Author Topic: HUGE Roth conversion mistake  (Read 4394 times)

OzzieandHarriet

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Re: HUGE Roth conversion mistake
« Reply #50 on: January 31, 2024, 05:13:14 PM »
It's all good!

elysianfields

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Re: HUGE Roth conversion mistake
« Reply #51 on: February 06, 2024, 08:03:47 AM »
Congrats @OzzieandHarriet, that must come as a great relief!

With that settled, I hope you don’t mind me taking this thread in a similar but somewhat different direction:

This is sort of outcome is one of the reasons I really dislike the near-religious fervor too many people feel about Roths. They usually are not that great an option. Most people don't save tax. Especially FIRE folk. Most people won't have RMD issues. Especially FIRE folk.

@SeattleCPA could you elaborate on these assertions?

My SO and I have significant Traditional IRA/TSP funds, were born after 1959, and stand to collect Federal pensions.  By the time we start taking RMDs at age 75, our Traditional balances could be 4x their current size, leading to large RMDs on top of our pensions and SS, potentially vaulting us into a much higher bracket (under current law with the TCJA expiring on 12/31/2025 for individual taxpayers).

Based on this, we did ~$60k of Roth conversions in 2023 up to the top of the 22% bracket, and have switched our TSP contributions to Roth (we max and catch up).

Are we the exceptions in your thinking (we’re already FI, will retire in 2026, but not especially early)?

Why do you say most people won’t have RMD issues?

Who are the sorts of people who face RMD issues?

dandarc

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Re: HUGE Roth conversion mistake
« Reply #52 on: February 06, 2024, 08:27:41 AM »
I think as a not-particularly-early retiree, you might well be the exception. And in the Traditional vs. Roth, you should take into account any existing traditional balance, so good on you for doing that. But some other things:

RMD "problems" boil down to having too much money for one thing - yeah tax bill is higher than you'd like, but if that initial ~4% you're being forced to take out is more than you actually need to meet your expenses, I mean, what are we talking about really?

#2 - FIRE folks tend to get a pretty good handle before the RMDs would kick in and start doing conversions and other adjustments as you're doing here.

And for me, this is the big one - if you're charitably inclined, assuming tax law doesn't change between now and then, you can meet your RMD with a qualified charitable distribution. Up to 105K for 2024. If you give away $105K per year and still are having RMD problems, see point #1 above.
« Last Edit: February 06, 2024, 08:31:55 AM by dandarc »

Omy

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Re: HUGE Roth conversion mistake
« Reply #53 on: February 06, 2024, 10:05:04 AM »
We fatFIREd and have a lot in IRAs. We have not converted much into Roths yet - and may decide not to in the future. I have 14 years and DH has 18 years before RMDs. We're currently optimizing for ACA so we don't have much space for conversions. I'm seriously thinking about not doing Roth conversions and just dealing with RMDs after we hit 75. Our beneficiaries may not be thrilled with the taxes they'll need to pay...

Turtle

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Re: HUGE Roth conversion mistake
« Reply #54 on: February 06, 2024, 10:22:27 AM »
We fatFIREd and have a lot in IRAs. We have not converted much into Roths yet - and may decide not to in the future. I have 14 years and DH has 18 years before RMDs. We're currently optimizing for ACA so we don't have much space for conversions. I'm seriously thinking about not doing Roth conversions and just dealing with RMDs after we hit 75. Our beneficiaries may not be thrilled with the taxes they'll need to pay...

Same here.  Though with 5 beneficiaries who can each split over 10 years, the individual tax hit is something they'll be able to do their own optimizing around. 

OzzieandHarriet

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Re: HUGE Roth conversion mistake
« Reply #55 on: February 06, 2024, 11:49:59 AM »
Based on our current stash, our RMDs will be about the same as what we are withdrawing now (assuming we live that long), so not really a problem.

SeattleCPA

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Re: HUGE Roth conversion mistake
« Reply #56 on: February 09, 2024, 04:56:22 PM »
Congrats @OzzieandHarriet, that must come as a great relief!

With that settled, I hope you don’t mind me taking this thread in a similar but somewhat different direction:

This is sort of outcome is one of the reasons I really dislike the near-religious fervor too many people feel about Roths. They usually are not that great an option. Most people don't save tax. Especially FIRE folk. Most people won't have RMD issues. Especially FIRE folk.

