Author Topic: How to estimate MAGI on future retirement income  (Read 1005 times)

ysette9

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How to estimate MAGI on future retirement income
« on: June 08, 2019, 01:55:12 PM »
Hi all - I would like to estimate what our MAGI will be once FIREd and living off just our investments. I've done a bunch of searches and looked at several calculators online on estimating MAGI, and they all start with "look at line x in section y of your tax return". This isn't at all helpful because we are currently working, so our current income is totally different from what it will be once we aren't working anymore.

I can log into Vanguard and see the Cost Basis tab to see what my short- and long-term capital gains are. If my total capital gains are x% of my investments, can I crudely estimate that my income from investments will be the $ that I withdraw to live on * x%?

Initially we will just live on our taxable account and plan to do Roth conversions of our traditional accounts in the background in whatever space we have. We have a nice mix of taxable, Roth, and traditional retirement accounts, so we have flexibility to tailor this all to our needs. I just need to do the learning to figure out what the hell to do! As we all know, understanding MAGI is really important for ACA subsidies as well as Roth conversion space and other stuff. Thanks in advance for the help.

secondcor521

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Re: How to estimate MAGI on future retirement income
« Reply #1 on: June 08, 2019, 02:10:12 PM »
If you want to estimate MAGI in early retirement, as I do for ACA and FAFSA purposes, just add up:

interest from savings accounts
dividends from taxable account
Roth conversion amounts
long term capital gains from sales from taxable account
any side gig income

(plus any other taxable income sources you have - the above are mine.)

Your x% method for LTCG is a good first estimate.  If you choose to sell using the specific identification method, then it could be higher or lower.

The first year or two of retirement it will be different and confusing.  If you have buffer in your plan (and you should), it won't matter that much.  After that, you'll start to see how taxes work and where you're actually at, and you'll understand things more and be able to optimize a little better.

The more effort you put into optimizing your taxes and calculating your estimates, the better off you'll be.  I think it's an individual decision as to how much effort to put into this area.  I do think it's definitely worth it to understand very well how taxes work and how the various things on a 1040 interact with each other.  After a certain point, the returns diminish because you'll have everything dialed in and you'll only want to spend a little time each year understanding the differences from the previous year (which are usually minimal).

Personally, I've been FIREd about three years.  I have a small spreadsheet with the above line items.  In December each year, I can use YTD actuals to estimate each item - except Roth conversions - very closely.  I then do a mock tax return with those estimates and decide, mostly based on my marginal tax bracket and non-refundable tax credits, what I want my AGI to be.  I then do a Roth conversion or two in late December to bring my AGI up to where I want it to be.
« Last Edit: June 08, 2019, 02:13:09 PM by secondcor521 »

ysette9

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Re: How to estimate MAGI on future retirement income
« Reply #2 on: June 08, 2019, 03:59:45 PM »
If you want to estimate MAGI in early retirement, as I do for ACA and FAFSA purposes, just add up:

interest from savings accounts
dividends from taxable account
Roth conversion amounts
long term capital gains from sales from taxable account
any side gig income

(plus any other taxable income sources you have - the above are mine.)

Your x% method for LTCG is a good first estimate.  If you choose to sell using the specific identification method, then it could be higher or lower.

The first year or two of retirement it will be different and confusing.  If you have buffer in your plan (and you should), it won't matter that much.  After that, you'll start to see how taxes work and where you're actually at, and you'll understand things more and be able to optimize a little better.

The more effort you put into optimizing your taxes and calculating your estimates, the better off you'll be.  I think it's an individual decision as to how much effort to put into this area.  I do think it's definitely worth it to understand very well how taxes work and how the various things on a 1040 interact with each other.  After a certain point, the returns diminish because you'll have everything dialed in and you'll only want to spend a little time each year understanding the differences from the previous year (which are usually minimal).

Personally, I've been FIREd about three years.  I have a small spreadsheet with the above line items.  In December each year, I can use YTD actuals to estimate each item - except Roth conversions - very closely.  I then do a mock tax return with those estimates and decide, mostly based on my marginal tax bracket and non-refundable tax credits, what I want my AGI to be.  I then do a Roth conversion or two in late December to bring my AGI up to where I want it to be.
This is really helpful. Thanks for the reply. Iíll do another pass adding in the dividends and interest. I like your strategy of leaving the Roth conversions to the very end of the year.

