I need advice on the appropriate split between Roth, IRA, and taxable accounts. NOT the specific investments in each, but help on how large each should be as a percentage of my total portfolio.

My portfolio is currently 38% IRA, 35% Roth, and 27% taxable. It is not large by most standards and I don’t expect to be able to "retire" until I am forced into it. I am single, 63, in good health, still working, renting, and in the 28% bracket. I will get roughly 1k per month in SS beginning at 66.

I also have a 401k with a zero balance with my current employer. The 38% in the IRA was recently rolled over from this 401k through an "in-service withdrawal" option. I can legally continue to contribute up to 20.5k to the 401k every year and immediately move that 20.5k at will into the IRA. So, I can contribute a total of 26.5k annually to IRAs, if I choose to. The 401k would just be a conduit.

If I contribute a significant amount to the IRA via the 401k, the IRA percentage of my total portfolio will rise rather quickly, perhaps to as much as 60 or 70 percent by the time I am forced to make RMDs (about 9 years). If I went hog wild, I could probably end up at something like 65 IRA/25 Roth/10 taxable/zero 401k within 2 or 3 years.

I could even sell all of my taxable holdings and replicate all or most of them inside the IRA and/or Roth. I would use the taxable sale proceeds for living expenses and immediately start a significant compensating 401k payroll deduction that would go directly to the IRA. That would shield me from immediate taxes and lower my taxable income, but would subject me to an even higher RMD in my early 70s.

If I liquidated the taxable account, my tax bill would go up by about $800, one time. The taxable account has 2 very tax efficient holdings and one not so tax efficient—Oakmark Equity Income, which threw off about $1100 in interest last year. All other things being equal, I would like to own it in an IRA.

Up to this point, I have deliberately restrained the 401k (now IRA) portion and kept the taxable account going because I felt a balanced approach couldn’t be far off the mark. However, due to the rollover, I now have many more tax-sheltered choices in the IRA than I had in the 401k. The 401k options were no better than average as a whole.

How do you all feel about the advantages of increasing the IRA percentage significantly to take advantage of more compounding versus the disadvantage of even higher RMDs??

Or should I restrain my impulses and keep the taxable account around, and maybe keep the IRA in check at say no more than 40% or 50% of total portfolio??

How undesirable are RMDs when the effective alternative is a taxable account? I guess it’s a comparison of the negative effect of losing the compounding effect on the forced withdrawals versus the negative effect of paying taxes now on taxable income.

Any insight appreciated.

Three notes only loosely connected with your question.

1. Don't let taxes dominate your investment decisions. Make the best investments first, then look at where to place your money.

2. You may be better off than you think. Look very closely at your EXPENSES during retirement, not current income. In many parts of this nation, an income of $20000 per year with health insurance (Medicare) is comfortable (even though not luxurious). 

3. You will want something in the taxable account to handle emergencies.

Have fun.

John Walter Russell 

JWR:

 

Thanks for your response. I understand all 3 of your points and have taken them into consideration.

Taxes don't drive my decisions, but I am unclear on the nuances explained in my iniital post--the downside of perhaps being 70% in an IRA versus perhaps 30%.

I do have a separate "emergency" taxable account that is above and beyond the accounts mentioned in my initial post. It is almost entirely a money market fund.

 I would appreciate any insight into the specific questions posed in the iniital post.

 

[quote user="ignatz"] I am single, 63, in good health, still working, renting, and in the 28% bracket. I will get roughly 1k per month in SS beginning at 66.

I can legally continue to contribute up to 20.5k to the 401k every year and immediately move that 20.5k at will into the IRA. So, I can contribute a total of 26.5k annually to IRAs, if I choose to. 

That would shield me from immediate taxes and lower my taxable income, but would subject me to an even higher RMD in my early 70s.

How undesirable are RMDs when the effective alternative is a taxable account? 

[/quote]

I assume your employer does not match any of your 401k contributions, and your only source of income in retirement will be from SS and investments (no pension or annuities),  

The main issue is at what rate your RMDs will be taxed and if, without the RMD, you can avoid taxation of your SS benefits.

Generally, if the RMD plus SS income will be taxed at less than your present 28%, it would be best put as much as possible into an IRA account

If you will be in a higher (or equal) bracket in retirement, then paying tax now and maximizing a Roth account would be advantages.

I would run the numbers on taxation at retirement using today's rates, but keep in mind that the government could raise or lower the rates by the time you reach retirement. 

(Also note that when some retire, they postpone taking SS so that they can convert their IRA to Roth status at lower tax rates, before reaching RMD time).

Dick 

 

 

 

 

Ignatz,

I think you have asked some very good questions, however I don't think anyone can give you an answer expressed as a percentage.  I would like to have 100% in a ROTH, but that is not possible.

I would take a hard look at what you expect your expenses will be after you retire and start spending the portfolio.  How much will you want/need to withdraw from the portfolio per year.  I would attempt to match the dollar amount in a 401K or regular IRA so that the RMD amount does not exceed your spending needs.  You have no choice on the RMD, it must be withdrawn, and you will have to pay the taxes on that amount in the year that it is withdrawn.  In an ideal situation, the $ amount in the IRA/401K will support the RMD which matches your cash flow needs.  I hate the thought of the IRS forcing me to withdraw more than I need to meet my expenses.

Any excess portfolio value would be better off in a ROTH where you can decide if and when you want to withdraw from it, tax free, while the value can build up without creating a taxable event caused by dividends and capital gains.

Then there is the question of what do you plan to do with the leftovers.  You stated that you were single, but did not say if you have children or others that you wanted to leave an estate value to.  If that is part of your plan, then don't overlook the step up value of equities when received as an inheritance from a taxable account.  That could be a valuable tax planning tool for the next generation.

