Tax efficiency in retirement

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
smartspider1106
Posts: 2
Joined: Tue Nov 06, 2018 3:15 pm

Tax efficiency in retirement

Post by smartspider1106 » Tue Nov 06, 2018 3:26 pm

Hello,

First time posting so please bear with me.

Trying to get some advice/ figure out how to be more tax efficient in retirement. Specifically, what share of retirement portfolio should be in Roths? should we be doing Roth 401k/ backdoor Roths going forward?

I'm 43, DW is 38. Tax bracket is 33%. Breakdown of assets is

1. $1.2M in tax deferred 401ks/ IRAs - going to try and consolidate IRAs with current employer 401k so I can do backdoor Roths. DW is self employed so not sure what her options are.
2. 750K in taxable
3. 50K in Roth

We also have about $100k cash and $100 in college funds. I will get a pension in retirement that'll be $40k-$150k depending on how long I stay with my employer.

Thanks for any guidance and hopefully it's not too late for us to make some smart choices.

CRTR
Posts: 148
Joined: Sat Apr 11, 2015 1:15 pm

Re: Tax efficiency in retirement

Post by CRTR » Tue Nov 06, 2018 5:48 pm

Well, for starters, most likely you're either in the 24% or 32% tax bracket in 2018 (assuming filing jointly). There is no 33% bracket currently.

You question is a common one and a dilemma. You can never know for sure the right answer because you don't what future tax rates on retirement income sources in both the federal and your home state will be. BTW, that's a fairly generous employer retirement plan that gives your a reasonable pension AND a 401k . . .congratulations on that!

The above being said, here are my recommendations . . . . .
1. ALWAYS make the maximum 401k contribution needed to capture the maximum employer matching . . .
2. Given you will have some sort of pension, social security and IRA/401k RMDs, your future tax bracket in retirement may be unavoidably high -- this is an educated guess. In light of this, a reasonable approach might be to split your remaining 401k contribution 50/50 between regular 401k and Roth 401k.
3. There is no reason to not do a backdoor Roth as well.

The net result of the above is you will end up with a nicely tax-diversified portfolio, which will give you the ability to adapt to whatever direction the tax winds blow . . .

bloom2708
Posts: 4907
Joined: Wed Apr 02, 2014 2:08 pm
Location: Fargo, ND

Re: Tax efficiency in retirement

Post by bloom2708 » Tue Nov 06, 2018 5:55 pm

It sounds like your Traditional IRA balance is interfering with your Back Door Roths. Getting everything into your 401k would allow you to do back door Roths again. Ideally you would like to have more in Roth as a ratio to pre-tax. My wife and I each have ~$100k in our Roths. Our incomes allow front door contributions. We haven't been able to do any mega-Roth from 401ks.

With the pension and SS, you are actually one that tips over to doing Roth 401k from this point forward. I'm a fan of deferring tax, but it may be at a point to consider all Roth 401k.

You have a sizable Pre-tax 401k balance (I assume the $1.2M is all pre-tax/traditional).

Roth Conversions would be done between 59.5 and SS. One or both would likely benefit from waiting until 70 to file for SS.

Getting 100% of your bond allocation into 401k would help slow the growth of your pre-tax. Taxable and Roth should be all stocks.

There are people more knowledgeable on Roth Conversions who I hope chime in.
"We are not here to please, but to provoke thoughtfulness." --Unknown Boglehead

User avatar
Duckie
Posts: 6014
Joined: Thu Mar 08, 2007 2:55 pm

Re: Tax efficiency in retirement

Post by Duckie » Tue Nov 06, 2018 7:24 pm

smartspider1106 wrote:$1.2M in tax deferred 401ks/ IRAs - going to try and consolidate IRAs with current employer 401k so I can do backdoor Roths. DW is self employed so not sure what her options are.
The self-employed have three basic retirement plans:
  • Solo 401k -- The option to choose if she wants to use the backdoor Roth method. It has a total contribution limit of $55K for 2018. She can have NO employees.
  • SIMPLE IRA -- The cheapest if there are employees because she only pays them matching, but the contribution limit is only $12.5K for 2018.
  • SEP IRA -- Can be expensive for the employer because she has to contribute the same to employees as to herself. The contribution limit is $55K for 2018.

User avatar
FiveK
Posts: 5734
Joined: Sun Mar 16, 2014 2:43 pm

Re: Tax efficiency in retirement

Post by FiveK » Wed Nov 07, 2018 3:52 am

smartspider1106 wrote:
Tue Nov 06, 2018 3:26 pm
Specifically, what share of retirement portfolio should be in Roths?
This is best answered not in percentages but as "up to X in traditional with the rest in Roth if possible and taxable otherwise." To determine X, see the "Estimating withdrawal tax rates is not an exact science, but here is one approach" section of Investment Order, cells Calculations!T2:V20 of the personal finance toolbox spreadsheet, and check your 2018 marginal rate.
should we be doing Roth 401k/ backdoor Roths going forward?
In short, you want enough in traditional that a 4% (or your choice) withdrawal rate, added to other "unavoidable" income, will incur a marginal tax rate equal to your current marginal tax rate. Once you reach that amount, switch to making Roth 401k contributions. A backdoor Roth, if you have no pro-rata issues with pre-tax IRA balances, is always a good idea if your income is that high.

A little inspection will show that the longer you expect to work, the higher your pension and thus the lower an optimal traditional balance. Similarly, the sooner you desire to retire, the lower your pension and thus the higher an optimal traditional balance. So polish up your crystal ball, and good luck!

smartspider1106
Posts: 2
Joined: Tue Nov 06, 2018 3:15 pm

Re: Tax efficiency in retirement

Post by smartspider1106 » Thu Nov 08, 2018 10:53 am

Thank you everyone for the thoughtful advice. I’ve initiated the transfers on my own IRAs and will hopefully get DW’s solo 401k going shortly.

What are the timing constraints to be aware of with backdoor Roth? Can we contribute and convert by tax time next year or is it 12/31?

User avatar
Duckie
Posts: 6014
Joined: Thu Mar 08, 2007 2:55 pm

Re: Tax efficiency in retirement

Post by Duckie » Thu Nov 08, 2018 6:01 pm

smartspider1106 wrote:I’ve initiated the transfers on my own IRAs and will hopefully get DW’s solo 401k going shortly.
I don't know where she plans to open the solo 401k but be aware than Vanguard's solo plan does not allow incoming rollovers. So since she needs to "hide" her non-Roth IRAs, Vanguard is not suitable.
What are the timing constraints to be aware of with backdoor Roth? Can we contribute and convert by tax time next year or is it 12/31?
You can contribute to an IRA for 2018 up til mid-April 2019. The non-deductible contribution will be reported on Part I of IRS Form 8606 with your 2018 taxes. Form 8606 is per person. So if you both contribute and/or convert, you file two forms.

If you don't convert until 2019 the conversion will go on Part II of Form 8606 with your 2019 taxes. It's best to have the contribution and conversion happen in and for the same year, but sometimes the first year is split (contributing in 2019 for 2018, contributing in 2019 for 2019 and then converting it all in 2019).

You can recharacterize (un-do) a contribution, but not a conversion. So don't convert until you're sure all non-Roth IRAs are transferred.

Post Reply