Kitces - Retirement Tax Rate Equilibrium

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jj
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Kitces - Retirement Tax Rate Equilibrium

Post by jj » Thu Jan 10, 2019 10:08 am

Masterful article by Michael Kitces talking about the decision-making process for Roth conversions and tax-gain harvesting in retirement to prevent the tax torpedo at age 70 caused by the income from RMDs and SS. This is a topic talked about so often on Bogleheads. There are interesting comments too, mentioning IRMAA, ACA, charitable legacy considerations, medical deductions, i-ORP, etc.

https://www.kitces.com/blog/tax-rate-eq ... e-57204617
...it is madness to risk losing what you need in pursuing what you simply desire. Warren E. Buffett

Silk McCue
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by Silk McCue » Thu Jan 10, 2019 10:59 am

Thanks for sharing. I took the time to read it through along with the comments and it nicely communicates its points. If reaffirms the path we are on (not a surprise) based upon what I have learned here over the past three years and modeling our numbers with this in mind. It will be an excellent link to provide to others in the future when their question explores this topic.

Cheers

livesoft
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by livesoft » Thu Jan 10, 2019 11:58 am

The article is a great reminder of the things to think about, but it sends some of the wrong signals about tax efficient asset class location and does not mention how tax-loss harvesting is helpful.

The examples that Kitces gives have retirees with lots of taxable bond interest in their taxable accounts. This is ridiculous.
In the meantime, the taxable account is projected to produce just about 3%/year in bond interest from the $300,000 invested in bonds, and 8%/year in qualified dividends and capital gains (on average at least) from their $100,000 in stocks.
Their portfolio is invested in a 40/60 conservative growth allocation, resulting in approximately $4.2M held in bonds generating an average yield of $126,000 (3%), and $2.8M in stocks that are producing $56,000/year (2%) in qualified dividends, and an average of $168,000/year (6%) in capital gains turnover.
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Roothy
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by Roothy » Thu Jan 10, 2019 12:33 pm

Livesoft, my guess is that it's because Kitces is at least somewhat skeptical of tax loss harvesting (one of the few areas I disagree with him).

See, e.g.,
https://www.kitces.com/blog/is-capital- ... vervalued/
https://www.kitces.com/blog/evaluating- ... arvesting/
and especially,
https://www.kitces.com/blog/the-wash-sa ... -and-etfs/

GAAP
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by GAAP » Thu Jan 10, 2019 6:59 pm

livesoft wrote:
Thu Jan 10, 2019 11:58 am
The examples that Kitces gives have retirees with lots of taxable bond interest in their taxable accounts. This is ridiculous.
Perhaps he has a lot of retirees with no or limited access to tax-deferred or tax-free accounts. My mother was certainly in that category -- as are many seniors.
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livesoft
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by livesoft » Thu Jan 10, 2019 7:06 pm

In both his examples, I would probably have done it differently. The 2nd example had only a taxable account and a relatively high tax bracket, but muni bonds were not in the equation. The 1st example could have had bonds only in tax-deferred I think.
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Alan S.
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by Alan S. » Thu Jan 10, 2019 10:21 pm

Also, it was not pointed out that married taxpayers will eventually be filing single, and some for many years. In those years the marginal rates would rise considerably because the single tax brackets would more than offset the reduction of income coming from elimination of the lower SS benefit, and traditional DB pensions that would have a reduced survivor benefit are being replaced by DC plans and IRAs where the full value is inherited. This would affect the equilibrium point.

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Re: Kitces - Retirement Tax Rate Equilibrium

Post by jeffyscott » Fri Jan 11, 2019 6:09 am

Alan S. wrote:
Thu Jan 10, 2019 10:21 pm
Also, it was not pointed out that married taxpayers will eventually be filing single, and some for many years. In those years the marginal rates would rise considerably because the single tax brackets would more than offset the reduction of income coming from elimination of the lower SS benefit, and traditional DB pensions that would have a reduced survivor benefit are being replaced by DC plans and IRAs where the full value is inherited. This would affect the equilibrium point.
Thanks, I only read it quickly yesterday and that's the sort of thing I was looking for. I was going to read it again to see if I missed something.

