Author Topic: To What Lengths Do Some Folks Go In Planning Their Income Taxes  (Read 23162 times)

Rob L

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Semi-retired, too much time on my hands, so I do this. I really need to get a life!
Thought some might find this interesting or at least amusing. Any comments will be appreciated.

A little background will be helpful. The bulk of my non-real estate retirement assets are Traditional IRA investments. My LC and Prosper accounts were Traditional IRA. We all know Traditional IRA distributions are taxed as regular income. I always bought into the idea that my tax bracket in retirement would be lower than in my prime earning years so, as I was always at or near the top bracket, I favored the Traditional IRA. I also have a small but non-trivial Roth IRA that is near the 5 year age threshold. The year 2019 holds a unique opportunity for me as it is my last year before I have to take annual RMD's from my Traditional IRA accounts. RMD's will tie my hands with regard to minimum distributions after 2019. My earned income this year is low; thus the opportunity and two questions to be answered.

1) Was my decades old bet that my taxes would be lower in retirement for this money than at the time I earned it correct?
2) The opportunity presented to me is to convert some of my Traditional IRA money into my Roth (and pay taxes on that amount). Optimally, how much?

The remainder of the post refers to the chart below.

The top blue line is my income weighted total effective tax rate (25.83%) that I actually paid on income. Total taxes paid (FED + Virginia) divided by total income over the years 2000 - 2018.

Question 1 is very clear; any amount I sensibly chose to convert is dramatically better than having paid taxes on the income when received.

Question 2 has a lot of moving parts. I have the flexibility to convert as little or as much as I want from Traditional to Roth IRA. It appears that the best choice is the inflection point where the Federal marginal bracket steps up from 12% to 22%. There is no way to avoid the taxation of 85% of Social Security benefits or the Virginia bracket increase from 2% to 5.75% (that is if I want to convert any money at all). The sweet spot seems to be where the Fed bracket steps up from 12% to 22% ("Target Income") and most certainly before the Virginia age deduction is phased out as income increases. "Target Income" gives me an effective total tax rate of 9.35%. I'm hoping to manage it to 11% or less in the future (dealing with RMD's). That's less than half the tax I would have paid at the time the income was earned.

Does anyone but a totally deranged soul perform calculations like this (i.e. Fed tax brackets and VA age deduction phase out, and enjoy it)??  :o



lascott

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Re: To What Lengths Do Some Folks Go In Planning Their Income Taxes
« Reply #1 on: August 04, 2019, 02:51:18 PM »
a) Yes, I spend a BUNCH of time doing retirement planning. I am retired and wife will be next year. We are in our low 50s.  We have 1/3 of our retirement in ROTH and 2/3 in tIRAs.  Using some ROTH money and some tIRA money via 72t/SEPP to live on and help kids with their ROTH IRA & ROTH 401Ks.  Need to avoid high RMDs in the future. May delay 1 or both Social Security incomes to let them grow (8%) and use more tIRAs before RMDs.

b1) There is a TON of advice from every Financial person on doing conversions before 2025 when the 2018 tax rates sunset (for individuals NOT the rich corporations).




b2) I think the real question is can you pay the taxes from non-IRA assets? Play with this calculator. https://www.calcxml.com/calculators/roth-ira-conversion-calculator



c) This calculator (i-ORP) has some interesting models. Including some ROTH Conversion options. The input and output is based in 1K increments so seems a little odd but it really allows for a more condensed report.  I use it on and off. https://i-orp.com/DI/Extended.html

I mainly use Golden Years from Money Tree Software and is part of their Total Planning Suite. It is outstanding and is a Financial Advisor grade tool that they let individuals buy for half the cost and half the annual maintenance.

UPDATE: Forgot I-ORP link: https://i-orp.com/DI/Extended.html & added ROTH vs tIRA info.
« Last Edit: August 04, 2019, 09:49:56 PM by lascott »
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lascott

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Re: To What Lengths Do Some Folks Go In Planning Their Income Taxes
« Reply #2 on: August 05, 2019, 11:59:23 PM »
@Rob L, Did you try out B or C?
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Rob L

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Re: To What Lengths Do Some Folks Go In Planning Their Income Taxes
« Reply #3 on: August 06, 2019, 03:05:31 PM »
Ah, a kindred deranged soul!

Here's how I have my non-real estate holdings allocated:
Non-IRA Liquid9%
Non-IRA Illiquid11%
Traditional IRA Liquid21%
Traditional IRA Illiquid49%
Roth IRA Liquid10%

My wife and I delayed our Social Security by 3 years. Ran the numbers and the total payments lines taking SS in our 4th year versus waiting two more years crossed at age 82 (wife and I are same age). Key part of decision was that I was retired and didn't expect any more significant earned income. But, as Michael said, "they pulled me back in" for another unexpected project and blew my projection. Hindsight I'd have waited the full 5. I should have known better.

Yes, I tried out calculator b1 but it isn't applicable to my situation. My plan is to attempt to hit the sweet spot of my effective tax rate (Target Income on the Chart) by converting variable amounts from tIRA to rIRA each year. This is my last year before I must start RMD's. My regular income was low so I have a one time chance to convert a fairly nice chunk of tIRA funds to rIRA funds at a low tax rate (around $40k or so). After 2019 I will have to take an RMD each year. A rollover from a tIRA to a rIRA does not count as a RMD so I'm thinking my regular income plus RMD will make the amount I can convert to a rIRA and keep my tax bill down will be pretty small. That's my gut feel but I will run the numbers in December each year to see if I can convert at least a small amount into my rIRA and keep my total effective tax rate on target. It is my plan to pay taxes from regular savings and not pre-tax dollars. We will leave the Roth dollars the last to spend to give them the max time to grow.

