Retirement Tax Plan to keep the Tax Man at bay

[G Money Stache]

I would appreciate advice and thoughts from the community as I prepare to fire in the near future. Trying to determine best way to take distributions and conversions. I have decent understanding of taxes and planning but still worry about screwing it up.

55 DH and 50 DW. DH looking to quite mega corp in 6-12 months. Might have some income for next 5 years ($20K annually). DW to work 2-3 years for medical insurance and $30K per year income.

Annual spend $110K. This has substantial flexibility.

Assets:
401K DH $900K ($820K pre tax, 80K after tax non Roth) Can take distributions penalty free as I am post 55.
Pension pre tax $120K
401K DW $55K
IRA DH $60K
Roth IRA DH $200K
IRA DW $190K
Brokerage $300K ($150K cost basis)
70/30 stocks/bonds across investments. Stocks in diversified indexes (VOO, VONV, VONG, RUT)

House $800K mortgage free

Total assets: $2625K

DH and DW will take SS at 67/62. $53k

Big Question: 99% chance of getting $500K-900K inheritance in 10-20 years. Some might frown on this but I have to plan for.
 
If income for next 4 years is $30K what is the best order to take distribution and or do conversions?

My current thinking:
1. Spend down brokerage and in first 3 years to have zero to minimal capital gains. $80K annually.
2. Take distributions from DH 401K years 4-11 to SSNRA 67

What about IRMMA?
Should I be doing Roth conversions?
Pending inheritance tax bomb?

Advice please.

Thank you,
G Money Stache

[lhamo]

Yes, in your position I would be looking hard a a Roth conversion strategy.

Gonna copy and paste what I posted on a thread yesterday with a very similar question.

The Bogleheads Retiree Portfolio model is a very complicated spreadsheet, but if you persist and fill in all your info it is VERY helpful for seeing what your tax rates will be on Roth conversions compared to waiting to take RMDs from unconverted accounts.  The Roth section is all the way at the end.  You can put in income from your spouse's job for whatever period they will likely continue to work, and then play around with different conversion amounts in the Roth table at the bottom.

Spreadsheet available through the links on the wiki page:

https://www.bogleheads.org/wiki/Retiree_Portfolio_Model

Be forewarned that the spreadsheet has TONS of red ink on it (error warnings) until you get your numbers mostly put in. JUst persist and work through it and eventually it goes away.

[G Money Stache]

Thank you. Unfortunately work computer will not allow file share access.

If we have 30k income in years 2-3 we can convert 100K to roth. 130k total income. 25k standard deduction 105K taxable. Should I be paying taxes out of brokerage account? Then I am paying 20% LTCG.

While do the conversions where do we take the distribution for the yearly $110K expenses?

[reeshau]

You have a bit of a conundrum.  You can withdraw at 55 *if your plan allows it*.  It is not universal.

You can and should roll over DH's 401k to an IRA.  At the time of rollover (and only then) you can separate the post-tax contributions into a Roth IRA.  But, as an IRA, rather than a 491k, you lose your 55 window.  There are, of course, other ways to access money pre-59 1/2.  Maybe you wait until 59 1/2 to do the rollover, but then you lose the potential appreciation of the $80k in a Roth.

For expenses, I would definitely look at the taxable account.  You will have $89k - your salaries of 0% taxable, as long as they are long-term gains.  Otherwise, they are 15% taxed for quite a bit beyond that.  Be careful about the dual action of Roth conversions: taxable, and crowding out your 0% LTCG cap.

[secondcor521]

I would first sit down and run your situation through FIREcalc to check to see if your spending is sustainable.  Ignoring the home equity (unless you plan to downsize significantly), $110K / $1825K is a bit on the precarious side except that you have SS coming in at some point.  FIREcalc can crunch the numbers for you - you can put in your assets and income streams and spending and it will run a historical analysis of how your situation would have turned out.

I would run opensocialsecurity.com with your SS situation.  It may recommend the higher earner taking SS later and the other earner taking at 62, but see what it says.  Look at the sensitivity analysis at the bottom to see how much it matters (it probably won't matter much when you claim).

Personally I plan to delay SS to do as much Roth conversions as makes sense for me.

I personally spend from my taxable as needed and then do Roth conversions up to a tax rate that I am willing to pay knowing my tax rate will be higher later.  I use the Case Study Spreadsheet (available on a thread here on MMM) to analyze this each year.  It requires genuine Excel to run the macros that generate the marginal tax rate analysis graph - I go to the library for this.

Another Roth conversion impact is that, as part of AGI, it affects anything derived from AGI, which notably includes ACA subsidies.  So the more Roth conversions you do, the lower your ACA subsidies.  Other AGI things are state taxes and FAFSA SAI calculations.

On the inheritance, if you're going to plan around it, you probably should find out if it's going to come as life insurance payout, traditional IRA, Roth IRA, real estate, or whatever.  The taxation to you of each of these differs, and if you're going to plan you might as well try to plan well.  But I will repeat the standard advice, that that inheritance money could disappear in any number of ways:  they could marry the pool girl/guy and change their will, they could lose it to a scam, or they could lose it to an expensive end of life illness.  Only you can decide how you want to handle those things, but "don't count on it yet" is the most conservative.

IRMAA applies at age 65 and there is a 2 year lookback, so your tax return when you turn 63 is where it starts to matter.  It is basically an extra 2-7% income tax.  Put it in your model, but it likely won't change any of the big building blocks of your plan (it could change things on the edges).

