situation.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by WoodSpinner »

JoinToday wrote: Sat Jan 07, 2023 12:24 pm
WoodSpinner wrote: Fri Jan 06, 2023 7:48 pm ........
[*]What I haven’t seen (yet) are her Tax projections (Fed + State) . A good general metric is to try balancing taxes paid across Retirement in order to optimize one’s Finances.
[*]If tax Savings are a key Conversion driver for Cheryl then she also needs to understand the Breakeven point of not doing Conversions versus other options. A breakeven point close to expected mortality is NOT a strong driver for paying taxes early to save on them later.

[/list]

Looking forward to seeing how this study evolves….

WoodSpinner
I agree with the tax projections (Fed + State). Balancing taxes + IRMAA + other fees paid across retirement is a good general starting point/guideline. But there are lots of uncertainties.

What is the break even point you are referring to? The decision to do Roth conversions is almost all based on "tax rates" (current vs future). Tax rates include IRMAA, etc. I think McQ had a previous posting where this was discussed. If there is some sort of break even point, I would argue that the decision to do Roth conversions would be acceptable even if the break even point was later than the expected lifespan (but it probably doesn't make too much difference one way or the other, so I agree with you that it is NOT a strong driver).

The argument is similar to the decision when to take social security: break even analysis says it doesn't matter too much. But waiting to take SS addresses the tail risk of living a long time. If you wait until age 70 to take SS, and die at 75, that is unfortunate. If you take SS at 62/65, and live to 95 barely getting by. One needs to look at not only the likelihood, but also the impact of the choice. In this case, the impact of Roth conversions is probably not too meaningful. As you stated, her retirement financing seems fragile.
Here is an example of a Roth Conversion Breakeven Chart. From my perspective it helps put the Tax Savings in perspective for each target scenario. It’s generated from the Forward looking tax projection and modeling different Roth Conversion targets. At least in this case, I don’t think Tax Savings are a strong driver for Conversions.

That said it’s optimized for Taxes paid as a Couple rather than for a Surviving Spouse or Beneficiaries. Different choices will significantly affect the Breakeven analysis.

IMHO, this is one of the decisions that should be made before any Conversion Planning.

Image

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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by veggivet »

Please forgive my naïveté, but can't both the shoals and the torpedo be avoided if the following conditions apply?

RMDs <$100k, and all are designated as QCDs.
Roth IRA is sufficient to fund all living expenses.
Social Security income plus any income from dividends and interest is low enough to stay below the threshold for SS taxation, after standard deduction is taken.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by curmudgeon »

veggivet wrote: Sun Jan 08, 2023 10:53 am Please forgive my naïveté, but can't both the shoals and the torpedo be avoided if the following conditions apply?

RMDs <$100k, and all are designated as QCDs.
Roth IRA is sufficient to fund all living expenses.
Social Security income plus any income from dividends and interest is low enough to stay below the threshold for SS taxation, after standard deduction is taken.
Yes, BUT...

1) it can be a pretty expensive process to get to that state (enough Roth conversions, and/or foregoing tax deferral at working years by doing Roth contributions).

2) your premise essentially devotes the full balance of your tax-deferred accounts to charity; a worthy goal, but not necessarily in the picture for most retirees.

3) the current tax brackets and large standard deduction are due to revert back in a few years with expiration of TCJA

4) while Social Security benefits are indexed for inflation, the taxation thresholds are not (which acts as a stealth tax increase, but one that's obscure enough it likely won't change).

Both IRMAA and the bump in marginal tax caused by SS taxation aren't so big as to justify twisting your life around to avoid them. Especially given that they are subject to the vagaries of congressional actions. At the same time, as the OP is illustrating, a bit of judicious reordering of tax payments that will have to be made in any case can yield some useful savings.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

WoodSpinner wrote: Fri Jan 06, 2023 7:48 pm McQ,

So far I am following the story and thought process — interesting case study.

