Help me understand post-RE taxes with an example...

[BuckeyeFinance]

I will preface this by saying that the scenario below is hypothetical as we are still 6-10 years from FIRE. I've recently gotten my SO on board and excited about FIRE so I've been trying to learn as much as possible. I'm at the point where I have our spending needs about as nailed down as I can get them. Our incomes are relatively high and we are just loading up our investments. However, I'm struggling a bit with some of the post-retirement tax concepts being new to them and am hoping you might be able to indulge me in an example to aid in my understanding. My hope is that this will help me determine what breakout at retirement would be best to aim for (401k vs roth vs taxable). The breakout below is about where I hope to be when we retire.

-Age: 40
-800k in taxable investments (>1 year)
-750k in traditional IRA (converted from 401k)
-170k in ROTH IRA
-60k needed for yearly expenses
-Assume 0 wages/other income sources
-80k equity in 300k house, 30 yr fixed mortgage @ 4.5% (I don't think this is relevant?).
-MFJ standard deduction
-No kids

How much can we convert from my tIRA to ROTH IRA each year to avoid all taxes? Is it equal to the amount of the standard deduction + any other tax breaks we can muster up?
Does it make sense to convert more to ROTH than the amount we can move tax-free given future impact of RMDs?
At what point will we owe taxes on the 60k we are taking out of the taxable investments (long terms capital gains)?

[BuckeyeFinance]

MOD EDIT: Merged duplicate topics.

[nereo]

I will preface this by saying that the scenario below is hypothetical as we are still 6-10 years from FIRE. I've recently gotten my SO on board and excited about FIRE so I've been trying to learn as much as possible. I'm at the point where I have our spending needs about as nailed down as I can get them. Our incomes are relatively high and we are just loading up our investments. However, I'm struggling a bit with some of the post-retirement tax concepts being new to them and am hoping you might be able to indulge me in an example to aid in my understanding. My hope is that this will help me determine what breakout at retirement would be best to aim for (401k vs roth vs taxable). The breakout below is about where I hope to be when we retire.

-Age: 40
-800k in taxable investments (>1 year)
-750k in traditional IRA (converted from 401k)
-170k in ROTH IRA
-60k needed for yearly expenses
-Assume 0 wages/other income sources
-80k equity in 300k house, 30 yr fixed mortgage @ 4.5% (I don't think this is relevant?).
-MFJ standard deduction
-No kids

How much can we convert from my tIRA to ROTH IRA each year to avoid all taxes? Is it equal to the amount of the standard deduction + any other tax breaks we can muster up?
Does it make sense to convert more to ROTH than the amount we can move tax-free given future impact of RMDs?
At what point will we owe taxes on the 60k we are taking out of the taxable investments (long terms capital gains)?

Conversions from a tIRA into a Roth IRA are taxed like earned income, while distributions taken from your post-tax investment accounts are subject to the much more favorable capitol gains taxes (typically LTCG if they've been held for a year or more).

Since you asked for a very simplified example...

For couples filing jointly (MFJ) the standard deduction is $24,000.  That means you could convert $24,000 from your tIRA into your Roth while paying $0 in taxes, assuming that you also had no earned income during that year.  If you wanted to convert a lot more, you'd simply treat it as earned income.  For example, if you converted $50,000 in 2019, you'd be taxed on $26k ($50k minus the $24k deduction).  A quick-and-dirty tax calculator shows you'd owe $2,739 in taxes on that $50k conversion (again, assuming you had zero other earned income that year).  lather, rinse, repeat each year.

As for paying taxes on oyur investments, if you take them out of your Roth IRA 'bucket' you pay $0.  If you take them out of your tIRA or taxable investments you would pay whatever the capitol gains rate is.  Due to the change with the new tax law, distributions from taxable accounts are no longer tied to your income (which would negligible for this hypothetical retirement scenario), but for MFJ you pay 0% on up to $77,200 of Long-term Capitol Gains (LTCG) each year (through 2025, which is when that provision of the law will (supposedly) expire).
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tl;dr - if you keep your expenses reasonable (and $60k is within that frame), it's very possible to pay almost no federal taxes at all in retirement, provided you don't also have earned income, pensions or SS. Once you have those it changes the calculations considerably.  you can use your standard deduction to help "future-proof" your portfolio by converting up to $24k each year into your Roth account from your tIRA. This will allow you to keep paying little/no taxes if they change the tax rates after 2025 (provided they don't also change the Roth distributions, but that would raise holy hell among people who've already paid taxes on that money going in).