@SeattleCPA could you elaborate on these assertions?

My SO and I have significant Traditional IRA/TSP funds, were born after 1959, and stand to collect Federal pensions.  By the time we start taking RMDs at age 75, our Traditional balances could be 4x their current size, leading to large RMDs on top of our pensions and SS, potentially vaulting us into a much higher bracket (under current law with the TCJA expiring on 12/31/2025 for individual taxpayers).

I think tax rates will go up a little bit. But not that much. At least for most of us.

Quote
Based on this, we did ~$60k of Roth conversions in 2023 up to the top of the 22% bracket, and have switched our TSP contributions to Roth (we max and catch up).

So it makes sense to pay the 22% tax rate now if you'll pay the 24% or 25% or 28% rate (or an even higher rate) in retirement.

My rough calculations say that you'd need in 2024 dollars around $200K of income to broach the next higher tax bracket. If you get $30K of SS that's sheltered by $30K of deductions (to keep this simple) and you get $80K of pensions, that means you'd need $3M generating another $120K to broach that next higher bracket. I'm applying the 4% SWR rule.

Quote
Are we the exceptions in your thinking (we’re already FI, will retire in 2026, but not especially early)?

Maybe.

When you say 4x your current balances, are you working in real dollars or nominal dollars (which have been reduced in size due to inflation)?

E.g., if you'd need $3,000,000 today to generate $120K in distributions so you broach that 22% tax bracket, with 3% inflation, in 24 years you'll need roughly $6,000,000 to generate distributions that broach the 22% tax bracket. Because the tax brackets creep up for inflation too.

Another way to say the same thing. Today the 24% bracket starts at roughly $200K. In 24 years if inflation is 3% annually, the 24% tax bracket would start at roughly $400K.

Quote
Why do you say most people won’t have RMD issues?

That Survey of Consumer Finances that comes out every three years says maybe 60% of people don't have retirement savings. So they don't need to worry obviously about RMDs.

Same Survey says that next 20% of people end up with somewhere between 0 and $500K. They also don't need to worry probably. If you have $500K and draw 4%, that's $20K a year. Couple that with SS or pension and I doubt someone gets past the 12% tax bracket.

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Who are the sorts of people who face RMD issues?

I'd look at your current income and apply the 4% rule. E.g., if you make $100K a year in a job, you need to have $2.5M in an IRA and draw 4% or $100K in order to have same income. It's unlikely statistically that someone making $100K reaches this. (Less than 10% of people end up with more than $1,000,000.) Even more unlikely someone making $100K a year ends up with way more than $2.5M (again working current day dollars.)

Another example: Say you guys make $500K. In that case you need roughly $12,500,000 in your IRAs to generate $500K. It is impossible in most realistic cases to end up with that much in an IRA.

BTW there are a couple of issues that high upper middle class people encounter and which can push the RMD risk up a bit. First if you're making an amount that pushes you into the range where you get an IRMAA hit. Also if you're married but either you or your spouse would as a widow widower pay a higher rate--this happens for some taxpayers--that can push your rate or your surviving spouse's rate us.

Sorry for ramble.

But the TLDR summary which I should have put at the beginning: Most people can't save enough to even have large enough IRA to worry about RMDs. And lots of people who think they might? They might not be doing the inflation adjustments correctly?


secondcor521

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Re: HUGE Roth conversion mistake
« Reply #57 on: February 09, 2024, 05:26:56 PM »
But the TLDR summary which I should have put at the beginning: Most people can't save enough to even have large enough IRA to worry about RMDs. And lots of people who think they might? They might not be doing the inflation adjustments correctly?

Sidebar question:  What do you think is a reasonable inflation rate for IRMAA premiums?  (The premiums themselves which are driven by Medicare program costs, not the IRMAA brackets, which are CPI adjusted IIRC.)

SeattleCPA

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Re: HUGE Roth conversion mistake
« Reply #58 on: February 10, 2024, 04:48:10 AM »
But the TLDR summary which I should have put at the beginning: Most people can't save enough to even have large enough IRA to worry about RMDs. And lots of people who think they might? They might not be doing the inflation adjustments correctly?

Sidebar question:  What do you think is a reasonable inflation rate for IRMAA premiums?  (The premiums themselves which are driven by Medicare program costs, not the IRMAA brackets, which are CPI adjusted IIRC.)

