Withdrawal Strategy and Estate Planning

[rae09]

I'm finally downshifting and will probably take a sabbatical year before I decide if I want to RE completely. DH will still be working so we will still have income for a while. We're doing our estate planning and finalizing our trust and will. We're DINK and our beneficiaries are not US residents so we need to plan around this. Our current assets after I downshift:

SE Net Income: $65k/year
Taxable account: $475k
Tax deferred (her): $227k
Tax deferred (his): $80k
HSA: $35k
Couple rental properties

Does it make sense to do the following to maximize our taxes?

• Refill our DAF account and take the higher % deduction now
• Live off SE net income & rental income, tax harvest loss whenever possible
• Maximize the 12% tax bracket to convert our 401(k) and tIRA to Roth IRA whenever possible until the tax deferred accounts are $0. The reason is with no children and non resident beneficiaries, leaving inheritance from tax sheltered accounts to the trust will result in much higher tax vs converting the funds to Roth IRA and pay 12% now.
• Sell the rental properties after death of 1st spouse and move the funds to Roth IRA if possible, if not, to taxable account. Reason is we don't want to burden the trustee too much with selling properties and stock/cash is easier for inheritance purpose vs real property since the beneficiaries are non US residents.
• Withdraw from taxable account if needed, lowest cap gain first, make donation from the shares with highest cap gain.
• Withdraw from Roth IRA last since non-taxable.

Anything else I missed? We talked to the attorney who's helping us with estate planning and he told us tax planning is not his expertise.

[secondcor521]

Those all look reasonable.

A few additional suggestions:

1.  Investigate whether realizing LTCG in the 0% bracket to reset your basis higher is a better or worse deal than Roth conversions.

2.  Investigate whether Roth converting more sooner (even beyond the 12% bracket) makes sense.  Mostly this involves looking at your tax rate at age 72 once SS and RMDs have both started; if it's higher than 12% it may make sense.

3.  Look at QCDs from your IRAs.  I don't think you can route them to your DAF, but maybe you can.  You're limited to $100K per year, and you still have to do your RMD if you're 72 or older.

Oh, and you can't put the proceeds from the rental sales into your Roth, although you can make a contribution to your Roth up to the annual limit if you (or your spouse) have earned income that year.

[rae09]

Those all look reasonable.

A few additional suggestions:

1.  Investigate whether realizing LTCG in the 0% bracket to reset your basis higher is a better or worse deal than Roth conversions.

2.  Investigate whether Roth converting more sooner (even beyond the 12% bracket) makes sense.  Mostly this involves looking at your tax rate at age 72 once SS and RMDs have both started; if it's higher than 12% it may make sense.

3.  Look at QCDs from your IRAs.  I don't think you can route them to your DAF, but maybe you can.  You're limited to $100K per year, and you still have to do your RMD if you're 72 or older.

Oh, and you can't put the proceeds from the rental sales into your Roth, although you can make a contribution to your Roth up to the annual limit if you (or your spouse) have earned income that year.

secondcor521, thank you so much for your input!

• I'm not quite sure what you meant. Can you please elaborate on this?
• It's unlikely that we'll go up to the 24% bracket again unless I take another FT job. My est SS if I don't work anymore will be $800ish/mo
• Thank you for pointing this out. I checked and you're right, we cannot route IRAs to QCD since we're way under 70 1/2. We'll put the charity as the contingent beneficiary on our taxable account (save taxes on gain) instead of naming them as beneficiary on the trust.
• I'll update my OP to reflect the rental sales proceeds.

[seattlecyclone]

You may wish to consider diverting as much of your SE income as possible to Roth 401(k)/IRA accounts while spending down your taxable assets. Getting more of your money into a place where it will likely never be taxed again can be nice.

[secondcor521]

1.  You can google "0% capital gains harvesting" and probably read plenty about it, but the basic idea starts with the idea that most people want to realize income up to the top of the 12% ordinary bracket *and* the top of the 0% LTCG bracket.

So lets say you have $60K of ordinary income this year and you have unrealized long term capital gains of $40K.  (I'm assuming you're filing status is MFJ for this example.  Even if you're not, the general approach still works.)

If you don't sell the stock, then you'll pay ordinary income taxes on your $60K.  You get to subtract your $24.4K standard deduction for MFJ, which puts you at around $36K.  The first ~$20K of that will be taxed at 10%, and the next $16K will be taxed at 12%.  So roughly speaking, you'll have a federal income tax bill of around $3900.

If you do sell the stock and realize LTCG of $40K, then all of the previous paragraph will be the same, plus you'll have $40K in LTCG, but that LTCG will be taxed at 0%.  That $40K in LTCG is federally income tax free.

Because the wash sale rule only applies to losses, you can sell and then immediately rebuy the stock at the same price.  You pay nothing on the gain, as noted in the previous paragraph, but your basis is now $40K higher than it was before, so if you sell that stock later, your gains and thus taxes will be lower.