A couple of points resonated with our plans:
  1. Using the TDA account to cover the Cashflow needs is a solid strategy, especially since she only has a TDA, Roth or SS for the funding.
  2. It may have been implied in your Case Study, but we are also doing the same for our Federal and State Taxes — paid via TDA distributions in December, with 100% withheld for taxes.
  3. Interestingly enough, our plan starting 2023 is to cover our Cashflow needs from TDA withdrawals and STOP further Roth Conversions. By targeting our income to the top of the 22% bracket (this should take care of our planned Cashflow), we are also at a Tax equilibrium point (at least as best we can model).
  4. The costs for hitting the IRMAA-Tier1 are really quite low so I am much more focused on the impact of changes to the Marginal Brackets.
  5. The primary driver for our previous years Roth conversions was to improve the Resilience of our Retirement Finances by growing our Roth accounts. We started in Retirement with 95/0/5 (TDA, Roth, Taxable) and are now (75/25/0).
What I think is missing from the Case Study so far:
  • We have little insight into her priorities and Retirement Goals.
  • Does she plan larger expenses now so she can take advantage of her GoGo years?
  • Is she pretty settled down?
  • How important are charity and bequeaths to her?
  • How is she planning for LTC needs? This may affect the amount she should LEAVE in the TDA since a majority of those expenses are Deductible.
  • We don’t know the size of her current Roth. It was implied (at least I think so) that her Taxable accounts are close to Zero.
  • Her Retirement Financing seems very Fragile since she has to tap her TDA for Emergencies or other unexpected expenses. Resilience is an underrated driver for conversions for many of us who do not have a well balanced asset location across IRA, Roth or Taxable.
  • What I haven’t seen (yet) are her Tax projections (Fed + State) . A good general metric is to try balancing taxes paid across Retirement in order to optimize one’s Finances.
  • If tax Savings are a key Conversion driver for Cheryl then she also needs to understand the Breakeven point of not doing Conversions versus other options. A breakeven point close to expected mortality is NOT a strong driver for paying taxes early to save on them later.
Looking forward to seeing how this study evolves….

WoodSpinner
Glad the OP engaged you, Woodspinner, and thank you for these posts. I was thinking of you when I prepared Post #4, due about Tuesday—specifically, the advice I gave you last year, which is that conversions into the IRMAA zone are not “robust.” I believe I can make a stronger claim now, that conversions into IRMAA are not wise; but you be the judge once you see it.

To address a few of your points:

1. Cheryl is not a real person seeking advice on the forum, but a composite designed to capture relatively general rules. So, no info on her investment policy, etc. She has a risk aversion consistent with holding a 30/70 portfolio as she approaches age 70, and is otherwise a utility-maximizer in the standard economic sense, preferring more (after-tax wealth) to less.

2. I don’t think it is fair to say that her retirement lacks resilience. She has $10,000 in a bank account for emergency funds (interest earnings so minimal as to be excluded here), she has a $100,000 equity line on her home that she can tap for any sudden large expense, and she has some $10,000s of Roth funds from last year’s conversion plus the Roth IRA contributions she made over the years. (She has no taxable account balance to speak of because she spent it paying conversion taxes outside, and because she accelerated the payoff of her mortgage once the interest ceased to be deductible after the 2017 tax changes (couldn’t itemize anymore), and because she paid some living expenses that way to stay in the 12% bracket for a few years).

3. We can ding her for not making more Roth conversions in past years (“This is the mess you’ll find yourself facing if you don’t get on those conversions RIGHT NOW.”). But in fairness to Cheryl, a dozen years ago, when she first started running spreadsheet projections, her TDA accounts totaled rather less than $500,000. She never imagined they would grow large enough to throw off $60,000 a year in RMDs (in part because she thought these would have to start at age 70.5). Then the bull market following 2012 occurred (she had a more aggressive allocation when she was still in the accumulation stage). And here she is.

4. Definitely, younger Cheryl did not grasp the details of how the tax torpedo works (she figured as soon as she hit income of $34,000, it would all be 85% taxable). She also was using the social security projections she got in the mail from the SSA.gov (the ones that don’t adjust for future inflation). And she didn’t think she’d be well enough off to defer social security to age 70. Using the constant dollar projections and taking benefits at full retirement age, her working estimate of SS was more like $25,000 when planning began.