I don't know. Sorry. This strikes me as more of a tax rate increase issue.

To expand this issue a bit, I'm not worried and don't think people should worry much about the Trump tax cuts expiring and the 22% and 24% rates going to 25% and 28%. I assume that will happen. And frankly think it should happen for sound fiscal policy reasons.

But it seems like at some point voters and Congress will accept reality that taxes need to go up even more. I find that impossible to model or predict. So I assume current tax law continues.

BTW not to go into weeds on this, but one could imagine the return of excise taxes on larger withdrawals from retirement accounts. (It has never mattered while I've been a tax accountant but there used to be an excise tax on large withdrawals from IRAs. I recall the threshold was $150K.)

A consumption tax would make a lot of sense as a policy thing I think.


SeattleCPA

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Re: HUGE Roth conversion mistake
« Reply #59 on: February 10, 2024, 05:10:20 AM »
I think as a not-particularly-early retiree, you might well be the exception. And in the Traditional vs. Roth, you should take into account any existing traditional balance, so good on you for doing that. But some other things:

RMD "problems" boil down to having too much money for one thing - yeah tax bill is higher than you'd like, but if that initial ~4% you're being forced to take out is more than you actually need to meet your expenses, I mean, what are we talking about really?

#2 - FIRE folks tend to get a pretty good handle before the RMDs would kick in and start doing conversions and other adjustments as you're doing here.

And for me, this is the big one - if you're charitably inclined, assuming tax law doesn't change between now and then, you can meet your RMD with a qualified charitable distribution. Up to 105K for 2024. If you give away $105K per year and still are having RMD problems, see point #1 above.

+1

SeattleCPA

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Re: HUGE Roth conversion mistake
« Reply #60 on: February 10, 2024, 05:11:33 AM »
We fatFIREd and have a lot in IRAs. We have not converted much into Roths yet - and may decide not to in the future. I have 14 years and DH has 18 years before RMDs. We're currently optimizing for ACA so we don't have much space for conversions. I'm seriously thinking about not doing Roth conversions and just dealing with RMDs after we hit 75. Our beneficiaries may not be thrilled with the taxes they'll need to pay...

+1

P.S. Your beneficiaries (as well as my beneficiaries) should be delighted if they have tax problems someday.

SeattleCPA

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Re: HUGE Roth conversion mistake
« Reply #61 on: February 10, 2024, 05:12:38 AM »
Based on our current stash, our RMDs will be about the same as what we are withdrawing now (assuming we live that long), so not really a problem.

+1

And I think above is exactly the right way to do the math.

secondcor521

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Re: HUGE Roth conversion mistake
« Reply #62 on: February 10, 2024, 10:12:16 AM »
But the TLDR summary which I should have put at the beginning: Most people can't save enough to even have large enough IRA to worry about RMDs. And lots of people who think they might? They might not be doing the inflation adjustments correctly?

Sidebar question:  What do you think is a reasonable inflation rate for IRMAA premiums?  (The premiums themselves which are driven by Medicare program costs, not the IRMAA brackets, which are CPI adjusted IIRC.)

I don't know. Sorry. This strikes me as more of a tax rate increase issue.

To expand this issue a bit, I'm not worried and don't think people should worry much about the Trump tax cuts expiring and the 22% and 24% rates going to 25% and 28%. I assume that will happen. And frankly think it should happen for sound fiscal policy reasons.

But it seems like at some point voters and Congress will accept reality that taxes need to go up even more. I find that impossible to model or predict. So I assume current tax law continues.

BTW not to go into weeds on this, but one could imagine the return of excise taxes on larger withdrawals from retirement accounts. (It has never mattered while I've been a tax accountant but there used to be an excise tax on large withdrawals from IRAs. I recall the threshold was $150K.)

A consumption tax would make a lot of sense as a policy thing I think.

Thanks for the reply.

Perhaps I should have written the question as "reasonable rate increase assumption".  I was more interested in the effects that has on my long term spreadsheet model and the resulting impact on my near term Roth conversion decisions.

I agree that in general the future is hard to predict.  I do expect future changes to tax policy, and I also expect many of them to be surprising to us.  There have already been several of those in the past decade.

