~1 year from FIRE - Tax diversification strategy?

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AlwaysWannaLearn
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~1 year from FIRE - Tax diversification strategy?

Post by AlwaysWannaLearn » Sun Jun 10, 2018 10:06 pm

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Last edited by AlwaysWannaLearn on Wed Jul 18, 2018 9:46 pm, edited 2 times in total.

aristotelian
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by aristotelian » Mon Jun 11, 2018 1:37 am

You are at 70x expenses and you are worried about tax diversification? I would convert every year up to the top of the 22% bracket while living off the dividends from the taxable account.

SGM
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by SGM » Mon Jun 11, 2018 4:04 am

I would consider converting up to the 24% tax bracket. Higher state taxes in 6 years will likely more than make up for the 2% difference in marginal rates of the 22% bracket and allow for a lot more conversions each year over your 6 year time frame.

State and local income taxes can be significant. It is good you are considering the effect of moving eventually to a high income tax state.

michaeljc70
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by michaeljc70 » Mon Jun 11, 2018 9:24 am

Note that some states don't have income tax on Roth conversations (mine being one of them).

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FiveK
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by FiveK » Mon Jun 11, 2018 2:05 pm

First, see How to withdraw funds from your IRA and 401k without penalty before age 59.5. You can have penalty-free withdrawals of large fractions of your tIRA and Roth accounts at any age. Not tax-free from the tIRA, though, which leads to the main question.

The percentages are much less important than the absolute amount you have in the traditional account. One rough (but not unreasonable) estimate procedure:
a) Estimate base income from dividends, interest, capital gains, etc. now. Set up to calculate your marginal rate on tIRA distributions above that base.
b) Estimate base income from SS, dividends, interest, capital gains, etc. at age 70. Set up to calculate your marginal rate on tIRA distributions above that base.

With things set up as above, try different annual tIRA distributions and calculate the rates you get for "a" and "b".

E.g., if you convert very small amounts in the coming years, you will likely pay lower tax rates in those years but get hit with high rates when RMDs start. If you convert large amounts in the coming years, you will likely pay high tax rates in those years but have low rates when RMDs start.

The "Goldilocks amount" of conversions (i.e., whatever amount leads to ~flat marginal rates in all years) is likely best for you. It's also likely that a range, rather than a single value, of conversion amounts will provide roughly the same results.

Or see something like Optimal Retirement Planner - Extended Parameter Form that will do an analysis similar to that described above.

terran
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by terran » Mon Jun 11, 2018 2:44 pm

michaeljc70 wrote:
Mon Jun 11, 2018 9:24 am
Note that some states don't have income tax on Roth conversations (mine being one of them).
Interesting! Based on https://www.forbes.com/sites/ashleaebel ... cc7159a462 it looks like Hawaii (401k or rollover IRA from 401k only), Illinois, Kentucky, and Pennsylvania are the ones that would apply to someone who is not yet "retirement age."

So I assume the disadvantage to these states as compared to no income tax states is that they still tax dividends and capital gains?

heyyou
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by heyyou » Mon Jun 11, 2018 2:45 pm

You have the right strategy. Consider just feeling grateful for whatever you do get converted into the Roth IRA (RIRA), instead of hoping for 100% conversion then feeling like you failed at age 70 if you are not finished. RMDs do start out low, and you can just save any income that you don't need to spend from the RMD.

One retirement spending method uses the RMD percentage for each year as the withdrawal percentage across the whole portfolio. That is intended to use up the portfolio at a very advanced age, not having so much leftover like the methods that are tailored to fit the worst retirement periods. If yours is going to be one of the worst retirement periods, it will be obvious in the first decade of a 30 year retirement. Also, there are RMD withdrawal % for younger people who have inherited traditional IRAs, not just starting at age 70.5.

For your size of portfolio, would it be worth paying a CPA tax specialist for long term plans showing how much to convert each year? With big conversions, you might be in the same, or an even higher tax bracket in retirement, as now.

per Google
Substantially equal periodic payments (SEPP) are one of the exceptions in the United States Internal Revenue Code §72(t)(1) that allows receiving payments without the 10% early distribution penalty from a retirement plan or deferred annuity before the usual 59​1⁄2 age restriction under certain circumstances.
Substantially equal periodic payments - Wikipedia
https://en.wikipedia.org/wiki/Substanti ... c_payments

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David Jay
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by David Jay » Mon Jun 11, 2018 2:51 pm

SGM wrote:
Mon Jun 11, 2018 4:04 am
I would consider converting up to the 24% tax bracket. Higher state taxes in 6 years will likely more than make up for the 2% difference in marginal rates of the 22% bracket and allow for a lot more conversions each year over your 6 year time frame.

