Does SEPP make more sense than Roth conversions for us?

[coaster831]

I’ve been attempting to model my drawdowns for ER and would like some feedback from the excellent minds here.  All responses are welcome (especially if I’ve made any logical errors!), but the main questions I’d like to try and answer are:

1)   For our situation, does some SEPP make a lot more sense than full Roth conversion ladder, especially in terms of limiting taxable income for ACA?
2)   Are there any major flaws in my drawdown plan?

Hypothetically, the estimated balances of our accounts at time of retirement (me 41, wife 39) accounts are:

My 401k: 715k
Spouse 401k: 415k
My Roth: 100k
Spouse Roth: 100k
Taxable: 500k
HSA: 15k

TOTAL: $1845k

The main driver for my SEPP question is: I plan to retire with a mortgage (29 yrs left, $345K balance, 3.875% fixed rate, monthly principal + interest = $1650).  Paying off the mortgage would make ER prohibitive due to low remaining taxable balance.

Including the mortgage, our expenses will be about $73k / yr.  After the mortgage is paid off (at which point we will also be eligible for SSA and medical benefits), I’m estimating $50k / yr spending.

Also, 15 yrs after retirement (~age 56), we will start receiving ~$6,500 / yr through an additional income stream.

NORMAL ROTH LADDER DRAWDOWN

Doing a standard Roth conversion ladder, our income during the first years of ER would look something like:

9k taxable dividends
60k from taxable accounts for current spending (basis + capital gains)
4k from Roth accounts (our existing contributions / backdoor conversions)
~66k / yr Roth conversion to support spending when taxable dries up

Total taxable income: 75k, which puts us near the ACA cliff and top of the 0% capital gains bracket.

SEPP drawdown

If we started an SEPP with my 401k, the first years look like:
9k taxable dividends
~30k SEPP for current spending from my 401k
4k from Roth accounts (our existing contributions / backdoor conversions)
30k from taxable accounts for current spending (basis + capital gains)
~10k / yr Roth conversion (from spouse 401k) to support spending when taxable dries up (the taxable account will last much longer in this scenario, so these conversions will accumulate to a level needed to support spending to bridge us until 59.5)

Total taxable income: $49k

The SEPP keeps our Roth conversions (and thus taxable income) lower to get us to the ages of 55 (when we get additional 6500k/yr) and 59.5 (full access to retirement accounts). 

Does this analysis look correct to you?

Thank you for reading and any feedback!

[zolotiyeruki]

Your analysis looks correct AFAICT.  The SEPP scenario would keep you further away from the top of the 0% LTCG range, but it's fixed once you start it.  If you decided at age 45 to go back to work, you'd still be stuck with the SEPP.  Of course, you could just turn around and re-contribute those withdrawals into another tax-deferred account.

[coaster831]

Thanks for spot checking it. Yes, the inability to stop the SEPP is a big drawback, which is why I really want to be sure the advantage from this analysis is correct.

[cangelosibrown]

The nice thing about the Roth conversion is the flexibility.  There's no reason you need to be doing 66k Roth conversions now. 5 years from now when that money is available, you will still have plenty of taxable money to spend. You can wait till December of every year and convert whatever makes sense tax-wise.

If you feel like you'll run out of taxable money in 5 years, you can start doing larger conversions, but even then you'll have the buffer of what you converted previously, plus the knowledge that if you're desperate you can always start a SEPP plan.

[cangelosibrown]

I just did some back of the envelope spreadsheet work, and ~45k a year in Roth conversions should see you through to 59.5 . I'm making a lot of assumptions to get to that, obviously, but I see absolutely no advantage of the SEPP over Roth conversions.

The only possible advantage is when you absolutely need the money to spend before 5 years is up. which is definitely not true in your case.

[coaster831]

Hmm, interesting.  I didn't think I could get stay funded (in terms of available cash flow until 59.5) with conversion amounts that low - I'll have to revisit my calculations as well.  The flexibility of Roth conversions is certainly more appealing.  I'll revisit my spreadsheet - thanks!

[BuildingFrugalHabits]

I haven't seen many folks using the SEPP method to retire but to me, it seems much simpler.  I understand the flexibility of the Roth but it seems like it could be a PITA accounting wise if your account is old and/or has been rolled over several times.  What about doing a SEPP with both you and your spouses 401k (30k yours and ~17k from spouse?) and meeting the remaining spending needs from your taxable account?  Your taxable account essentially provides the buffer between your SEPP and your spending without having to worry about rolling over funds aging them five years etc. 

[coaster831]

I haven't seen many folks using the SEPP method to retire but to me, it seems much simpler.  I understand the flexibility of the Roth but it seems like it could be a PITA accounting wise if your account is old and/or has been rolled over several times.  What about doing a SEPP with both you and your spouses 401k (30k yours and ~17k from spouse?) and meeting the remaining spending needs from your taxable account?  Your taxable account essentially provides the buffer between your SEPP and your spending without having to worry about rolling over funds aging them five years etc.

This is an interesting idea, too.  It is certainly simpler, which is a huge plus when there are so many moving parts.  I am still leaning towards doing a blend (SEPP from one 401k, Roth conversion from the other) to provide a bit of income flexibility, but I will talk this over with my wife.   Thanks!

[Catbert]

Also consider what would happen to your SEPP withdrawals if/when the market takes a major crash.  You still need to take out the same amount even in a dwindling account.  You could still be okay if your profolio isn't too aggressive and the market rebounds fairly quickly (e.g., 2008).  But a lot can happen in 20 years.  If you go this route do it with just a segment of your family's overall 401k.

[coaster831]

Also consider what would happen to your SEPP withdrawals if/when the market takes a major crash.  You still need to take out the same amount even in a dwindling account.  You could still be okay if your profolio isn't too aggressive and the market rebounds fairly quickly (e.g., 2008).  But a lot can happen in 20 years.  If you go this route do it with just a segment of your family's overall 401k.

Fair point.  I think we'd keep the SEPP 401k at around 50/50 and the other 401k more aggressive to balance it. 

[robartsd]

Also consider what would happen to your SEPP withdrawals if/when the market takes a major crash.  You still need to take out the same amount even in a dwindling account.  You could still be okay if your profolio isn't too aggressive and the market rebounds fairly quickly (e.g., 2008).  But a lot can happen in 20 years.  If you go this route do it with just a segment of your family's overall 401k.

You can change the SEPP withdrawal basis to the RMD method as an emergency effort to avoid depletion (of course if the markets recover before your SEPP ends that locks you in to even higher withdraws post recovery).


I'm having trouble believing the tax situation under a Roth conversion ladder is as limited as you are projecting. What are you holding in your 500k taxable that spits off 9k (1.8% of your total holdings) in non-qualified dividends each year (it seems like it'd have to be mostly REIT, bonds, or recent trades for this to be true)? How do you manage to have 200k in Roth, but can only pull out 20k (4k/yr * 5 years to build ladder) in contributions and backdoor conversions (90% of your Roth is investment returns)?