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To What Lengths Do Some Folks Go In Planning Their Income Taxes

Started by Peter, January 10, 2020, 11:00:00 PM

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Rob L

Semi-retired, too much time on my hands, so I do this. I really need to get a life!
Thought some might find this interesting or at least amusing. Any comments will be appreciated.

A little background will be helpful. The bulk of my non-real estate retirement assets are Traditional IRA investments. My LC and Prosper accounts were Traditional IRA. We all know Traditional IRA distributions are taxed as regular income. I always bought into the idea that my tax bracket in retirement would be lower than in my prime earning years so, as I was always at or near the top bracket, I favored the Traditional IRA. I also have a small but non-trivial Roth IRA that is near the 5 year age threshold. The year 2019 holds a unique opportunity for me as it is my last year before I have to take annual RMD's from my Traditional IRA accounts. RMD's will tie my hands with regard to minimum distributions after 2019. My earned income this year is low; thus the opportunity and two questions to be answered.

1) Was my decades old bet that my taxes would be lower in retirement for this money than at the time I earned it correct?
2) The opportunity presented to me is to convert some of my Traditional IRA money into my Roth (and pay taxes on that amount). Optimally, how much?

The remainder of the post refers to the chart below.

The top blue line is my income weighted total effective tax rate (25.83%) that I actually paid on income. Total taxes paid (FED + Virginia) divided by total income over the years 2000 - 2018.

Question 1 is very clear; any amount I sensibly chose to convert is dramatically better than having paid taxes on the income when received.

Question 2 has a lot of moving parts. I have the flexibility to convert as little or as much as I want from Traditional to Roth IRA. It appears that the best choice is the inflection point where the Federal marginal bracket steps up from 12% to 22%. There is no way to avoid the taxation of 85% of Social Security benefits or the Virginia bracket increase from 2% to 5.75% (that is if I want to convert any money at all). The sweet spot seems to be where the Fed bracket steps up from 12% to 22% ("Target Income") and most certainly before the Virginia age deduction is phased out as income increases. "Target Income" gives me an effective total tax rate of 9.35%. I'm hoping to manage it to 11% or less in the future (dealing with RMD's). That's less than half the tax I would have paid at the time the income was earned.

Does anyone but a totally deranged soul perform calculations like this (i.e. Fed tax brackets and VA age deduction phase out, and enjoy it)??  https://forum.lendacademy.com/Smileys/default/shocked.gif" alt=":o" title="Shocked" class="smiley" />

https://i.imgur.com/N0HhS0U.png" alt="" class="bbc_img" />

lascott

a) Yes, I spend a BUNCH of time doing retirement planning. I am retired and wife will be next year. We are in our low 50s.  We have 1/3 of our retirement in ROTH and 2/3 in tIRAs.  Using some ROTH money and some tIRA money via 72t/SEPP to live on and help kids with their ROTH IRA & ROTH 401Ks.  Need to avoid high RMDs in the future. May delay 1 or both Social Security incomes to let them grow (8%) and use more tIRAs before RMDs.

b1) There is a TON of advice from every Financial person on doing conversions before 2025 when the 2018 tax rates sunset (for individuals NOT the rich corporations).

https://i.imgur.com/yPf1l7y.jpg" alt="" class="bbc_img" />


b2) I think the real question is can you pay the taxes from non-IRA assets? Play with this calculator. https://www.calcxml.com/calculators/roth-ira-conversion-calculator" class="bbc_link" target="_blank">https://www.calcxml.com/calculators/roth-ira-conversion-calculator

https://i.imgur.com/WA4FQcI.jpg" alt="" class="bbc_img" />

c) This calculator (i-ORP) has some interesting models. Including some ROTH Conversion options. The input and output is based in 1K increments so seems a little odd but it really allows for a more condensed report.  I use it on and off. https://i-orp.com/DI/Extended.html" class="bbc_link" target="_blank">https://i-orp.com/DI/Extended.html

I mainly use Golden Years from Money Tree Software and is part of their Total Planning Suite. It is outstanding and is a Financial Advisor grade tool that they let individuals buy for half the cost and half the annual maintenance.