5. Under those projections, with small RMDs and small social security, she figured to be in the 15% bracket in retirement. As her tax bracket while working was 25% or 28% (33% for a stretch, when she lived in a state with an income tax), Roth conversions didn’t seem to make sense. Why convert at 25% to save 15%? Why not take the government subsidy at 33% to contribute to a traditional 401(k)?

Bottomline: regardless of whether Cheryl could have done a better job with her retirement planning, it is what it is: now she’s high up in the social security tax torpedo staring down IRMAA.

Our focus must be on how to play the hand she was dealt.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Soon2BXProgrammer »

McQ wrote: Sun Jan 08, 2023 2:11 pm

Bottomline: regardless of whether Cheryl could have done a better job with her retirement planning, it is what it is: now she’s high up in the social security tax torpedo staring down IRMAA.
I currently do not have time to model the scenario you have created, but from past experience, the sooner the better doing a Roth conversion up to the top or either the tax bracket or the IRMAA tier that the person has spilled over into. Because if your subject to the additional tax you should maximize the space it buys.

Then repeat the analysis and see if this is likely to pull you out of the IRMAA in the future, if no, add another year.

While this is painful and the exact opposite of pushing out paying the IRMAA, if you can get under the limit, it can be helpful. This might not play out with only a single person, I see the biggest benefit in the married plans where you model eventually switching to single.

The marginal rate of the IRMAA with this logic should be calculated not as a spike but as a tax on the whole window being bought and utilized. (If you fail to use it, it is a spike, but if you use the whole window conceptually it is a rate on the whole window)

I'd be interested to hear your thoughts.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

Soon2BXProgrammer wrote: Sun Jan 08, 2023 2:31 pm
McQ wrote: Sun Jan 08, 2023 2:11 pm

Bottomline: regardless of whether Cheryl could have done a better job with her retirement planning, it is what it is: now she’s high up in the social security tax torpedo staring down IRMAA.
I currently do not have time to model the scenario you have created, but from past experience, the sooner the better doing a Roth conversion up to the top or either the tax bracket or the IRMAA tier that the person has spilled over into. Because if your subject to the additional tax you should maximize the space it buys.

Then repeat the analysis and see if this is likely to pull you out of the IRMAA in the future, if no, add another year.

While this is painful and the exact opposite of pushing out paying the IRMAA, if you can get under the limit, it can be helpful. This might not play out with only a single person, I see the biggest benefit in the married plans where you model eventually switching to single.

The marginal rate of the IRMAA with this logic should be calculated not as a spike but as a tax on the whole window being bought and utilized. (If you fail to use it, it is a spike, but if you use the whole window conceptually it is a rate on the whole window)

I'd be interested to hear your thoughts.
Stay tuned for a more on-point post in the next few days. In the meantime, I wanted to ratify one of your points: if you must incur IRMAA, best to voluntarily withdraw all the way up to the next IRMAA boundary.

Taking the IRMAA payment as $1000, and the IRMAA span as $25,000, and the underlying tax rate as 24%, if you freeze/choke one dollar in, your marginal tax rate is ($1000 +0.24)/$1 or 100,024%. Oww...

But if you voluntarily withdraw (convert) an additional $24,999, your marginal rate is 24% + ($1000/$24,999), which rounds to 28%. Much more palatable, and likely to reduce next year's RMD by about $1000--not enough to escape IRMAA in year two, but maybe allowing a QCD of modest amount to take you home.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

What QCDs can do for Cheryl

A Qualified Charitable Distribution is made directly from the TDA. If timely made, it counts against any RMDs due that year. Although not deducted on Schedule A and not included in AGI, a QCD functions as a tax deduction insofar as the RMD dollars it reduces would have been taxed. The tax savings are equal to ($ reduction in RMD * tax rate). And if a QCD should drop the taxpayer below an IRMAA threshold, the entire IRMAA payment is also saved.

The combination makes possible a sizable QCD which reduces spending power by $0, i.e., is effectively deducted at 100%. It will be useful in what follows to establish a baseline: the dollar amount of QCD which is exactly 100% deductible. Put another way, there must be some dollar increment over the IRMAA threshold which, removed as a QCD, drops income to the threshold, saving both income tax and IRMAA penalty, and thus, reducing spending power by nothing.