State and local income taxes can be significant. It is good you are considering the effect of moving eventually to a high income tax state.
I think that either the top of the 22% bracket or the top of the 24% bracket makes sense, whichever you choose. Filing Single, the 22% tax bracket may limit the amount too much.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

AlwaysWannaLearn
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by AlwaysWannaLearn » Mon Jun 11, 2018 7:32 pm

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michaeljc70
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by michaeljc70 » Mon Jun 11, 2018 8:04 pm

terran wrote:
Mon Jun 11, 2018 2:44 pm
michaeljc70 wrote:
Mon Jun 11, 2018 9:24 am
Note that some states don't have income tax on Roth conversations (mine being one of them).
Interesting! Based on https://www.forbes.com/sites/ashleaebel ... cc7159a462 it looks like Hawaii (401k or rollover IRA from 401k only), Illinois, Kentucky, and Pennsylvania are the ones that would apply to someone who is not yet "retirement age."

So I assume the disadvantage to these states as compared to no income tax states is that they still tax dividends and capital gains?
I believe so. But there are a few states with no state income tax, so those would be ideal. But as implied in other posts, most people aren't going to move to a state they don't want to to save a few percent. However, Florida and Texas are two of the biggest states.

Living in IL, there not being taxes on Roth conversions is the first personally beneficially tax "deal" I feel I've gotten. :shock:
Last edited by michaeljc70 on Tue Jun 12, 2018 9:33 am, edited 1 time in total.

terran
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by terran » Mon Jun 11, 2018 8:14 pm

AlwaysWannaLearn wrote:
Mon Jun 11, 2018 7:32 pm
aristotelian wrote:
Mon Jun 11, 2018 1:37 am
You are at 70x expenses and you are worried about tax diversification?
Is that bad? :confused
Not bad, as such, it's just that even 35x is considered pretty conservative, so at 70x you're pretty well bullet proof. You could have retired a lot sooner, or you could spend a lot more. If not, you should probably give some thought to what you'd like to happen with all the money that you won't spend in your lifetime.
AlwaysWannaLearn wrote:
Mon Jun 11, 2018 7:32 pm
Given the size of my taxable account - which has to stay fairly large to pay the taxes on the conversions and pay living expenses until 59.5...
In addition to the SEPP method Heyyou linked above, also note that the amount you convert to Roth each year (but not the gains on that amount) can be withdrawn tax and penalty free five years later, so you actually only need enough in taxable to pay for 5 years of taxes and living expenses. After that you can just keep the so called "roth conversion ladder" going using the money you withdraw. You can also withdraw roth contributions (but again, not gains) at any time.
AlwaysWannaLearn wrote:
Mon Jun 11, 2018 7:32 pm
The one question I guess I still have is: Even if the stars align and I have the opportunity to convert everything in my 6-10 year timeframe - Is there some percentage of assets I should deliberately leave in tIRA/401k? If so, what would it be? For example, if I have some serious and costly health issue at 65, where I'd want to draw from the tIRA/401k to pay the medical bills and then take a med. expense deduction. Or if tax laws change in a way that makes drawing from tIRA more favorable than drawing from Roth?
Ideally you want to equalize your tax bracket throughout your life, so you wouldn't want to convert everything in the next 6-10 years as you would then have many years of a very low tax bracket. What exactly the amount you want left in traditional is hard to pinpoint though since you don't know what tax rates will be or what the rate of return will be on your remaining traditional assets.

heyyou
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by heyyou » Tue Jun 12, 2018 12:57 am

Edited to add: It is RMD % plus annual dividends and interest, but not cap gains.

Per the OP's request, below is the link to the brief that suggests using the RMD % as the retirement withdrawal rate on the entire portfolio. Be aware that the table showing the percentages is on page 7, in the Appendix, and that is not mentioned in the brief.

Careful readers will ask, since the authors compared all methods to an optimal one, why can't we just use it? In academia, the optimal method is often the one if you had known every future return at the start of your investing period. The brief does not say if that is what they used as the comparison tool.

http://crr.bc.edu/wp-content/uploads/20 ... 19-508.pdf

Searching for the two authors will bring up other papers by them since the 2012 publication of the one above. On some, the lead author position is reversed from the paper above. Maybe including their first names would capture all their papers in one search.

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kramer
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by kramer » Tue Jun 12, 2018 4:21 am

SGM wrote:
Mon Jun 11, 2018 4:04 am
I would consider converting up to the 24% tax bracket. Higher state taxes in 6 years will likely more than make up for the 2% difference in marginal rates of the 22% bracket and allow for a lot more conversions each year over your 6 year time frame.