SeattleCPA

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Re: HUGE Roth conversion mistake
« Reply #63 on: February 11, 2024, 07:33:51 AM »
Thanks for the reply.

Perhaps I should have written the question as "reasonable rate increase assumption".  I was more interested in the effects that has on my long term spreadsheet model and the resulting impact on my near term Roth conversion decisions.

I agree that in general the future is hard to predict.  I do expect future changes to tax policy, and I also expect many of them to be surprising to us.  There have already been several of those in the past decade.

Sorry but I don't have a good answer for you. I assume you're trying to model stuff like Harry Sit discusses here: https://thefinancebuff.com/medicare-irmaa-income-brackets.html

I guess personally I'd (a) probably just use inflation rate and (b) not worry about too much about trying to get real precise. That's a personality trait thing BTW. Not a professional advice thing.

BTW I just finished my basically second read of "The Missing Billionaires" (which is a great book)... and an idea there pops into my head. Here it is: Who knows what the right number is... but maybe a decent guess would be something between the inflation rate expectation implicit in Treasuries and TIPS... and then the other number you calculate based on history or your expectations?...

secondcor521

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Re: HUGE Roth conversion mistake
« Reply #64 on: February 11, 2024, 08:57:57 PM »
Thanks for the reply.

Perhaps I should have written the question as "reasonable rate increase assumption".  I was more interested in the effects that has on my long term spreadsheet model and the resulting impact on my near term Roth conversion decisions.

I agree that in general the future is hard to predict.  I do expect future changes to tax policy, and I also expect many of them to be surprising to us.  There have already been several of those in the past decade.

Sorry but I don't have a good answer for you. I assume you're trying to model stuff like Harry Sit discusses here: https://thefinancebuff.com/medicare-irmaa-income-brackets.html

I guess personally I'd (a) probably just use inflation rate and (b) not worry about too much about trying to get real precise. That's a personality trait thing BTW. Not a professional advice thing.

BTW I just finished my basically second read of "The Missing Billionaires" (which is a great book)... and an idea there pops into my head. Here it is: Who knows what the right number is... but maybe a decent guess would be something between the inflation rate expectation implicit in Treasuries and TIPS... and then the other number you calculate based on history or your expectations?...

I'm 54 going on 55, and I sort of model out my taxes for the next 30 years or so trying to see what my max marginal rate will be over that time frame.  So I can then Roth convert up to somewhere in that marginal rate neighborhood using the CSS and looking at various cliffs / breakpoints.

You're right that it's not very precise.  I think I'm only within maybe 5 percentage points on the marginal rate prediction.  The biggest lack of precision though is probably in the IRMAA premium increase rate.

I might read the book based on your recommendation.

I might also just try some sensitivity analysis and see how much difference it makes.  I don't have enough confidence in my spreadsheet to convert to within a percentage point or so, mainly because that results in massive conversions and large tax payments now.  On balance, I think I'd rather take my chances under-converting.

SeattleCPA

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Re: HUGE Roth conversion mistake
« Reply #65 on: February 14, 2024, 07:41:16 AM »

I'm 54 going on 55, and I sort of model out my taxes for the next 30 years or so trying to see what my max marginal rate will be over that time frame.  So I can then Roth convert up to somewhere in that marginal rate neighborhood using the CSS and looking at various cliffs / breakpoints.

So, just for the record, that's exactly what I'd do...

Quote
You're right that it's not very precise.  I think I'm only within maybe 5 percentage points on the marginal rate prediction.  The biggest lack of precision though is probably in the IRMAA premium increase rate.

It's hard. But again for the record the fact that someone knows and considers the imprecision is pretty savvy. You already know that. Just want you to know that I know you know.


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I might read the book based on your recommendation.

I've been thinking about the "innovations" or positive developments that I've personally observed and tried to adapt to over the decades (yikes!) that I've been learning about this stuff: Moving out of individually owned stocks. (BTW the first editions of Random Walk Down Wall Street used to talk about how you could get diversified by holding a couple of dozen stocks.) Moving to no load mutual funds. (Why pay the broker based on hope she or he knows who the superior manager is.) Moving to really low cost mutual funds. (E.g. Vanguard.) Moving to index funds. (Initially just Vanguard's Index Trust 500!) Building totally passive portfolios (mostly) once there were lots of good index funds. Etc.