Let the IRMAA penalty be $1000 and the applicable tax rate 22%. The formula is:

100% deductible QCD = IRMAA + [(IRMAA * tax rate) / (1 – tax rate)]

For example: $1000 + (220 / .78) = $1,282.05

In words: if you are $1282.05 over the IRMAA threshold, and make a QCD of that amount, you will save the $1000 IRMAA penalty, and you will save $282.50 in income tax you would have owed on $1282.05 of RMD income.

(In practice, no one would or should try to cut it that close; you would set the QCD at $14-1500 or so, just in case you forgot about interest on some savings account, yada yada. No sane sightseer stands with the nail of their big toe right at the cliff edge.)

(Technically, you could also gamble that IRMAA thresholds two years from now, which this year’s income will be measured against, will be higher than today’s published thresholds; but that IS a gamble. I ignore that two-year delay for simplicity in this thread; but if you are 63 and contemplating a conversion, you had better not ignore that two-year look-back.)

Back to Cheryl: let’s say the highest tax rate she ever enjoyed (?) against a charitable contribution while she was working was the pre-TCJA rate of 28%. She neither expects nor needs her QCD to be 100% deductible.

And that means that if, say, she was over the IRMAA threshold by two or three or four thousand dollars, a QCD in that higher amount might still be acceptable in terms of the hit to spending power. Looking at the current illustration (3rd screenshot in my prior post), if her annual QCD allowance was that high, she might stay out of IRMAA for several more years, well into her 80s.

Still, there must be a limit, a pain point beyond where the QCD becomes so large that, deductible or not, Cheryl will shrink from donating that many thousands of dollars. Yes, she is really quite well off, but even with this level of assets and income, she can’t be confident she won’t run out of money if she lives to 100 and beyond (see post upthread by tibbitts). And even if she is feeling quite charitable, IRMAA comes around each year, and an annual series of modest charitable contributions that adds up to a substantial sum over 5-10 years is likely to be more psychologically acceptable.

How to estimate the pain point in general terms for a person in Cheryl’s approximate situation?

I see two possibilities:
1. Suppose, for grins, she’ll accept a QCD amount up to where it is 28% deductible, best she’s ever had. Sticking with the $1000 IRMAA and the 22% rate, how big would the QCD be that is exactly 28% deductible?
2. Alternatively, she will accept a hit to spending power of 2.5% of her income, call it $2500 for this illustration (2.5% is a typical level of charity in the US, not deductible for most people once the TCJA raised the standard deduction).

For the arithmetic below, I add to each row $1000, compute the deductible portion of the total QCD, and compute the dollar amount of the hit to spending power. Each extra $1000 is deducted at 22%, Cheryl’s marginal rate in the vicinity of the IRMAA threshold. To get to 28% overall will require a large enough contribution deducted at 22% to produce a weighted average of 28%, factoring in the 100% deductibility of the first $1282.05. Here is the table:

Image

Unsurprisingly, it takes a big QCD to get the weighted average down to 28%: over $16,000, about 15% of total income in the running example, and over one-fourth of Cheryl’s total RMD. That’s unlikely to be comfortable in the general case; but it is useful to know just how far over the IRMAA threshold you can go and still wipe it out with a QCD, while achieving a level of deductibility not different from what someone like Cheryl might find usual, customary, and familiar from the years before she was retired.

If the target instead is set at a $2,500 hit to spending power, then Cheryl could go $4,282.05 over the IRMAA #1 threshold, and wipe it out with a QCD that is deductible at 45%, even as it costs her less than $2500 in terms of spending power.

Looking back at Cheryl’s actual projections, a willingness to make a QCD that large should avert IRMAA for three more years, to age 83, fifteen years down the road.

And from the perspective of tax planning, that’s a long time in the future.

This concludes the discussion of Cheryl 1.0, showing how voluntary withdrawals for living expenses, modest Roth conversions up to IRMAA #1, and calibrated QCDs could push out the first IRMAA penalty for years and years and years.

