The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: Rubic on October 16, 2015, 10:40:35 AM
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Given my current FIRE plans, I'm not relying on SS benefits and could probably defer them until age 70. However that's also when the Required Minimum Distribution (RMD) will take effect and, with current projections, push my income into the 28% bracket.
In one scenario I elect to take SS early at age 62 with $1680 monthly payments, nearly tax-free or very low taxes. If I defer until age 70, I receive $3000 monthly, but due to RMD pushing up my tax bracket I'm actually receiving an effective $2160/month benefit. Now in the 8 years I've been collecting early SS, my accumulated benefits have exceeded $161,000. It's going to take a long time for my higher-taxed, deferred benefits to catch up with my earlier benefits, not even taking into consideration the time value of money received in earlier years.
Is my understanding of the situation correct?
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I believe a high expected balance of tax deferred savings (which is what will cause high RMDs) is also in favor delaying SS because it gives you more time and more low tax bracket space to convert your tax deferred money into Roth money thereby reducing RMDs.
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You might run different SS scenarios in www.i-orp.com. That program will calculate the optimal traditional->Roth conversion profile (as terran suggested), including tax implications, for each different SS starting time and amount you choose. Might make a big difference, or it might not - doesn't take much time to check.
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@MDM: The http://www.i-orp.com/ (http://www.i-orp.com/) is an excellent tool and vastly un-complicates my planning.
Well-timed Roth conversions will greatly reduce (though not eliminate) the impact of RMD. Thanks to you and @terran!
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If you have good health and super longevity in your family (e.g., 90+ a good possibiity) the likely better way to deal with this possible jump in income tax rates is to start doing Roth conversions as soon as you retire and/or distributions when you turn 59.5.
Several years ago I realized that when RMDs hit I would go from bottom of 25% bracket to top of 28% or beyond. I seriously stepped up Roth conversions to fill the 25% bracket. (I have a pension but no SS so that wasn't part of my equation.) Do as many conversions as possible before you get SS.
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One shortcoming with the ORP tool is for those of us who've maxed out our IRA contributions and invested in taxable accounts.
In my situation, I have 1/3 of my assets in a taxable account with long-term gains currently at a 25% basis cost. This radically changes my strategy for Roth conversion planning, but the ORP model doesn't appear to handle this scenario.
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One shortcoming with the ORP tool is for those of us who've maxed out our IRA contributions and invested in taxable accounts.
In my situation, I have 1/3 of my assets in a taxable account with long-term gains currently at a 25% basis cost. This radically changes my strategy for Roth conversion planning, but the ORP model doesn't appear to handle this scenario.
ORP's comments on this are quoted below. Unless you are a very high earner the 20% is too high, but the point remains the same. Don't know if this will help.
The After-tax Account includes all investments for which taxes have already been paid on the original investment. The After-tax account does not include money held in IRAs, 401(k)s, Roth IRAs, and other tax-deferred accounts.
The After-tax Account initial balance will include accrued capital gains on which no tax has been paid, and on which capital gains taxes must be paid at the time of the sale of the assets. This presents one of those problems at the margin that drive mathematical modelers nuts. What ORP should do is pay capital gains taxes on the accrued capital gains at the time it is withdrawn. This assumes that the original assets are not sold until withdrawal occurs. This is inaccurate because the assets may be sold in the near feature and reinvested. Capital gains will have to be paid before the reinvestment occurs.
This problem is significant only when there is a large (relative to the Tax-deferred Account) after-tax, untaxed capital gain in the After-tax Account. There are two adjustments that can be made to your input parameters to accommodate this situation:
If you are near retirement then reduce your After-tax Account balance by any unpaid capital gains taxes. Unpaid capital gains taxes are the accrued capital appreciation times the long term capital gains rate of 20%. Since ORP usually draws down the After-tax Account first, this method does not sacrifice much accuracy for the older user. It is unsatisfactory for younger users because appreciation on the removed unpaid capital gains tax is lost.
Younger users may want to increase their estate by the amount of the capital gains tax that would be paid if the assets were sold today. Again, Unpaid capital gains taxes are the accrued capital appreciation times the long term capital gains rate of 20%. This allows after-tax accumulation to occur in the normal fashion and reduces the total distributed funds by the capital gains tax. Again, this method is inaccurate but not significantly so.
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@MMM: Thanks, I had reviewed the FAQ, but it seems like ORP could account for funds in a taxable account with a simple scalar value for an average cost basis by adding two more inputs (total assets, % cost basis).
It would be great to have this plugged into the model to assist with ACA calculations and keep withdrawal income below the 400% FPL.
So many working variables ...
EDIT: A back of the envelope manual estimate shows that my long-term capital gains tax will more than double my taxes paid during the calculated Roth conversion years, essentially compromising the ORP projections. There's no way I want to front-load my tax payments in earlier years of retirement.
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Just a brief update to say I received a nice email from James Welch, the guy who wrote and maintains the ORP calculator. He agrees that for large after-tax accounts asset returns might make a strategic difference. It would be great to see a feature added to a future version of ORP to accommodate funds in a taxable account. My understanding from a long ago course in linear programming is that adding additional inputs to the model isn't too difficult, though that doesn't mean the coding is easy.
@MDM, thanks again for bringing ORP to my attention.
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Just a brief update to say I received a nice email from James Welch, the guy who wrote and maintains the ORP calculator. He agrees that for large after-tax accounts asset returns might make a strategic difference. It would be great to see a feature added to a future version of ORP to accommodate funds in a taxable account. My understanding from a long ago course in linear programming is that adding additional inputs to the model isn't too difficult, though that doesn't mean the coding is easy.
@MDM, thanks again for bringing ORP to my attention.
rubic, great work making the comment to Mr. Welch. Yes, that would be a nice addition indeed.