Just as a sanity check, since my taxable account is pretty new the cost basis isnít too much higher than the total value. So that means we could draw whatever we need to live on, and then if our income were, say, $10k capital gains, maybe another $10k in dividends and interest, we could have a bunch of Roth conversions space and stil stay within the $78k 0% long term capital gains federal tax bracket as a married couple and get some decent ACA subsidies? It almost feels too good to be true. This being rich thing is a good life!

MDM

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Re: How to estimate MAGI on future retirement income
« Reply #3 on: June 08, 2019, 04:24:25 PM »
So that means we could draw whatever we need to live on, and then if our income were, say, $10k capital gains, maybe another $10k in dividends and interest, we could have a bunch of Roth conversions space and stil stay within the $78k 0% long term capital gains federal tax bracket as a married couple and get some decent ACA subsidies? It almost feels too good to be true. This being rich thing is a good life!
Pretty much.

You could enter your filing status, ages, all your other income as applicable, and then change cell G107 to "D31" (w/o quotes), click the nearby "Update chart" button, and adjust cell P83 as desired to see your marginal rates for various amounts of tIRA withdrawals/conversions, using the case study spreadsheet Calculations tab in Excel.

secondcor521

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Re: How to estimate MAGI on future retirement income
« Reply #4 on: June 08, 2019, 04:45:53 PM »
(yadda yadda)
This is really helpful. Thanks for the reply. Iíll do another pass adding in the dividends and interest. I like your strategy of leaving the Roth conversions to the very end of the year.

Just as a sanity check, since my taxable account is pretty new the cost basis isnít too much higher than the total value. So that means we could draw whatever we need to live on, and then if our income were, say, $10k capital gains, maybe another $10k in dividends and interest, we could have a bunch of Roth conversions space and stil stay within the $78k 0% long term capital gains federal tax bracket as a married couple and get some decent ACA subsidies? It almost feels too good to be true. This being rich thing is a good life!

ACA subsidies end at 400% of FPL.  FPL is determined by your tax household size and where you live.  If you're a married couple with no dependents living in the continental US and looking at the ACA for 2020, then ACA subsidies end at $67,640 of AGI  (https://thefinancebuff.com/federal-poverty-levels-for-obamacare.html):  $16,910 * 400%.

I'm 99% sure that capital gains tax brackets are based on taxable income, which is after the standard deduction.  So your AGI for 0% LTCG would be $78,750 + $24,000.  (Those are 2019 numbers assuming MFJ and no dependents; 2020 numbers will be somewhat higher).

So ACA subsidies phase out at a lower income level than the 0% LTCG rates.

You'll get to make game time decisions as to how much AGI to have versus how many tax benefits you want to have.  I actually keep a list of tax benefits and the various applicable AGI levels which helps me make the tradeoffs.  The nice thing is each year starts a new game, and as you play the game you get better with experience.

(Personally I find that - with a paid off house in a LCOL area - my spending needs are low enough to where I qualify for a fair number of tax benefits.)

ysette9

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Re: How to estimate MAGI on future retirement income
« Reply #5 on: June 08, 2019, 04:53:38 PM »
You are right. I failed to mention that we are a family of 4, about to become a family of 5. For us the 400% FPL is a little over $110k, so I was honing in on the top of the 0% tax bracket as it is lower. Thanks for pointing out the standard deduction. It is amazing how comfortable I feel with investment stuff and how utterly clueless I am on the tax side. Time to fix that.

As for balancing Roth conversions vs ACA subsidies I guess we should just run some scenarios and see what feels better?

MDM

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Re: How to estimate MAGI on future retirement income
« Reply #6 on: June 08, 2019, 05:08:19 PM »
As for balancing Roth conversions vs ACA subsidies I guess we should just run some scenarios and see what feels better?
If you are trying to decide whether to convert now or later, whichever time will provide the lower marginal rate for the conversion amount in question will be better.  The marginal rate includes the effect of ACA subsidies, Medicare premiums, and all the intricacies of the tax code.

secondcor521

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Re: How to estimate MAGI on future retirement income
« Reply #7 on: June 08, 2019, 05:21:57 PM »
You are right. I failed to mention that we are a family of 4, about to become a family of 5. For us the 400% FPL is a little over $110k, so I was honing in on the top of the 0% tax bracket as it is lower. Thanks for pointing out the standard deduction. It is amazing how comfortable I feel with investment stuff and how utterly clueless I am on the tax side. Time to fix that.