Whether there is an inheritance tax bomb depends on the nature of the inheritance.  The inheritance itself generally isn't taxable - you probably know that - but any income that the inheritance throws off is taxable to you generally, and traditional IRAs generally are required to be drained within 10 years of death of the owner and RMDs are also generally required during that 10 year period.

I agree you should take a hard look at Roth conversions.  Also disclaimers and QCDs if you have plenty of excess.

[G Money Stache]

Thank you. I have run through both fire calc and rich,broke,dead. If I use 300K of the house equity and 500K inheritance with $130K annual spend I am at 96% on fire calc with not spend flexibility. RBD has it at 100% with 10% spend flex at 85% portfolio reduction level. I am completely comfortable with the safety level. I have no problem using only 300K of the house equity as I think that is very conservative. House has CAGR of 6% over last 18 years and I view it as the same as a REIT. $800K value is land value and is conservative.

The SS numbers have been run through SS.gov. High earning waiting until 67 so survivor benefit is solid. Even with one of us passing early it still works as most of the SS benefit is from the high earner.

I am aware of the Roth and AGI for ACA. We should be on DW medical for the first three years so that would be the time to do the conversions I would think.

The inheritance is being moved yearly out of 403B and into after tax due to RMD. It is most likely to be 30% 403B, 30% equities after tax step basis and 40% property with step up basis. So longer it goes less of a tax issue it becomes. On the models I am using the full 20 years and I hope its longer. I am the sole heir and they were MMM before MMM when it comes to spending and being smart about it. That's how I got to where I am. It's in the genes. They are greatly enjoying their retirement but net worth continues to grow as they have good pensions, SS and health. Neither is likely running off with the pool boy/girl. $500K is ultra conservative value. Could very likely be 3X that. In the case the inheritance is zero I am comfortable with using more home equity in the models.

Would like to get any conversions done prior to 63 to avoid the IRMAA issue but that window is getting smaller by the day.

I appreciate your feedback and help.

[seattlecyclone]

You have a bit of a conundrum.  You can withdraw at 55 *if your plan allows it*.  It is not universal.

To be clear, the penalty-free withdrawals for those who leave their job after 55 are a feature of the tax code and an employer cannot override this.

What the employer can do is put rules into their plan that former employees cannot take partial distributions of their money from the plan. The employee is entitled to leave the money there as long as they like, but once they want to touch any of it they must take it all out and move it to their own account. If your employer has this rule in place what you can do is take your full withdrawal into your checking account and redeposit most of it to your traditional IRA as a rollover contribution. This lets you get the penalty-free access to whatever amount you leave in the checking account to cover your short-term spending needs. It's not as good as being able to make a small withdrawal each year from 55-60 to cover what you want to spend that year, but it's something.

I do encourage you to look into your employer plan rules and verify whether or not they allow partial withdrawals. That will inform your tactics here.

[Sandi_k]

But if you roll it over from a 401(k) to a rollover IRA, you cannot use the Rule of 55 - you have to wait until 59.5 to have penalty-free withdrawals.

So, that's kinda like the plan itself is the final arbiter of whether you can use the Rule of 55.

[secondcor521]

If I use 300K of the house equity

What is your plan for spending $300K of your house equity?  Downsize?  Reverse mortgage?  HELOC you never pay off?

But if you roll it over from a 401(k) to a rollover IRA, you cannot use the Rule of 55 - you have to wait until 59.5 to have penalty-free withdrawals.

A person can always do a 72(t) at age 55, although those don't allow access to as much of the account balance as Rule of 55.  It works out to be about 6% of the balance per year at most.

[seattlecyclone]

But if you roll it over from a 401(k) to a rollover IRA, you cannot use the Rule of 55 - you have to wait until 59.5 to have penalty-free withdrawals.

So, that's kinda like the plan itself is the final arbiter of whether you can use the Rule of 55.

The part you leave in your checking account instead of rolling into your IRA gets to benefit from the age 55 rule.

[Sandi_k]

But if you roll it over from a 401(k) to a rollover IRA, you cannot use the Rule of 55 - you have to wait until 59.5 to have penalty-free withdrawals.

So, that's kinda like the plan itself is the final arbiter of whether you can use the Rule of 55.

The part you leave in your checking account instead of rolling into your IRA gets to benefit from the age 55 rule.

I understand that. Just pointing out a possible problem if people choose to roll over to an IRA from the 401(K), and trap themselves.

[seattlecyclone]

Right, I just want to be clear that the plan doesn't control whether you can benefit from the age 55 rule at all, but they do get to control whether it's a thing you can benefit from in multiple years.

[Bear Stache]

+1 for @seattlecyclone  advice above. Both my and my wife's employer 401k plans did not allow partial withdrawals, the only choices were leave it, or withdraw all of it at once. Fortunately we had enough in brokerage to cover us until 59 1/2, so we rolled them into IRAs. The bottom line is, read the fine print on your employer 401k plan, don't assume you can make partial withdrawals like you can with an IRA. Good observation from Seattlecyclone, as usual.

[G Money Stache]

I have confirmed the 401 allows partial distributions. It has great investment options and very low fees. I am fine leaving the funds in there as I take distributions. The company is about as stable as it gets. Too big to have a take over or anything that could be concerning to the 401K.