You probably want to be careful to avoid selling any shares of the stock at a loss within 30 days either side of the $40K gain sale, as that would trigger the wash sale rule on those shares.

You can do this every year and escape taxation on LTCG and raise your basis.  Depending on how much unrealized gain you have, you might need to do this over several years.  (So, you could eliminate taxes on $200K of unrealized capital gains over five years doing this.)

Note that many states treat LTCG as ordinary income, so you might have to pay state income taxes on the $40K gain in this scenario.  Something to consider in your tax planning for the current year, but unless you're planning on moving to a lower income tax state later, this will be a wash - you'll owe those state taxes regardless of when you sell.

Even if you don't owe federal income taxes on the gain, it does add to your AGI, which in turn can affect other tax benefits.  So if you're planning on ACA subsidies, or FAFSA benefits, or anything else, you'll have to consider the tradeoffs there.

...

The overarching thing to note is that Roth conversions create ordinary income, which can push some of those LTCG up into the 15% bracket (which starts at ~$80K of taxable income).  So to optimize, you'd need to play with two variables:  (1) how much Roth conversion to do, and (2) how much LTCG to realize.  They're both good strategies, but which one is better for each individual situation varies.  I think @MDM has a spreadsheet to help evaluate this tradeoff, but honestly I tried it once and couldn't understand how to use it.  Maybe he'll chime in with the spreadsheet and how to use it.

HTH.

[MDM]

The overarching thing to note is that Roth conversions create ordinary income, which can push some of those LTCG up into the 15% bracket (which starts at ~$80K of taxable income).  So to optimize, you'd need to play with two variables:  (1) how much Roth conversion to do, and (2) how much LTCG to realize.  They're both good strategies, but which one is better for each individual situation varies.  I think @MDM has a spreadsheet to help evaluate this tradeoff, but honestly I tried it once and couldn't understand how to use it.  Maybe he'll chime in with the spreadsheet and how to use it.

I'm guessing you're referring to the '0% LTCG or t->R' tab in the case study spreadsheet?

Happy to help decipher the inputs, but because "it's obvious" to me I'll need to know what inputs are confusing - and hope that the answer isn't "all of them." :)

As with the marginal tax rate chart on the 'Calculations' tab, it may work only in Excel and not other tools such as Google Sheets, LibreOffice Calc, etc.

[rae09]

You may wish to consider diverting as much of your SE income as possible to Roth 401(k)/IRA accounts while spending down your taxable assets. Getting more of your money into a place where it will likely never be taxed again can be nice.

Great idea. We'll do that.
What are your thoughts on reducing Roth IRA conversion (from tIRA) and giving up some of the 12% bracket to maximize Saver's Credit? We should be able to contribute to tIRA on top of Roth IRA to get $2k saver's credit if we keep our AGI at $65k.

[rae09]

1.  You can google "0% capital gains harvesting" and probably read plenty about it, but the basic idea starts with the idea that most people want to realize income up to the top of the 12% ordinary bracket *and* the top of the 0% LTCG bracket.

So lets say you have $60K of ordinary income this year and you have unrealized long term capital gains of $40K.  (I'm assuming you're filing status is MFJ for this example.  Even if you're not, the general approach still works.)

If you don't sell the stock, then you'll pay ordinary income taxes on your $60K.  You get to subtract your $24.4K standard deduction for MFJ, which puts you at around $36K.  The first ~$20K of that will be taxed at 10%, and the next $16K will be taxed at 12%.  So roughly speaking, you'll have a federal income tax bill of around $3900.

If you do sell the stock and realize LTCG of $40K, then all of the previous paragraph will be the same, plus you'll have $40K in LTCG, but that LTCG will be taxed at 0%.  That $40K in LTCG is federally income tax free.

Because the wash sale rule only applies to losses, you can sell and then immediately rebuy the stock at the same price.  You pay nothing on the gain, as noted in the previous paragraph, but your basis is now $40K higher than it was before, so if you sell that stock later, your gains and thus taxes will be lower.

You probably want to be careful to avoid selling any shares of the stock at a loss within 30 days either side of the $40K gain sale, as that would trigger the wash sale rule on those shares.

You can do this every year and escape taxation on LTCG and raise your basis.  Depending on how much unrealized gain you have, you might need to do this over several years.  (So, you could eliminate taxes on $200K of unrealized capital gains over five years doing this.)

Note that many states treat LTCG as ordinary income, so you might have to pay state income taxes on the $40K gain in this scenario.  Something to consider in your tax planning for the current year, but unless you're planning on moving to a lower income tax state later, this will be a wash - you'll owe those state taxes regardless of when you sell.