For the big picture Financial planning I've been using ESPlanner for many years now.
See: https://esplanner.com/
It's got more answers than I have questions.  :)


lascott

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Re: To What Lengths Do Some Folks Go In Planning Their Income Taxes
« Reply #4 on: August 09, 2019, 02:42:02 AM »
After 2019 I will have to take an RMD each year. A rollover from a tIRA to a rIRA does not count as a RMD so I'm thinking my regular income plus RMD will make the amount I can convert to a rIRA and keep my tax bill down will be pretty small. That's my gut feel but I will run the numbers in December each year to see if I can convert at least a small amount into my rIRA and keep my total effective tax rate on target. It is my plan to pay taxes from regular savings and not pre-tax dollars. We will leave the Roth dollars the last to spend to give them the max time to grow.

I don't really see how you are getting that low of effective tax rate in your chart? RMDs from a tIRA and addition income from a tIRA to rIRA conversion seem like it be a much higher effective tax rate.



I've used several planners but ended up paying for the professional one mentioned above (and yearly maint).  Gives me a lot more confidence in the planning and it is known to be accurate with taxes.
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Rob L

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Re: To What Lengths Do Some Folks Go In Planning Their Income Taxes
« Reply #5 on: August 09, 2019, 10:24:09 AM »
Think you hit a typo selecting Married Filing Separately. We're MFJ.



Additionally I think that only 85% of Social Security income being taxed (as in my case) makes a difference. A fair amount of my income is S Corp profits that qualify for the TCJA QBI deduction and our Long Term Care insurance premiums are paid by the company and are deductible on the front page. Everybody's a bit different every year. Take $15k off the $115k total income for these reasons and tax as a percent of income is 8.74% and the tax bracket is 12% according to the on-line calculator. The chart is pretty close to that.

lascott

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Re: To What Lengths Do Some Folks Go In Planning Their Income Taxes
« Reply #6 on: August 09, 2019, 12:01:20 PM »
Think you hit a typo selecting Married Filing Separately. We're MFJ.
<snip>
Additionally I think that only 85% of Social Security income being taxed (as in my case) makes a difference. A fair amount of my income is S Corp profits that qualify for the TCJA QBI deduction and our Long Term Care insurance premiums are paid by the company and are deductible on the front page. Everybody's a bit different every year. Take $15k off the $115k total income for these reasons and tax as a percent of income is 8.74% and the tax bracket is 12% according to the on-line calculator. The chart is pretty close to that.
Doh! My bad.  That is outstanding all things considered. Nice job!
Our situation is odd because we are in our early 50s so it is more complicated for tIRA withdrawals and healthcare. Until we are 59.5, we are dipping into our ROTH IRAs for half of our income and tIRAs via 72t/SEPP for the other half. Good for taxes and ACA 400 FPL%. One of us has health issues so it gets expensive quick. Also helping kids with tax-free gifting to boast their retirement ROTH IRA/401K investing while they are young for a few years.  Our effective rate is about 6.57%.
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Rob L

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Re: To What Lengths Do Some Folks Go In Planning Their Income Taxes
« Reply #7 on: August 10, 2019, 12:00:18 PM »
Very sorry to hear about the medical issues; both emotionally and financially challenging.
It does sound like your situation is pretty unique. Only 1% retire in their early 50's. I have no idea how that's done but I assume a lot of hard work and an exceptional amount of planning were required. I'd never heard of the 72t/SEPP and ACA 400% FPL until you mentioned them so I looked them up. Your plan is working very well. That 6.57% is terrific!

lascott

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Re: To What Lengths Do Some Folks Go In Planning Their Income Taxes
« Reply #8 on: August 11, 2019, 12:41:02 AM »
Very sorry to hear about the medical issues; both emotionally and financially challenging.
It does sound like your situation is pretty unique. Only 1% retire in their early 50's. I have no idea how that's done but I assume a lot of hard work and an exceptional amount of planning were required. I'd never heard of the 72t/SEPP and ACA 400% FPL until you mentioned them so I looked them up. Your plan is working very well. That 6.57% is terrific!
Hey thanks. Medical issues are under good control but just regular (quarterly) doctor and specialist visits. Just makes you think about the future and additional cost.
It was quite a mixture of things that got us to this point. Mosting doing the recommended things of maximizing 401Ks (before & after tax -- after tax then convertible to ROTH IRAs ** via 2014-54) as well as IRAs each year regardless of what the market is doing. Doing that for 25 years.  Of course, we both had to have decent jobs to be able to do that. Lot of hours during early years. One of the best things I can do for the kids is teach them, guide them, and help them take advantage of the savings plans. ROTH type accounts are one of the best things going now. Makes tax planning simple! :)

UPDATE: ** IRS Tax Notice 2014-54 -- https://www.irs.gov/pub/irs-drop/n-14-54.pdf
« Last Edit: August 11, 2019, 01:08:47 PM by lascott »
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