We can remain in 12% bracket, but DB pension (with 100% survivor benefit) may pretty much fill that when there is a single filer. It is simplified somewhat, in that there's little chance that the single filer would ever reach the 24% bracket and if they did, it is only a 2 percentage point rate difference.

Also being in a marital property state, seems to me to lead to there being no reason to harvest capital gains, since cost basis will step up for the survivor and then again for heirs.
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Cyclesafe
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by Cyclesafe » Fri Jan 11, 2019 10:17 am

This approach forces one to confront a number of unknowables, the most important of which is actual investment returns. Whether one will still be filing jointly is another biggie.

Implementing at one's theoretical tax equilibrium rate forces one to incur real "unnecessary" taxes now, before the future returns are realized. Feeling lucky?

Maybe.

As pointed out in the article, investors facing the tax torpedo are (most likely) best served by taking advantage of current tax rates before reversion of the law in tax year 2026. 24%+3.8% for $321k of 2019 MFJ AGI is much better than 28%+3.8% for roughly $280k of 2026 MFJ AGI (2017 brackets adjusted upwards by recent chained CPI data - 2.0476%/year - all reflecting current law).
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by RadAudit » Fri Jan 11, 2019 12:51 pm

Cyclesafe wrote:
Fri Jan 11, 2019 10:17 am
Implementing at one's theoretical tax equilibrium rate forces one to incur real "unnecessary" taxes now, before the future returns are realized. Feeling lucky?
And then, there's also trying to figure out what the tax law is going to be in 10 years. :wink: Of course, we can't discuss that here.
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GoldStar
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by GoldStar » Fri Jan 11, 2019 2:03 pm

I get a "Tax Torpedo" every year :D - not entirely sure if the one that I get at age 70 will be better or worse but thanks for the sharing the article!

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jj
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by jj » Fri Jan 11, 2019 4:53 pm

Alan S. wrote:
Thu Jan 10, 2019 10:21 pm
Also, it was not pointed out that married taxpayers will eventually be filing single, and some for many years. In those years the marginal rates would rise considerably because the single tax brackets would more than offset the reduction of income coming from elimination of the lower SS benefit, and traditional DB pensions that would have a reduced survivor benefit are being replaced by DC plans and IRAs where the full value is inherited. This would affect the equilibrium point.
You make a very good point here. In analyzing our own situation, it appears that when the first of us is no more and the survivor files taxes as a single person, we will definitely be moving up three IRMAA bands, doubling the standard premium (a tax by any other name). While at the same time moving up at least one income tax bracket. This is the result of our being immigrants and having almost nothing in pensions/SS and most of our assets in taxable and IRA's.
...it is madness to risk losing what you need in pursuing what you simply desire. Warren E. Buffett

DrGoogle2017
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by DrGoogle2017 » Fri Jan 11, 2019 9:16 pm

Thanks for posting the link. I read that single pays a tax rate of 32% at just $157k. For some people, the income will not be drop off significantly when one spouse is not alive. I know mine won’t because I get survivor benefits on everything. So it’s important to plan ahead. It does confirm my thinking to convert tIRA as much as we can, even on to the next tax bracket like 22% because the tax torpedo is real.

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Re: Kitces - Retirement Tax Rate Equilibrium

Post by DG99999 » Fri Jan 11, 2019 9:53 pm

jj wrote:
Thu Jan 10, 2019 10:08 am
Masterful article by Michael Kitces talking about the decision-making process for Roth conversions and tax-gain harvesting in retirement to prevent the tax torpedo at age 70 caused by the income from RMDs and SS. This is a topic talked about so often on Bogleheads. There are interesting comments too, mentioning IRMAA, ACA, charitable legacy considerations, medical deductions, i-ORP, etc.

https://www.kitces.com/blog/tax-rate-eq ... e-57204617
+1

Thanks for posting, Michael is far and away my favorite blogger and in terms of FP acumen he is at the top of the heap. (NONE of us posting on this site could shine his shoes on our best day!)
I am not a financial professional. My posts are only my opinion on the topic. You need to do your own due diligence and consult with a professional when addressing your financial questions.

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WoodSpinner
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by WoodSpinner » Fri Jan 11, 2019 10:01 pm

One of the things I would like to better understand is how to come up with a reasonable guess on future tax rates.