[terran]

Here's one way to think about it.

Your total stash is $1.72 million, which makes it about 46.5% taxable, 43.6% tax deferred and 9.9% Roth. If you withdraw from all of them proportionally you'd withdraw $27,900 from taxable, $26,160 from tax deferred and $5940 from Roth. After a $24000 standard deduction you'd pay 10% tax on $2160 of traditional to Roth conversions or $216 tax. This would leave you $74,040 of headroom in the 0% long term capital gains ($77400 top of the bracket minus $2160 taxable traditional IRA withdrawal). Even if your taxable account was all gains (obviously it's not) this would leave you $47,140 of space above what you need to withdraw for living expenses.

This only works if we assumed you were able to withdraw from your traditional IRA immediately, but that would cost you an additional $2616/year in early withdrawal penalties. In reality you're going to withdraw more from taxable and/or Roth to cover the $26160 of living expenses for the first five years while you get a Roth conversion ladder going. That's going to throw the proportions off though, which would mean you need to get a little more converted from traditional to Roth. If you assume you'll always be in the 10% bracket in retirement then you can make as much as $19050+24000 = $43050 of conversions each year without changing our lifetime taxes (if you make the conversion earlier that just means you don't pay the tax later and vice versa). On the other hand you always want to fill the standard deduction with traditional to Roth conversions, so you don't want to draw down your traditional balance too much such that you can't continue to convert at least $24000 forever, so that's the balance you want to strike.

The 5 year conversion ladder part got be a little stuck, so I'll be interested to see what else people come up with. It might be helpful if you could estimate how much of the Roth balance will be contributions (and therefore eligible for penalty free withdrawal).

Due to the change with the new tax law, distributions from taxable accounts are no longer tied to your income (which would negligible for this hypothetical retirement scenario), but for MFJ you pay 0% on up to $77,200 of Long-term Capitol Gains (LTCG) each year (through 2025, which is when that provision of the law will (supposedly) expire).

This is the second time I'm seeing a comment like this, but I hadn't come across it before. Are you sure about this? Can you point me to a source?

Edit: Yeah, I just took another look at the Qualified Dividends and Capital Gain Tax Worksheet in the draft 2018 form 1040 instructions (page 40) and it looks to me like other sources of income are subtracted from the top of the capital gains bracket. Let me know if you have a different reading of this.

[MDM]

Due to the change with the new tax law, distributions from taxable accounts are no longer tied to your income (which would negligible for this hypothetical retirement scenario), but for MFJ you pay 0% on up to $77,200 of Long-term Capitol Gains (LTCG) each year (through 2025, which is when that provision of the law will (supposedly) expire).

This is the second time I'm seeing a comment like this, but I hadn't come across it before. Are you sure about this? Can you point me to a source?

Edit: Yeah, I just took another look at the Qualified Dividends and Capital Gain Tax Worksheet in the draft 2018 form 1040 instructions (page 40) and it looks to me like other sources of income are subtracted from the top of the capital gains bracket. Let me know if you have a different reading of this.

I don't understand what "no longer tied to your income" is supposed to mean.

The 2018 QD&CG Tax Worksheet appears practically identical to the one for 2017.  One can compare the 2018 version to cells Calculations!K3:M33 in the case study spreadsheet if desired.

[MDM]

My hope is that this will help me determine what breakout at retirement would be best to aim for (401k vs roth vs taxable).

See Investment Order for a general strategy, including a way to estimate the retirement marginal rates you need to inform your current choice of traditional vs. Roth.

In short, you probably want as much as the IRS allows in (traditional + Roth) combined, with as much as you can put into taxable beyond that.  The optimum amount in traditional is "just enough that it takes for 4%/yr withdrawals from that amount to match your current marginal tax saving rate" with the rest going to Roth.  See cells Calculations!T2:V29 in the afore-mentioned spreadsheet for a quick back-of-the-envelope calculation.

[terran]

Due to the change with the new tax law, distributions from taxable accounts are no longer tied to your income (which would negligible for this hypothetical retirement scenario), but for MFJ you pay 0% on up to $77,200 of Long-term Capitol Gains (LTCG) each year (through 2025, which is when that provision of the law will (supposedly) expire).

This is the second time I'm seeing a comment like this, but I hadn't come across it before. Are you sure about this? Can you point me to a source?

Edit: Yeah, I just took another look at the Qualified Dividends and Capital Gain Tax Worksheet in the draft 2018 form 1040 instructions (page 40) and it looks to me like other sources of income are subtracted from the top of the capital gains bracket. Let me know if you have a different reading of this.