State and local income taxes can be significant. It is good you are considering the effect of moving eventually to a high income tax state.
Here is another reason to do that. By converting to the top of the 22% bracket, you are moving all of your qualified dividends from 0% to 15% taxation. This does not happen again when going from 22 to 24. So when moving into the 22% bracket, your marginal rate temporarily moves to 27% then back down to 22% once all of your qualified dividends (and cap gains) have been moved to 15%. This won't be a factor if your qualified dividends plus dividends already reach the 15% bracket (around 50K dividends for a single person) before any conversions.

AlwaysWannaLearn
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by AlwaysWannaLearn » Tue Jun 12, 2018 4:47 pm

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AlwaysWannaLearn
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by AlwaysWannaLearn » Tue Jun 12, 2018 5:47 pm

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AlwaysWannaLearn
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by AlwaysWannaLearn » Tue Jun 12, 2018 5:54 pm

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AlwaysWannaLearn
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by AlwaysWannaLearn » Tue Jun 12, 2018 5:59 pm

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LucyB
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by LucyB » Wed Jun 13, 2018 9:05 am

Hello, I find this thread very helpful. I am confused about the comments by Kramer and SGM. Are you saying that since the result is that dividends and capital gains from the taxable accounts will be put into a higher tax situation, it would be better to convert to a higher level (meaning convert more for the same tax cost for that year of capital gain and dividend income), so as to reduce the number of years that happens? Also, would you suggest keeping conversions under the NITT threshold or do you think that is still worth it to the top of the 24% bracket?
The above comments are merely an expression of personal opinion and should not be considered advice in any form—tax, legal, financial or otherwise.

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kramer
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by kramer » Thu Jun 14, 2018 4:24 pm

LucyB wrote:
Wed Jun 13, 2018 9:05 am
Hello, I find this thread very helpful. I am confused about the comments by Kramer and SGM. Are you saying that since the result is that dividends and capital gains from the taxable accounts will be put into a higher tax situation, it would be better to convert to a higher level (meaning convert more for the same tax cost for that year of capital gain and dividend income), so as to reduce the number of years that happens? Also, would you suggest keeping conversions under the NITT threshold or do you think that is still worth it to the top of the 24% bracket?
There is a temporary 27% tax bracket as you push any qualified dividends and capital gains from the 0% to 15% bracket. Qualified dividends and capital gains are stacked on top of your ordinary income, so as you convert more Roth as ordinary income, the qualified divs and cap gains can be pushed from the 0% to 15% bracket (plus you are paying 12% for the actual conversion).

The OP is single, so he doesn't reach the higher capital gains tax threshold (200K, I think) even if he goes to the top of the 24% bracket. This is not true for couples (250K, I think), so that will be another factor to consider.

I know I didn't explain this thoroughly, maybe someone can point you to the appropriate place in the Wiki...

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FiveK
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by FiveK » Thu Jun 14, 2018 5:01 pm

kramer wrote:
Thu Jun 14, 2018 4:24 pm
I know I didn't explain this thoroughly, maybe someone can point you to the appropriate place in the Wiki...
There is the Marginal tax rate wiki that addresses the general concept of marginal rates and how they can differ from nominal bracket rates.

Tax law isn't the most straightforward thing (yes, I know everyone is shocked at that...) and can lead to some strange situations. E.g., see the chart in this post and #cruncher's explanation in the following post.

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LucyB
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by LucyB » Thu Jun 14, 2018 10:02 pm

Thank you for the added explanation. I am still trying to get my arms around all of this and will eventually post my own questions. It is all a bit overwhelming. Thank you to the OP for letting me learn from the OP’s post. I really appreciate it!!
The above comments are merely an expression of personal opinion and should not be considered advice in any form—tax, legal, financial or otherwise.

AlwaysWannaLearn
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by AlwaysWannaLearn » Thu Jun 14, 2018 10:23 pm

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AlwaysWannaLearn
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by AlwaysWannaLearn » Thu Jun 14, 2018 10:39 pm

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LucyB
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by LucyB » Thu Jun 14, 2018 10:45 pm

Thank you all!
The above comments are merely an expression of personal opinion and should not be considered advice in any form—tax, legal, financial or otherwise.

hawkfan55
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by hawkfan55 » Fri Jun 15, 2018 12:55 am

I would recommend the Optimal Retirement Planner, i-orp.com. Use the Extended Version for best results.
Forum Library of Investing Advice: https://www.bogleheads.org/wiki/Main_Page

AlwaysWannaLearn
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Re: ~1 year from FIRE - Tax diversification strategy?

Post by AlwaysWannaLearn » Thu Jun 21, 2018 8:24 pm

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