Next up: What if Cheryl had a somewhat larger TDA, so that expenses and Roth conversions below IRMAA #1 in 2023 and 2024 did NOT suffice to drop her out of future IRMAA #1? Should she convert high up into the IRMAA zone in 2023 and 2024, as cousin Celia suggested? How much benefit should she expect from two years of IRMAA’d Roth conversions, i.e., could she get out of future IRMAA for, say, the first fifteen years, through age 88, twenty years from the present point of scheming?

Was her brother Charles correct or did her nephew the CPA have the right of it, with his sobering present-value analysis?
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Soon2BXProgrammer »

McQ wrote: Sun Jan 08, 2023 10:19 pm
Soon2BXProgrammer wrote: Sun Jan 08, 2023 2:31 pm
McQ wrote: Sun Jan 08, 2023 2:11 pm

Bottomline: regardless of whether Cheryl could have done a better job with her retirement planning, it is what it is: now she’s high up in the social security tax torpedo staring down IRMAA.
I currently do not have time to model the scenario you have created, but from past experience, the sooner the better doing a Roth conversion up to the top or either the tax bracket or the IRMAA tier that the person has spilled over into. Because if your subject to the additional tax you should maximize the space it buys.

Then repeat the analysis and see if this is likely to pull you out of the IRMAA in the future, if no, add another year.

While this is painful and the exact opposite of pushing out paying the IRMAA, if you can get under the limit, it can be helpful. This might not play out with only a single person, I see the biggest benefit in the married plans where you model eventually switching to single.

The marginal rate of the IRMAA with this logic should be calculated not as a spike but as a tax on the whole window being bought and utilized. (If you fail to use it, it is a spike, but if you use the whole window conceptually it is a rate on the whole window)

I'd be interested to hear your thoughts.
Stay tuned for a more on-point post in the next few days. In the meantime, I wanted to ratify one of your points: if you must incur IRMAA, best to voluntarily withdraw all the way up to the next IRMAA boundary.

Taking the IRMAA payment as $1000, and the IRMAA span as $25,000, and the underlying tax rate as 24%, if you freeze/choke one dollar in, your marginal tax rate is ($1000 +0.24)/$1 or 100,024%. Oww...

But if you voluntarily withdraw (convert) an additional $24,999, your marginal rate is 24% + ($1000/$24,999), which rounds to 28%. Much more palatable, and likely to reduce next year's RMD by about $1000--not enough to escape IRMAA in year two, but maybe allowing a QCD of modest amount to take you home.
Don't' forget that the tax cuts and jobs ACT is going to expire (current law).. I'm actually suggesting one converts up to the replacement marginal bracket rate and any IRMAA surcharges in that zone for the next couple of years if needed to make a long term impact on staying under the IRMAA.

Basically the goal is to do what you must, so that you don't get stuck on the edge of the IRMAA. The edge is what is punitive.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by JoinToday »

WoodSpinner wrote: Sun Jan 08, 2023 10:31 am
Here is an example of a Roth Conversion Breakeven Chart. From my perspective it helps put the Tax Savings in perspective for each target scenario. It’s generated from the Forward looking tax projection and modeling different Roth Conversion targets. At least in this case, I don’t think Tax Savings are a strong driver for Conversions.

That said it’s optimized for Taxes paid as a Couple rather than for a Surviving Spouse or Beneficiaries. Different choices will significantly affect the Breakeven analysis.

IMHO, this is one of the decisions that should be made before any Conversion Planning.

Image

WoodSpinner
Thank you. When I did my analysis, I also considered taxes paid by beneficiaries (assuming 10 year payout/RMDs of remaining traditional IRA) and tax drag of unspent RMDs by both spouse and beneficiaries. The tax drag was surprising to me -- not a dominant number, but big enough to make a difference.

In my modelling of Roth conversions, my traditional IRA will be depleted at some point (leaving money for either QCD or long term care, so RMDs are effectively 0 at some point). At this point taxes dropped (another break point in your lines), with some of the qualified dividends then taxed at 0%. I am also concerned about increased tax rates after 2026. Once the first spouse passes away (me I assume), the surviving spouse does not have a lot of room to do meaningful Roth conversions without increasing tax brackets.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by FiveK »

curmudgeon wrote: Thu Jan 05, 2023 9:51 pm ...other income (interest, qualified dividends/LTCG, pension, etc)...QCDs....congress changing the rules...etc....make overly elaborate planning for naught.
+1
As often applies, "it depends..." on all the above, plus state taxes, considerations of heirs' situations, what Cheryl herself wants, etc.