I don't understand what "no longer tied to your income" is supposed to mean.

The 2018 QD&CG Tax Worksheet appears practically identical to the one for 2017.  One can compare the 2018 version to cells Calculations!K3:M33 in the case study spreadsheet if desired.

I've come to the conclusion that the people making this claim (there's a marketwatch article, possibly others) either wrote something confusing or were confused themselves by the fact that the ordinary income brackets and the long term capital gains brackets are no longer aligned. That's all that changed in this regard though. Capital gains are still stacked on top of ordinary income for purposed of finding out what bracket they're in -- the brackets haven't been separated. 

[nereo]

I think I've been among those confused by this - glad to have it corrected.

[radram]

What are you planning for healthcare?

Given your numbers, you should be able to select where you want to fall on the scale by making your withdrawals accordingly.

You could have an income so low you qualify for Medicaid, all the way up to earning so much you no longer qualify for ACA subsidies.

There are plenty of forum threads to discuss the moral implications of healthcare and paying for it, so please lets not use this thread to create yet another one. These options are available under current law. Where you want to be on that scale will dictate how you plan out your next 6 years. If you choose to, your health care costs can completely dwarf your tax bill, or vice versa.

[BuckeyeFinance]

What are you planning for healthcare?

Given your numbers, you should be able to select where you want to fall on the scale by making your withdrawals accordingly.

You could have an income so low you qualify for Medicaid, all the way up to earning so much you no longer qualify for ACA subsidies.

There are plenty of forum threads to discuss the moral implications of healthcare and paying for it, so please lets not use this thread to create yet another one. These options are available under current law. Where you want to be on that scale will dictate how you plan out your next 6 years. If you choose to, your health care costs can completely dwarf your tax bill, or vice versa.

I'm not sure yet. It seems that healthcare costs and legislation keep changing so it makes it a bit more difficult to plan for. Medicaid, taking a class at a local community college and enrolling in cheaper student healthcare, or ACA subsidies all seem like possibilities but I haven't gotten down into the details yet.

[clarkfan1979]

For minimizing my tax burden with real estate, I like to buy homes in areas that I visit often. When I travel on vacation to those areas, I get to deduct the trip as a business expense as long as I stop by the house to fix a few things.

You also depreciate your property, which reduces your tax liability. This works better for people who cash flow very little and have multiple properties. It's very possible for the depreciation to be higher than your "profit" and that would result in paying zero income tax.

I prefer to have a smaller number of rentals but have those rentals throw off larger amounts of cash flow. I will pay more in tax, but I'm ok with it.

Are you estimating your yearly spend to be 60K/year once your mortgage is paid off? Is 60K/year before taxes or after taxes?

[nsmall]

I am sorry, but I am a rookie and cant offer any advice.  Great job saving!  Hopefully someone will chime in for you.  I pay my tax lady $75 an hour and she helps me out when I have questions I cant answer.  Just a thought for you.

[clifp]

Well avoiding all taxes is going to be difficult if you need spending to be at $60K.  However, you should be able to keep yourself in the 10% bracket and pay approximately $1,000-2,000 in taxes.

I assuming that $800K invested primarily in index funds should pay about 2% in dividend so that will generate at around $16K. If you did a conversion of say $30K per that would leave you with taxable income of 46,000 - the standard deduction of $24,000 leaving you with a taxable income of $22,000 which has taxes per turbo tax of $1,037.

You need would need about $45K a year in additional cash. You'd get that by selling some of your existing taxable investment and withdrawing some from your ROTH IRA (but only contributions that were made at least 5 years ago, no appreciation.) So eyeballing your projected assets I'd say $15K from your Roth and $30K from existing investments.  (Odds are very high that there will be capital gains associated with selling the investments but as long as it long-term gains you shouldn't owe additional taxes).

After 5 years of doing this, you will be eligible to withdraw the $30K from your first year of Roth conversion.

[terran]

Link to duplicate thread which has since been merged.

[nsmall]

@BuckeyeFinance   Just wanted to make sure you saw the math above.

[Laura Ingalls]

If you are in Ohio it looks like capital gains are taxed at the same rate as earned income.

[markbike528CBX]

I scared myself by looking at Standard Deduction Worksheet for Dependents—Line 8, where the deduction is only on earned income.   I was going to post here, but....

Since neither I or my spouse are dependents so this doesn't apply to us. So MFJ = 24k.

Whew,

Nothing to see here. Move along :-).      Writing it here so I remember in the morning. Sleeping soon.