Even if you don't owe federal income taxes on the gain, it does add to your AGI, which in turn can affect other tax benefits.  So if you're planning on ACA subsidies, or FAFSA benefits, or anything else, you'll have to consider the tradeoffs there.

...

The overarching thing to note is that Roth conversions create ordinary income, which can push some of those LTCG up into the 15% bracket (which starts at ~$80K of taxable income).  So to optimize, you'd need to play with two variables:  (1) how much Roth conversion to do, and (2) how much LTCG to realize.  They're both good strategies, but which one is better for each individual situation varies.  I think @MDM has a spreadsheet to help evaluate this tradeoff, but honestly I tried it once and couldn't understand how to use it.  Maybe he'll chime in with the spreadsheet and how to use it.

HTH.

Ah okay. So this is sorta reversed tax loss harvesting. The idea is to bump up the basis to a higher number to minimize cap gain taxes when selling later, right?
I'll have to marinade more on this. My first thought is to prioritize Roth IRA conversion first because our beneficiaries are non US residents and I'm not familiar how the taxation would be if we both die simultaneously. Also, I don't think we have that much in LTCG since we had late start in investing.

But this is a great strategy I never thought of, so thank you for bringing it up. I've noted that once we're done converting all the tax deferred to Roth, we should utilize the tax bracket to harvest the cap gain at 0% whenever possible.

Re:MDM spreadsheet, if it's the 2020 spreadsheet, I use it mainly for estimating our tax but I haven't played much with the other tabs since it looks quite complicated. I'm guessing you're referring to "0% LTCG or t->R" tab?

[MDM]

You may wish to consider diverting as much of your SE income as possible to Roth 401(k)/IRA accounts while spending down your taxable assets. Getting more of your money into a place where it will likely never be taxed again can be nice.

Great idea. We'll do that.
What are your thoughts on reducing Roth IRA conversion (from tIRA) and giving up some of the 12% bracket to maximize Saver's Credit? We should be able to contribute to tIRA on top of Roth IRA to get $2k saver's credit if we keep our AGI at $65k.

Unfortunately the saver's credit doesn't work that way.  The most a MFJ couple can get at $65K is $400: 10% of each person's $2000 allowable contribution amount.  See Income eligibility.

[secondcor521]

<me>

Ah okay. So this is sorta reversed tax loss harvesting. The idea is to bump up the basis to a higher number to minimize cap gain taxes when selling later, right?

Yup, exactly.  It's sometimes called tax gain harvesting.

I'm guessing you're referring to the '0% LTCG or t->R' tab in the case study spreadsheet?

Happy to help decipher the inputs, but because "it's obvious" to me I'll need to know what inputs are confusing - and hope that the answer isn't "all of them." :)

As with the marginal tax rate chart on the 'Calculations' tab, it may work only in Excel and not other tools such as Google Sheets, LibreOffice Calc, etc.

Yup, that's the one.

I looked at it again (2020 version), and I think I understand most of the inputs, but:

1.  Dividend yield (B16) is on my taxable account, right?

2.  How do I properly decide what to put in for Fraction used by t->R conversion (B23)?  Is this the fraction of the amount of space I have for both TGH and t->R conversions that I want to allocate to the Roth conversion?  Why is this even an input?  I thought the point of the spreadsheet was to figure out which of the two to use, so it seems like it should be an output, not an input.

I guess another general question is this - with the default values in the spreadsheet, it looks like which one chooses doesn't make much of a difference - after 32 years the difference is only $20K between the high and the low (G19 vs I19).  Am I reading that result correctly?

Also, it mostly seems that longer periods of time until withdrawal mean that Roth conversions are the preferred strategy.  If that's correct - is it? - then I'm happy because that's what I've been doing with my available space for conversions and TGH.

[MDM]

1.  Dividend yield (B16) is on my taxable account, right?

Yes.

2.  How do I properly decide what to put in for Fraction used by t->R conversion (B23)?  Is this the fraction of the amount of space I have for both TGH and t->R conversions that I want to allocate to the Roth conversion?  Why is this even an input?  I thought the point of the spreadsheet was to figure out which of the two to use, so it seems like it should be an output, not an input.

Yes, I "Haven't noticed any situations in which the Total Future Value has a maximum or minimum other that at 0% or 100% of the "Fraction used by t->R conv." for a given number of years until withdrawal."  That's the text in row 47, to which I've added the identifier for what "0% or 100%" references.  So, no need to decide anything

I guess another general question is this - with the default values in the spreadsheet, it looks like which one chooses doesn't make much of a difference - after 32 years the difference is only $20K between the high and the low (G19 vs I19).  Am I reading that result correctly?

Yes, you are reading that correctly.

Also, it mostly seems that longer periods of time until withdrawal mean that Roth conversions are the preferred strategy.  If that's correct - is it? - then I'm happy because that's what I've been doing with my available space for conversions and TGH.

Seems that way for all the testing I've done.