As for balancing Roth conversions vs ACA subsidies I guess we should just run some scenarios and see what feels better?

Ah, yes, having a larger tax family size, as the ACA and IRS so poetically put it, changes the relative AGI levels.  As well as where you live.  The link I provided for FPL in my previous post is one of the clearer explanations of that part of it that I have found; I would refer you there.

Balancing Roth conversions and ACA subsidies, there are a number of things to consider, depending on how complicated you want to get:

1.  All other things being equal, Roth conversions reduce ACA subsidies between ~138% and 400% of FPL.

2.  There are actually three (I think) different graduated rates in the above range.  So Roth conversions between, say 138% and 150% reduce your ACA subsidies at a more rapid rate than between 300% and 400% of FPL.  You can see this by playing around with Form 8962 or doing careful math with the "Applicable Figure" in Table 2 of the Form 8962 instructions.

3.  Roth conversions increase AGI and taxable income, so there are other effects of Roth conversions beyond ACA subsidies.  Using my particular case as an example, the increase my state income taxes, affect my FAFSA results two years from now, and affect AGI eligibility for other tax benefits (like the retirement savings tax credit).

4.  On a very long term view, Roth conversions help avoid what is called the tax torpedo.  Basically, if you're FIRE, then when you hit 70 and are collecting Social Security and taking RMDs from your traditional IRA, it can push you into a high tax bracket.  So what I do is figure out what bracket I'll be in when I am 70, and then try to do my Roth conversions now so that I shift forward some of that higher-when-I'm-70-taxed-money to now.  This is a hard to impossible thing to get exactly right, but it's probably worth thinking about if you think you'll live past 70 and if you think the tax rules will be approximately the same as they are now.

5.  In a shorter term view, you want to make sure you Roth convert enough to live on five years later (to the extent that you're living off your Roth conversion ladder).

6.  With dependents, the child tax credits and other dependent tax credits are non-refundable.  This means that you have to create a high enough income to create a high enough tax bill to use up all of these non-refundable credits; otherwise they are "wasted".  Personally I always Roth convert enough to make sure I don't leave any of those credits on the table.

Acastus

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Re: How to estimate MAGI on future retirement income
« Reply #8 on: June 10, 2019, 01:30:07 PM »
One of the important concepts for qualifying for ACA subsidies is that income is income, regardless of what the tax rate is on it. Capital gains and tax exempt bond income have a federal tax of 0%, but they count as income for the ACA MAGI.

I have personally been wondering if it is worth it to keep my income below 250% poverty so we qualify for cost sharing subsidies. I am not sure those subsidies are worth much if you are near 250% as I am targeting. Incremental income has an ACA excise tax of about 8% on top of regular income tax. I am in the 12% federal bracket between 250 and 400%, so I would pay 20% overall. Is  that better than paying some future tax rate on RMD's 15 years from now? I am not sure how to assess.

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Re: How to estimate MAGI on future retirement income
« Reply #9 on: June 10, 2019, 01:45:27 PM »
One of the important concepts for qualifying for ACA subsidies is that income is income, regardless of what the tax rate is on it. Capital gains and tax exempt bond income have a federal tax of 0%, but they count as income for the ACA MAGI.

I have personally been wondering if it is worth it to keep my income below 250% poverty so we qualify for cost sharing subsidies. I am not sure those subsidies are worth much if you are near 250% as I am targeting. Incremental income has an ACA excise tax of about 8% on top of regular income tax. I am in the 12% federal bracket between 250 and 400%, so I would pay 20% overall. Is  that better than paying some future tax rate on RMD's 15 years from now? I am not sure how to assess.

The cost sharing subsidies aren't all that valuable in the 200-250% of FPL range. Below 200% they become more lucrative (essentially a platinum plan for the price of a silver). Hard to give any general advice on the tradeoff between lower income now and higher RMDs later. It depends so much on your specific situation.

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Re: How to estimate MAGI on future retirement income
« Reply #10 on: June 10, 2019, 03:11:05 PM »

If you plan to take SS at age 62 while still wanting to take advantage of the ACA PCT and CSR, you will need to add both taxable and non-taxable SS benefits in calculating your MAGI in determining your eligibility for those subsidies.  Under current law, I'm planning to hold off on taking SS until at least age 65 for this reason.

secondcor521

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Re: How to estimate MAGI on future retirement income
« Reply #11 on: June 10, 2019, 03:25:18 PM »
One of the important concepts for qualifying for ACA subsidies is that income is income, regardless of what the tax rate is on it. Capital gains and tax exempt bond income have a federal tax of 0%, but they count as income for the ACA MAGI.