While overly elaborate planning isn't justified, some thought is worthwhile.

Using $55K in SS benefits, $20K qualified dividends, and 2023 tax laws, Cheryl's future federal tax rates on non-QCD tIRA distributions would look something like this (the spikes on all charts are the IRMAA effects):
Image


With the same $20K qualified dividends but no SS in 2023, her federal tax rates on tIRA distributions will be
Image
That argues for making the first ~$40K a "go do it" because she may never see rates that low again.


If she chooses to withdraw/convert more than $40K this year, the federal tax rates on those amounts would be
Image


That next ~$44K doesn't look too bad, so...if she does that much and wants to be even more aggressive, the federal tax rates on those amounts would be
Image
...and so on (marginal rates starting just under each subsequent IRMAA tier get even higher, but still may be justifiable.

Depending on all the "it depends..." items mentioned above (and perhaps others), one can make reasonable arguments for a very wide range of what she should do. E.g., her likely best strategies would be wildly different if she
a) wants the bulk of her estate to go to charity while she is alive and after death, vs.
b) worries about running out of spendable money and is concerned that tax rates will be much higher in future years for her.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by WoodSpinner »

McQ wrote: Sun Jan 08, 2023 2:11 pm
WoodSpinner wrote: Fri Jan 06, 2023 7:48 pm McQ,

....

What I think is missing from the Case Study so far:
  • We have little insight into her priorities and Retirement Goals.
  • Does she plan larger expenses now so she can take advantage of her GoGo years?
  • Is she pretty settled down?
  • How important are charity and bequeaths to her?
  • How is she planning for LTC needs? This may affect the amount she should LEAVE in the TDA since a majority of those expenses are Deductible.
  • We don’t know the size of her current Roth. It was implied (at least I think so) that her Taxable accounts are close to Zero.
  • Her Retirement Financing seems very Fragile since she has to tap her TDA for Emergencies or other unexpected expenses. Resilience is an underrated driver for conversions for many of us who do not have a well balanced asset location across IRA, Roth or Taxable.
  • What I haven’t seen (yet) are her Tax projections (Fed + State) . A good general metric is to try balancing taxes paid across Retirement in order to optimize one’s Finances.
  • If tax Savings are a key Conversion driver for Cheryl then she also needs to understand the Breakeven point of not doing Conversions versus other options. A breakeven point close to expected mortality is NOT a strong driver for paying taxes early to save on them later.
Looking forward to seeing how this study evolves….

WoodSpinner
Glad the OP engaged you, Woodspinner, and thank you for these posts. I was thinking of you when I prepared Post #4, due about Tuesday—specifically, the advice I gave you last year, which is that conversions into the IRMAA zone are not “robust.” I believe I can make a stronger claim now, that conversions into IRMAA are not wise; but you be the judge once you see it.

To address a few of your points:

1. Cheryl is not a real person seeking advice on the forum, but a composite designed to capture relatively general rules. So, no info on her investment policy, etc. She has a risk aversion consistent with holding a 30/70 portfolio as she approaches age 70, and is otherwise a utility-maximizer in the standard economic sense, preferring more (after-tax wealth) to less.

Which is more important to her, maximizing her after-tax wealth or passing an inheritance on to benificiaries in a higher tax bracket than she is as tax efficiently as possible?

Does she want to reserve funds in the TDA to cover Charity Bequeaths or Self Funding Long Term Care?

Am I correct, the primary goal is to Maximize her After Tax Wealth and this is more important than the Taxes paid across Retirement?

2. I don’t think it is fair to say that her retirement lacks resilience. She has $10,000 in a bank account for emergency funds (interest earnings so minimal as to be excluded here), she has a $100,000 equity line on her home that she can tap for any sudden large expense, and she has some $10,000s of Roth funds from last year’s conversion plus the Roth IRA contributions she made over the years. (She has no taxable account balance to speak of because she spent it paying conversion taxes outside, and because she accelerated the payoff of her mortgage once the interest ceased to be deductible after the 2017 tax changes (couldn’t itemize anymore), and because she paid some living expenses that way to stay in the 12% bracket for a few years).

