What to do first: Sell taxable investments or start Roth IRA conversion ladder?

[seattleite]

I'm trying to put together a plan for life after quitting my job and I'd like some advice and a sniff test.

Let's say I have $700k in a traditional IRA and $350k in a taxable investment account with a $150k cost basis. I want to structure my investments so that the majority of my income comes from dividends, which means that I'll need to sell my $350k of taxable investments and buy dividend paying equities. Let's also say I have another $300k in cash from the sale of my house in the year before I quit my job so I won't need any of the money from my retirement account nor the taxable investments for a while.

The calendar year after I quit will be the first year in a long long time that I'll be in the lower tax brackets and so I'm trying to figure out how to optimize the opportunity. What I can't figure out for myself is whether I should sell my taxable investments first and get away with paying no capital gains taxes on it (before that law potentially changes) or should I start my Roth IRA conversion ladder first (before that law potentially changes)?

Since I'm married filing jointly this should mean that I'll be able to make a capital gain of $73,800 per year without taxes. So, I could conceivably sell those shares over a period of 3 years and assuming no other income I wouldn't have to pay any tax on it. This is correct, no? Should I go ahead an do that first?

[SaintM]

Your question boils down to which tax break do you think the government will eliminate first:

- Long-term capital gain rate of 0% for those in the 10%-15% tax bracket

- The 15% tax bracket

My prediction would be the LTCG rate goes away first.

If you sell all your taxable securities first, I assume you will use some of the proceeds to fund your lifestyle over those three years.  If you buy a $300k portfolio of dividend paying stocks with a 5% yield, you will have $15k of annual dividend income.  At today's tax bracket, a married couple with no other income tax considerations can convert about $79,100 ($73,800 - $15k dividends + $12,400 standard deduction + $3950*2 exemptions) of your tIRA to a ROTH per year and remain in the 15% bracket.

I don't know how CA state taxes work, other than the perception that they are very high.

[fartface]

Guy above ^^^^^^^^^^knows what he's talking about.

I'd:

1. collect $15,000/year dividends from sale of $300K house
2. convert $20,000 from my traditional IRA to Roth IRA
3. cash in $40,000 in long term cap gains each year

This should result in a 0% federal tax liability for you..I think... because of your standard deductions + exemptions.

Go Curry Cracker has a good post on this that lots of Mustachians reference.

How much money are you budgeting for annual spending? With this scenario above you'll generate $55,000/year income.
Let's say you can live off $30,000/year...you'll be re-purchasing index funds (presumably) in your taxable brokerage w/the $25K surplus.

[zolotiyeruki]

Good advice from both above posters
Stage 1:
1) max out your IRA-to-Roth conversion without paying any tax (about $20k)
2) Sell/reinvest your taxable accounts until you hit the 15% tax bracket. 
3) Live off the cash from your house.

Stage 2: (once you've exhausted the stash of cash)
1) max out your IRA-to-Roth conversion without paying any tax (about $20k)
2) Sell/reinvest your taxable accounts until you hit the 15% tax bracket. 
3) Live off Roth contribution withdrawals, and if your spending is >$20k, use some of the money from step 2

You want to maximize your Roth conversion ladder to minimize the tax exposure down the road.

[Catbert]

Great advice above.  I'll add a couple of small additional techniques:

If you contribute to charity donate appreciated stock/mutual funds instead.  You'll get the charitable donation (if you itemize) but won't owe any capital gains.  Obviously, donate the stock/funds will the largest capital gain.  Fidelity has a Charitable Gift Fund to facilitate these transfers - I'm sure other brokerage companies do also.

On your taxable accounts you probably currently have it set up to re-invest internal capital gains and dividends in the current mutual fund.  If so, change it to pay out to you.  If you have individual stocks this doesn't apply.