I mention all of the above to say that I think dynamic asset allocation and then the whole "Merton share" concept belongs on this list. (And that's really what the "Missing Billionaires" book is about.)

Will also acknowledge here that I probably sat through some MBA in finance class lecture decades ago where Merton's math was discussed. But didn't at the time find it relevant. (I had zero net worth.) And then later when it would have been relevant, I'd forgotten it.

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On balance, I think I'd rather take my chances under-converting.

My marginal rate in retirement will be lower even though we did a great job saving. But I too think under-converting is the practical choice.

Stuff like high medical expenses could help one "solve" the RMD problem late in the game. Also if one has heirs, the new ten-year draw down rules make it harder but I still think my kids can inherit and pretty effectively drain the balances. People who are charitably inclined might be able to use qualified charitable distributions to "solve" the RMD problem.

secondcor521

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Re: HUGE Roth conversion mistake
« Reply #66 on: February 14, 2024, 10:21:35 AM »
My marginal rate in retirement will be lower even though we did a great job saving. But I too think under-converting is the practical choice.

Stuff like high medical expenses could help one "solve" the RMD problem late in the game. Also if one has heirs, the new ten-year draw down rules make it harder but I still think my kids can inherit and pretty effectively drain the balances. People who are charitably inclined might be able to use qualified charitable distributions to "solve" the RMD problem.

Thanks for the detailed reply

In addition to all you wrote above, the argument that clinches the under converting argument for me is what some people refer to as the "asymmetric risk" argument:  If I convert at rate X% now and my tIRA tanks and I therefore over converted, then I'm really going to regret it because I will have wasted money I really might need in my poor dotage.  But if my investments perform well and I have "too much" money in my tIRA and large RMDs, then the worst that happens is I can grump about my high rate tax bill from my villa in the south of Europe or whatever.

(I won't really ever have a villa, but you get the point I'm sure.)

SeattleCPA

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Re: HUGE Roth conversion mistake
« Reply #67 on: February 14, 2024, 05:02:11 PM »
My marginal rate in retirement will be lower even though we did a great job saving. But I too think under-converting is the practical choice.

Stuff like high medical expenses could help one "solve" the RMD problem late in the game. Also if one has heirs, the new ten-year draw down rules make it harder but I still think my kids can inherit and pretty effectively drain the balances. People who are charitably inclined might be able to use qualified charitable distributions to "solve" the RMD problem.

Thanks for the detailed reply

In addition to all you wrote above, the argument that clinches the under converting argument for me is what some people refer to as the "asymmetric risk" argument:  If I convert at rate X% now and my tIRA tanks and I therefore over converted, then I'm really going to regret it because I will have wasted money I really might need in my poor dotage.  But if my investments perform well and I have "too much" money in my tIRA and large RMDs, then the worst that happens is I can grump about my high rate tax bill from my villa in the south of Europe or whatever.

(I won't really ever have a villa, but you get the point I'm sure.)

+1


elysianfields

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Re: HUGE Roth conversion mistake
« Reply #68 on: February 17, 2024, 02:52:35 AM »
I think as a not-particularly-early retiree, you might well be the exception.

I keep forgetting how unusual our case is - most people fund consumption with debt, have little savings, no pension, and rely on Medicare in retirement. 

And in the Traditional vs. Roth, you should take into account any existing traditional balance, so good on you for doing that. But some other things:

RMD "problems" boil down to having too much money for one thing - yeah tax bill is higher than you'd like, but if that initial ~4% you're being forced to take out is more than you actually need to meet your expenses, I mean, what are we talking about really?

#2 - FIRE folks tend to get a pretty good handle before the RMDs would kick in and start doing conversions and other adjustments as you're doing here.

And for me, this is the big one - if you're charitably inclined, assuming tax law doesn't change between now and then, you can meet your RMD with a qualified charitable distribution. Up to 105K for 2024. If you give away $105K per year and still are having RMD problems, see point #1 above.

Right, we do have some charities we wish to support, and would prefer to see them enjoy our gifts during our lifetimes.

Congrats @OzzieandHarriet, that must come as a great relief!

With that settled, I hope you don’t mind me taking this thread in a similar but somewhat different direction:

This is sort of outcome is one of the reasons I really dislike the near-religious fervor too many people feel about Roths. They usually are not that great an option. Most people don't save tax. Especially FIRE folk. Most people won't have RMD issues. Especially FIRE folk.