I will take this as additional insights into her Financial situation and shift focus away from Resilience as a goal.

3. We can ding her for not making more Roth conversions in past years (“This is the mess you’ll find yourself facing if you don’t get on those conversions RIGHT NOW.”). But in fairness to Cheryl, a dozen years ago, when she first started running spreadsheet projections, her TDA accounts totaled rather less than $500,000. She never imagined they would grow large enough to throw off $60,000 a year in RMDs (in part because she thought these would have to start at age 70.5). Then the bull market following 2012 occurred (she had a more aggressive allocation when she was still in the accumulation stage). And here she is.

Fair enough ....

4. Definitely, younger Cheryl did not grasp the details of how the tax torpedo works (she figured as soon as she hit income of $34,000, it would all be 85% taxable). She also was using the social security projections she got in the mail from the SSA.gov (the ones that don’t adjust for future inflation). And she didn’t think she’d be well enough off to defer social security to age 70. Using the constant dollar projections and taking benefits at full retirement age, her working estimate of SS was more like $25,000 when planning began.

To be honest, all of my modeling assumes income just blows through the Tax Torpedo and I haven't given much planning or thought to that case. Should be interesting to see how this thread develops and tackles this issue.


5. Under those projections, with small RMDs and small social security, she figured to be in the 15% bracket in retirement. As her tax bracket while working was 25% or 28% (33% for a stretch, when she lived in a state with an income tax), Roth conversions didn’t seem to make sense. Why convert at 25% to save 15%? Why not take the government subsidy at 33% to contribute to a traditional 401(k)?


Bottomline: regardless of whether Cheryl could have done a better job with her retirement planning, it is what it is: now she’s high up in the social security tax torpedo staring down IRMAA.

Also seems reasonable -- given my own preparation for Retirement I am in no position to judge.

Our focus must be on how to play the hand she was dealt.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

FiveK wrote: Mon Jan 09, 2023 3:05 am
curmudgeon wrote: Thu Jan 05, 2023 9:51 pm ...other income (interest, qualified dividends/LTCG, pension, etc)...QCDs....congress changing the rules...etc....make overly elaborate planning for naught.
+1
As often applies, "it depends..." on all the above, plus state taxes, considerations of heirs' situations, what Cheryl herself wants, etc.

While overly elaborate planning isn't justified, some thought is worthwhile.

Using $55K in SS benefits, $20K qualified dividends, and 2023 tax laws, Cheryl's future federal tax rates on non-QCD tIRA distributions would look something like this (the spikes on all charts are the IRMAA effects):
Image


With the same $20K qualified dividends but no SS in 2023, her federal tax rates on tIRA distributions will be
Image
That argues for making the first ~$40K a "go do it" because she may never see rates that low again.


If she chooses to withdraw/convert more than $40K this year, the federal tax rates on those amounts would be
Image


That next ~$44K doesn't look too bad, so...if she does that much and wants to be even more aggressive, the federal tax rates on those amounts would be
Image
...and so on (marginal rates starting just under each subsequent IRMAA tier get even higher, but still may be justifiable.

Depending on all the "it depends..." items mentioned above (and perhaps others), one can make reasonable arguments for a very wide range of what she should do. E.g., her likely best strategies would be wildly different if she
a) wants the bulk of her estate to go to charity while she is alive and after death, vs.
b) worries about running out of spendable money and is concerned that tax rates will be much higher in future years for her.
Thanks for posting those charts, FiveK. It is good to see a graphic demonstration of how very different marginal and cumulative tax rates can be, when the tax torpedo and IRMAA apply.

FWIW, in the next few posts I'll be challenging the utility of folding IRMAA penalties into the marginal tax rate; and more generally, question the applicability of the fact that for a certain stretch of income, Cheryl's marginal rate is 40.7%.

See what you think. I learned quite a bit from you on last year's Roth conversion posts, and look forward to your comments here.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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