What I am doing right now is using the latest tax tables (right now 2018) and projecting forward future income and RMDs against these tables.

Thinking is, I am probably underestimating future taxes so if I can smooth out the taxable income, I am likely to be close to the equilibrium point. Saving some on taxes now, while avoiding huge increases in the future. Recalculating yearly will help improve accuracy and deal with changing circumstances.

Does anyone have a better way of projecting future tax barackets?

Thanks in Advance

WoodSpinner

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Re: Kitces - Retirement Tax Rate Equilibrium

Post by The Wizard » Fri Jan 11, 2019 10:07 pm

WoodSpinner wrote:
Fri Jan 11, 2019 10:01 pm
...Does anyone have a better way of projecting future tax brackets?
No.
Just assume current tax law will remain roughly the same, until further notice...
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by jeffyscott » Fri Jan 11, 2019 10:32 pm

DrGoogle2017 wrote:
Fri Jan 11, 2019 9:16 pm
Thanks for posting the link. I read that single pays a tax rate of 32% at just $157k.
I wouldn't use "just" in association with that figure, but adding the $12K std deduction, puts at $169K.
Time is your friend; impulse is your enemy. - John C. Bogle

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Re: Kitces - Retirement Tax Rate Equilibrium

Post by The Wizard » Fri Jan 11, 2019 10:41 pm

jeffyscott wrote:
Fri Jan 11, 2019 10:32 pm
DrGoogle2017 wrote:
Fri Jan 11, 2019 9:16 pm
Thanks for posting the link. I read that single pays a tax rate of 32% at just $157k.
I wouldn't use "just" in association with that figure, but adding the $12K std deduction, puts at $169K.
And the 32% rate is for income (AGI) over that $169K.
Can't tell if that poster is aware of how tax brackets actually work or not...
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DrGoogle2017
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by DrGoogle2017 » Fri Jan 11, 2019 10:54 pm

jeffyscott wrote:
Fri Jan 11, 2019 10:32 pm
DrGoogle2017 wrote:
Fri Jan 11, 2019 9:16 pm
Thanks for posting the link. I read that single pays a tax rate of 32% at just $157k.
I wouldn't use "just" in association with that figure, but adding the $12K std deduction, puts at $169K.
Yes, I understand that’s include $12k deduction, but it’s not like it’s $315k something for a couple, which is much large amount.
Last edited by DrGoogle2017 on Fri Jan 11, 2019 11:02 pm, edited 2 times in total.

DrGoogle2017
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by DrGoogle2017 » Fri Jan 11, 2019 10:57 pm

The Wizard wrote:
Fri Jan 11, 2019 10:41 pm
jeffyscott wrote:
Fri Jan 11, 2019 10:32 pm
DrGoogle2017 wrote:
Fri Jan 11, 2019 9:16 pm
Thanks for posting the link. I read that single pays a tax rate of 32% at just $157k.
I wouldn't use "just" in association with that figure, but adding the $12K std deduction, puts at $169K.
And the 32% rate is for income (AGI) over that $169K.
Can't tell if that poster is aware of how tax brackets actually work or not...
Hmm, I only did my own tax for nearly 35 years. But it’s still consider in 32% tax bracket,isn’t it? Not sure why the snarky comment?

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Ben Mathew
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by Ben Mathew » Sat Jan 12, 2019 1:04 pm

This is an important point:
Notably, not all of the income considered for the projection of future tax rates will necessarily be income that the retiree needs for retirement spending purposes. While a lot of sufficient taxable accounts to fund retirement spending will cause some withdrawals from pre-tax retirement accounts eventually, Required Minimum Distributions almost by definition are forced withdrawals for tax purposes that weren’t needed for cash flow purposes (or the retiree would have already been taking enough withdrawals to satisfy the RMD obligation).
Though Kitces didn't dwell on it, it brings up an important consideration. Our retirement accounts would ideally have a generous cushion to protect against unexpected negative events (low returns, high expenses). That means our typical expenses in retirement could be a lot less than RMD requirements. In these circumstances, RMDs would force us to move money from the traditional account to taxable, potentially losing decades of tax-free growth during retirement. Roths don't have RMDs. Money won't be forced out of it during your lifetime. That could tilt the scale towards some Roth contributions/conversions during working years even when marginal tax rates are expected to be lower in retirement.