@SeattleCPA could you elaborate on these assertions?

My SO and I have significant Traditional IRA/TSP funds, were born after 1959, and stand to collect Federal pensions.  By the time we start taking RMDs at age 75, our Traditional balances could be 4x their current size, leading to large RMDs on top of our pensions and SS, potentially vaulting us into a much higher bracket (under current law with the TCJA expiring on 12/31/2025 for individual taxpayers).

I think tax rates will go up a little bit. But not that much. At least for most of us.

Quote
Based on this, we did ~$60k of Roth conversions in 2023 up to the top of the 22% bracket, and have switched our TSP contributions to Roth (we max and catch up).

So it makes sense to pay the 22% tax rate now if you'll pay the 24% or 25% or 28% rate (or an even higher rate) in retirement.

My rough calculations say that you'd need in 2024 dollars around $200K of income to broach the next higher tax bracket. If you get $30K of SS that's sheltered by $30K of deductions (to keep this simple) and you get $80K of pensions, that means you'd need $3M generating another $120K to broach that next higher bracket. I'm applying the 4% SWR rule.

Quote
Are we the exceptions in your thinking (we’re already FI, will retire in 2026, but not especially early)?

Maybe.

When you say 4x your current balances, are you working in real dollars or nominal dollars (which have been reduced in size due to inflation)?

E.g., if you'd need $3,000,000 today to generate $120K in distributions so you broach that 22% tax bracket, with 3% inflation, in 24 years you'll need roughly $6,000,000 to generate distributions that broach the 22% tax bracket. Because the tax brackets creep up for inflation too.

Another way to say the same thing. Today the 24% bracket starts at roughly $200K. In 24 years if inflation is 3% annually, the 24% tax bracket would start at roughly $400K.

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Why do you say most people won’t have RMD issues?

That Survey of Consumer Finances that comes out every three years says maybe 60% of people don't have retirement savings. So they don't need to worry obviously about RMDs.

Same Survey says that next 20% of people end up with somewhere between 0 and $500K. They also don't need to worry probably. If you have $500K and draw 4%, that's $20K a year. Couple that with SS or pension and I doubt someone gets past the 12% tax bracket.

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Who are the sorts of people who face RMD issues?

I'd look at your current income and apply the 4% rule. E.g., if you make $100K a year in a job, you need to have $2.5M in an IRA and draw 4% or $100K in order to have same income. It's unlikely statistically that someone making $100K reaches this. (Less than 10% of people end up with more than $1,000,000.) Even more unlikely someone making $100K a year ends up with way more than $2.5M (again working current day dollars.)

Another example: Say you guys make $500K. In that case you need roughly $12,500,000 in your IRAs to generate $500K. It is impossible in most realistic cases to end up with that much in an IRA.

BTW there are a couple of issues that high upper middle class people encounter and which can push the RMD risk up a bit. First if you're making an amount that pushes you into the range where you get an IRMAA hit. Also if you're married but either you or your spouse would as a widow widower pay a higher rate--this happens for some taxpayers--that can push your rate or your surviving spouse's rate us.

Sorry for ramble.

But the TLDR summary which I should have put at the beginning: Most people can't save enough to even have large enough IRA to worry about RMDs. And lots of people who think they might? They might not be doing the inflation adjustments correctly?

Thanks for the reply.  You’re correct that I wasn’t adjusting for inflation, but our traditional buckets are rather large, if not quite at the level that you mention.

We’re not worried about IRMAA because with the FEHB in retirement, we probably won’t bother paying Medicare part B, especially if we spend much of our retirement outside of the US.

Whether by luck (we’ve selected a few individual stocks that have multiplied, bought a SFH in a VHCOL area which we’re renting profitably) or by design (low-consumption lifestyle, high savings rate, maxed our 401ks/TSPs/IRAs for years), we really are the exception.  The pension & health care on top lead us to different choices than non-USG employees might consider.

The MFJ vs. single filer is a wild card which we hope not to face for a long time and which we really cannot control, though we continue to make healthy lifestyle choices.  But regardless, Death will come a-knocking one day, and I doubt my chess-playing skills can keep him at bay for long once he shows up.
« Last Edit: February 17, 2024, 02:59:44 AM by elysianfields »