UPDATE: Forgot I-ORP link: https://i-orp.com/DI/Extended.html" class="bbc_link" target="_blank">https://i-orp.com/DI/Extended.html & added ROTH vs tIRA info.


TravelingPennies

Ah, a kindred deranged soul!

Here's how I have my non-real estate holdings allocated:
Non-IRA Liquid9%
Non-IRA Illiquid11%
Traditional IRA Liquid21%
Traditional IRA Illiquid49%
Roth IRA Liquid10%

My wife and I delayed our Social Security by 3 years. Ran the numbers and the total payments lines taking SS in our 4th year versus waiting two more years crossed at age 82 (wife and I are same age). Key part of decision was that I was retired and didn't expect any more significant earned income. But, as Michael said, "they pulled me back in" for another unexpected project and blew my projection. Hindsight I'd have waited the full 5. I should have known better.

Yes, I tried out calculator b1 but it isn't applicable to my situation. My plan is to attempt to hit the sweet spot of my effective tax rate (Target Income on the Chart) by converting variable amounts from tIRA to rIRA each year. This is my last year before I must start RMD's. My regular income was low so I have a one time chance to convert a fairly nice chunk of tIRA funds to rIRA funds at a low tax rate (around $40k or so). After 2019 I will have to take an RMD each year. A rollover from a tIRA to a rIRA does not count as a RMD so I'm thinking my regular income plus RMD will make the amount I can convert to a rIRA and keep my tax bill down will be pretty small. That's my gut feel but I will run the numbers in December each year to see if I can convert at least a small amount into my rIRA and keep my total effective tax rate on target. It is my plan to pay taxes from regular savings and not pre-tax dollars. We will leave the Roth dollars the last to spend to give them the max time to grow.

For the big picture Financial planning I've been using ESPlanner for many years now.
See: https://esplanner.com/" class="bbc_link" target="_blank">https://esplanner.com/
It's got more answers than I have questions.  https://forum.lendacademy.com/Smileys/default/smiley.gif" alt=":)" title="Smiley" class="smiley" />



TravelingPennies

Think you hit a typo selecting Married Filing Separately. We're MFJ.

https://i.imgur.com/8JLSj64.png" alt="" class="bbc_img" />

Additionally I think that only 85% of Social Security income being taxed (as in my case) makes a difference. A fair amount of my income is S Corp profits that qualify for the TCJA QBI deduction and our Long Term Care insurance premiums are paid by the company and are deductible on the front page. Everybody's a bit different every year. Take $15k off the $115k total income for these reasons and tax as a percent of income is 8.74% and the tax bracket is 12% according to the on-line calculator. The chart is pretty close to that.


TravelingPennies

Very sorry to hear about the medical issues; both emotionally and financially challenging.
It does sound like your situation is pretty unique. Only 1% retire in their early 50's. I have no idea how that's done but I assume a lot of hard work and an exceptional amount of planning were required. I'd never heard of the 72t/SEPP and ACA 400% FPL until you mentioned them so I looked them up. Your plan is working very well. That 6.57% is terrific!


TravelingPennies

Well as of 12/20/2019 the SECURE act was passed and signed. By eliminating the Stretch IRA congress has imposed a huge "death tax" on savers with Traditional IRA's and have stolen much of our children's inheritances. Don't you just love Christmas surprises. Another case of changing the rules in the middle (or actually near the end) of the game. Unprecedented bipartisan support. Gee, wonder why. They don't need to be greedy now since they just print the money and spend it anyway.

https://www.wsj.com/articles/congress-is-coming-for-your-ira-11562713559" class="bbc_link" target="_blank">https://www.wsj.com/articles/congress-is-coming-for-your-ira-11562713559





TravelingPennies

A *very* well known and respected site provided a good overview.

SECURE Act And Tax Extenders Creates Retirement Planning Opportunities And Challenges
DECEMBER 23, 2019 07:35 AM
https://www.kitces.com/blog/secure-act-2019-stretch-ira-rmd-effective-date-mep-auto-enrollment" class="bbc_link" target="_blank">https://www.kitces.com/blog/secure-act-2019-stretch-ira-rmd-effective-date-mep-auto-enrollment


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