So, a summary reasons to contribute/convert to Roth even if the marginal tax rate is expected to be a bit higher:

(1) If RMDs>>needed income, Roth might be better. Money can stay in Roth, while it will be forced into taxable with traditional

(2) If running out of tax-advantaged space and looking for more, Roth might be better than traditional+taxable side account.

(3) If planning to leave an inheritance, Roth is better--heirs can leave the money in the inherited Roth IRAs for longer.

(4) Pre-paying the tax with Roth is insurance. Once you pay the tax, you're done. You don't have to worry about what fraction of your funds the IRS will take from you in fifty years.

DrGoogle2017
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by DrGoogle2017 » Sat Jan 12, 2019 1:44 pm

Thanks to this thread, I’ve looked up the distribution for inherited Roth IRA from Boggle Wikipedia. Much clearer than the one I’ve read from the IRS. I’ve always under the impression that the five year rule for Inherited Roth is a must for withdrawal method, I didn’t realize there’s a lifetime withdrawals method, this assures that Roth conversion is a winner, at least in my book.

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Re: Kitces - Retirement Tax Rate Equilibrium

Post by gneeby » Mon Jan 14, 2019 10:51 am

Ben Mathew wrote:
Sat Jan 12, 2019 1:04 pm
So, a summary reasons to contribute/convert to Roth even if the marginal tax rate is expected to be a bit higher:

(1) If RMDs>>needed income, Roth might be better. Money can stay in Roth, while it will be forced into taxable with traditional

(2) If running out of tax-advantaged space and looking for more, Roth might be better than traditional+taxable side account.

(3) If planning to leave an inheritance, Roth is better--heirs can leave the money in the inherited Roth IRAs for longer.

(4) Pre-paying the tax with Roth is insurance. Once you pay the tax, you're done. You don't have to worry about what fraction of your funds the IRS will take from you in fifty years.
The engineers amongst you may recognize Kitces' article to be a functional definition of ORP, which has been available as an online retirement calculator for many years now. Or you might say that ORP is a computerization of Kitces' concepts. Their shared central concept is to manage income subject to keeping personal income taxes in the same tax bracket throughout the plan. Kitces shows the theory, ORP does it in practice.

Kitces' "point is not to project spending income (i.e., cash flow distributions), but taxable income instead (i.e., literally, income for tax purposes, regardless of whether/how it will be spent at the time!)." ORP maximizes disposable income, but offers no guidance as how the income is to be spent.

ORP users are familiar with 3 key results:

1. Partial IRA to Roth IRA conversions can be done with taxable income at much higher, but still constrained, tax rates during the first few years of retirement. Some ORP users suffer a panic attack when they first turn on unconstrained conversions and see the resultant tax bill for the first few years of retirement.

2. Tax efficient retirement income management can done without IRA to Roth IRA conversions.

3. Both methods give much the same disposable income for any given model; i.e. there is no particular economic advantage to doing conversions.

Conversions move tax payments up to the front of the retirement plan while the non conversion method spreads the tax-deferred withdrawals and thus income taxes across retirement. In most cases, conversions will pay less total taxes than non-conversions, an irrelevant consideration since the goal is to maximize disposable income. Both approaches incorporate the RMD in their plans.

In conclusion, the big difference is in how the two approaches address conversions. Kitces levels taxes throughout the plan while ORP may show a spike in taxes early on.

There are many reasons for doing conversions, only a few of which can be quantitatively modeled.

randomguy
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Re: Kitces - Retirement Tax Rate Equilibrium

Post by randomguy » Mon Jan 14, 2019 11:33 am

Got to love an example of a couple worth 7.8 million who is only spending 120k/year:) But lets look at the problem
a) 7 million in taxable. Bonds generate 126k, qdivs of 56k, capital gains turnover of 168k
b) IRA of 800k with RMDs of 39k

Anyone think it is really odd that they are spending any time optimizing the 39k of RMDs verus say investing so they don't get 168k of capital gains every year? And since the 7 million is mainly from a recent sale of a business there aren't going to be embedded capital gains.:)

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