[rae09]

Unfortunately the saver's credit doesn't work that way.  The most a MFJ couple can get at $65K is $400: 10% of each person's $2000 allowable contribution amount.  See Income eligibility.

Right, I misread it. In this case, that makes it easier and we'll just fill up the 12% bracket with Roth IRA conversion then.
Thank you so much for building the spreadsheet btw.

To add to the questions from secondcor521:
- How do I calculate Space available for TGH (B21)? The ceiling for 12% tax rate + std deduction less ordinary income or the SUM of our taxable accounts?
- What does cell B28 and C28 mean? I see the formulas but am not understanding it.
- Cell B22, taxable basis as % of balance, if the capital gain is 20% of the tIRA balance, I would put 80% as the basis here, is that correct?

[rae09]

2.  How do I properly decide what to put in for Fraction used by t->R conversion (B23)?  Is this the fraction of the amount of space I have for both TGH and t->R conversions that I want to allocate to the Roth conversion?  Why is this even an input?  I thought the point of the spreadsheet was to figure out which of the two to use, so it seems like it should be an output, not an input.

Yes, I "Haven't noticed any situations in which the Total Future Value has a maximum or minimum other that at 0% or 100% of the "Fraction used by t->R conv." for a given number of years until withdrawal."  That's the text in row 47, to which I've added the identifier for what "0% or 100%" references.  So, no need to decide anything

So leave B23 at 95%?

[secondcor521]

Unfortunately the saver's credit doesn't work that way.  The most a MFJ couple can get at $65K is $400: 10% of each person's $2000 allowable contribution amount.  See Income eligibility.

Right, I misread it. In this case, that makes it easier and we'll just fill up the 12% bracket with Roth IRA conversion then.
Thank you so much for building the spreadsheet btw.

To add to the questions from secondcor521:
- How do I calculate Space available for TGH (B21)? The ceiling for 12% tax rate + std deduction less ordinary income or the SUM of our taxable accounts?
- What does cell B28 and C28 mean? I see the formulas but am not understanding it.
- Cell B22, taxable basis as % of balance, if the capital gain is 20% of the tIRA balance, I would put 80% as the basis here, is that correct?

@MDM, thanks for the replies to my questions.  I'll try to help out here with answers to the first and third questions above.

Space available for TGH is simply the difference between your existing, guaranteed income that you don't have a choice about, and the level of income you're willing to go up to by adding TGH or Roth conversions, which in your case appears to be the top of the 12% bracket.  So it's the first part of your suggested answer - top of 12% bracket plus stdded minus regular income.

I think B22 refers to your taxable account, so it would be the percentage of your taxable account that is basis as opposed to gains.  If you put $100K into your taxable account and it has since grown to $150K, then you'd put in 66.6%.  The spreadsheet needs this to figure out how much of your cap gain harvesting is gain vs. basis.

[MDM]

- How do I calculate Space available for TGH (B21)? The ceiling for 12% tax rate + std deduction less ordinary income

This one.  The spreadsheet assumes the top of the 0% LTCG and 12% ordinary federal tax brackets are equal, which they aren't, but for 2020 it's only a $250 difference so I wouldn't worry about that model error. ;)

- What does cell B28 and C28 mean? I see the formulas but am not understanding it.

Calculations start by looking at B21 (see above).  When selling stock, not all the sale is taxable - only the gain.  Basis is what you paid for the stock, and gain is what you sell it for, minus the basis.  B28 and C28 are the gain and basis that correspond to what you have entered in B21 and B22 (and see below for that).

- Cell B22, taxable basis as % of balance, if the capital gain is 20% of the tIRA balance, I would put 80% as the basis here, is that correct?

Taxable balance, not tIRA balance.  We're assuming that everything coming from the tIRA is taxed as ordinary income (in other words, no Backdoor Roth IRA going on).

Does that all make sense?

[MDM]

@MDM, thanks for the replies to my questions.  I'll try to help out here with answers to the first and third questions above.

Space available for TGH is simply the difference between your existing, guaranteed income that you don't have a choice about, and the level of income you're willing to go up to by adding TGH or Roth conversions, which in your case appears to be the top of the 12% bracket.  So it's the first part of your suggested answer - top of 12% bracket plus stdded minus regular income.

I think B22 refers to your taxable account, so it would be the percentage of your taxable account that is basis as opposed to gains.  If you put $100K into your taxable account and it has since grown to $150K, then you'd put in 66.6%.  The spreadsheet needs this to figure out how much of your cap gain harvesting is gain vs. basis.

Beat me by a few seconds. ;)

At least we gave the same answers. :)

[rae09]

Thank you @MDM and @secondcor521 for the explanation. I understand the sheet better now.

It's suggesting that Roth conversion is the preferred way for us regardless of the number of years until withdrawal period so we'll do that. Thank you again for your help!