I have personally been wondering if it is worth it to keep my income below 250% poverty so we qualify for cost sharing subsidies. I am not sure those subsidies are worth much if you are near 250% as I am targeting. Incremental income has an ACA excise tax of about 8% on top of regular income tax. I am in the 12% federal bracket between 250 and 400%, so I would pay 20% overall. Is  that better than paying some future tax rate on RMD's 15 years from now? I am not sure how to assess.

If you have state or local income taxes, you would also pay those respective rates on the incremental income.  Also, if you will have someone in college two years from now and might get financial aid, then you would have to add the loss of financial aid as an incremental tax rate.

It is hard to assess, but the basic question is whether you think your total marginal rate now would be lower than the marginal rate on those RMD's 15 years from now.  It also depends on your assessment of how the tax laws will change in the next 15 years, which I think is very hard to predict.

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Re: How to estimate MAGI on future retirement income
« Reply #12 on: June 12, 2019, 04:30:31 AM »
One of the important concepts for qualifying for ACA subsidies is that income is income, regardless of what the tax rate is on it. Capital gains and tax exempt bond income have a federal tax of 0%, but they count as income for the ACA MAGI.

I have personally been wondering if it is worth it to keep my income below 250% poverty so we qualify for cost sharing subsidies. I am not sure those subsidies are worth much if you are near 250% as I am targeting. Incremental income has an ACA excise tax of about 8% on top of regular income tax. I am in the 12% federal bracket between 250 and 400%, so I would pay 20% overall. Is  that better than paying some future tax rate on RMD's 15 years from now? I am not sure how to assess.

Remember that your RMDs are treated similar to W-2 income.  So they will get applied toward your standard deduction before your LT capital gains and qualified dividends.  So the key question is how big do you expect your RMDs to be?  If they fit within your standard deduction, then they basically will take up the space that your Roth conversions used to take up (assuming you're doing Roth conversions).  I expect that this will be my situation.  In which case it makes sense to prioritize minimizing MAGI now instead of maximizing Roth conversions.

But it sounds like your situation is different, given that you expect your income to be near 250% of FPL.  As with most of these optimization problems, you just have to run all the numbers for yourself and see what works out best in your situation.

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Re: How to estimate MAGI on future retirement income
« Reply #13 on: June 12, 2019, 03:26:12 PM »

Remember that your RMDs are treated similar to W-2 income.  So they will get applied toward your standard deduction before your LT capital gains and qualified dividends.  So the key question is how big do you expect your RMDs to be?  If they fit within your standard deduction, then they basically will take up the space that your Roth conversions used to take up (assuming you're doing Roth conversions).  I expect that this will be my situation.  In which case it makes sense to prioritize minimizing MAGI now instead of maximizing Roth conversions.

But it sounds like your situation is different, given that you expect your income to be near 250% of FPL.  As with most of these optimization problems, you just have to run all the numbers for yourself and see what works out best in your situation.

My family size is 3, but will drop to 2 in 5 years or so. That puts the 250% FPL at 51k for now. I am filling the 24k standard deduction and the 19k in the 10% tax bracket with a couple thousand of interest and the rest Roth conversion. I can let cap gains and qualified dividends float up another 5-10k. Making a final conversion in late December worked last year to stay on target. If I have large medical costs, I will pay closer attention to the detailed numbers so I keep the CSR. Actual expenses come out of taxable accounts. This sounds like a good limit to how far I can push Roth conversions. I do not want to go further, based on possible scholarships and state taxes.

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Re: How to estimate MAGI on future retirement income
« Reply #14 on: June 12, 2019, 04:42:58 PM »
So that means we could draw whatever we need to live on, and then if our income were, say, $10k capital gains, maybe another $10k in dividends and interest, we could have a bunch of Roth conversions space and stil stay within the $78k 0% long term capital gains federal tax bracket as a married couple and get some decent ACA subsidies? It almost feels too good to be true. This being rich thing is a good life!
Pretty much.

You could enter your filing status, ages, all your other income as applicable, and then change cell G107 to "D31" (w/o quotes), click the nearby "Update chart" button, and adjust cell P83 as desired to see your marginal rates for various amounts of tIRA withdrawals/conversions, using the case study spreadsheet Calculations tab in Excel.

Using the case study spreadsheet is my preferred method as well!