I would suggest that you don't reply stating any of your personal dollar amounts on this forum or anywhere on the internet.  The above questions are for you to think about in dollar terms instead of percentages.

I will have to start taking the RMD from my 401K next year, so I have thought about this.  But the ROTH IRA option did not exist until after I retired and all we can do is make the most of the options that are/were available to us.  

Gordon

Dick:

Thanks for the response. You are correct in your assumption that all I have is my investments and SS.

For single people, the 28% bracket goes from roughly 31k to I think about 77k. I am in the midrange of those numbers and expect to stay there, barring job loss or Congressional action on tax rates. 

I hope to be able to work beyond the date I must take RMDs. I expect to "retire" only when forced out.

It's very, very unlikely I will ever have income beyond the current 77k upper limit of the 28% bracket.

For a back of the envelope calculation, figure 50k taxable income if I am still working, plus whatever the RMD might be on say 100k IRA, plus 12k per year from SS, plus. I am guessing that would still fall below 77k.

Of course, it is possible I could be unemployed or unemployable at age 73, and my income then would be SS plus RMD plus net return on the remaining portfolio, with no earned income. If that were the case, my income might be say 20k or 25k, which would mean a lower tax bracket.

My tentative plan is to maximize my Roth in any case. My questions relate to how much I should put in the IRA (not the Roth) over the next 8 or 10 years. The more I put in, the greater the RMDs.

Depending on my employment and health status, I could be forced into making substantial withdrawals from any or all of my accounts at any time simply to keep a roof over my head.

Am I correct that postponing SS beyond 66 means I will get more when I do elect to take it, but that at some age (70?), further postponements don't mean a larger eventual monthly payment?

Any further insight?

 

Gordon:

To your points:

I will try to avoid referring to dollar amounts per your suggestion, but can say this:

Estate planning is completely irrelevant. It’s me versus the actuarial tables.

I expect to stay single and remain in the mid-range of the 28% bracket so long as I am employed, but all bets are off if I lose the job or have health issues. I have no qualms about working until I can’t. I have resigned myself to that. So "retirement" will be forced.

I must deal with the idea of rent probably doubling in the next 10 to 15 years.

I can currently save at least 25% of gross income. The Roth will be maxed out. My question effectively is how much of the remainder should go to the IRA versus taxable.

Just using random numbers, how large must an IRA be to force a 20k RMD?

Taxable accounts obviously have the advantage of no RMD, but does that advantage offset the IRA advantage and how do I quantify it?

Hello Ignatz,

---------------
How do you all feel about the advantages of increasing the IRA percentage significantly to take advantage of more compounding versus the disadvantage of even higher RMDs??

Or should I restrain my impulses and keep the taxable account around, and maybe keep the IRA in check at say no more than 40% or 50% of total portfolio??

How undesirable are RMDs when the effective alternative is a taxable account? I guess it’s a comparison of the negative effect of losing the compounding effect on the forced withdrawals versus the negative effect of paying taxes now on taxable income.
---------------

---------------
If you will be in a higher (or equal) bracket in retirement, then paying tax now and maximizing a Roth account would be advantages.

I would run the numbers on taxation at retirement using today's rates, but keep in mind that the government could raise or lower the rates by the time you reach retirement.

(Also note that when some retire, they postpone taking SS so that they can convert their IRA to Roth status at lower tax rates, before reaching RMD time).
---------------

 

If I were in your circumstance, I'd seriously consider doing the following:

* max contribution to Roth [6k (+unknown future increases to max)]
{ you're doing } --> no RMD & tax-free earnings

* max contribution to 401k [20.5k (+unknown future increases to max)]
{ you're doing } --> decrease to AGI optimized

* move 401k contributions to IRA
{ you're doing } --> better investment options than 401k

* partial conversion of IRA to Roth [amount = ? / & don't have taxes withheld from such -- pay from another source]
--> $ not subject to RMD
-->--> [deadline for given tax year = end of calendar year -- i.e. does *not* have same deadline as IRA contribution deadline]

Depending on potential variation to income, & overall tax circumstance for a given year (including impact due to taxable investments), you could analyze such (realizing that there will be some educated guesses involved, due to one likely not having full picture of such (& particularly re: taxable investments) until after the end of the calendar year), & determine just how much of a conversion would be practical or otherwise ~'optimal' for a given year (e.g. if there were a year when contributions to a Flexible Spending Account were increased, one could 'utilize' such to 'offset' [the AGI increase from] a corresponding increase in amt to be converted to Roth for that tax year).

If you have your existing IRA invested in holdings you'd like to maintain/leave-alone/not-remove, could avoid doing conversion from the existing IRA by targetting conversion of subset of yearly 401k --> IRA $.

Additionally, if you have the luxury of contributing the max to 401k as early in the year as possible, & then moving the 401k contributions to IRA as early in the year as possible, could perform partial conversion of that year's contributions as early in the year as possible (assuming that you know @ least the minimum of how much you would convert for that year), to optimize the length of time during which the converted $ is working on generation of tax-free earnings in Roth.

I realize that there are circumstances when this/conversions would not necessarily be optimal (e.g. if in lower tax bracket during retirement), & that none of us can predict the future.  Additionally, I realize that 'lower' tax bracket is relative, & if taxes are increased in the future, one could perhaps find (much to one's dismay) that the taxation rate associated with current tax bracket happens to ~equate to taxation rate associated with the future's version of a 'lower' tax bracket.  Again, we just don't know what will happen in the future, & thus, we simply do our best to 'cover bases', etc.

I, personally, would prefer the option of partial conversions, in order to [1] increase the amount of ~'I determine whether & when' $ (re: no RMD), [2] increase the amount of $ eligible for tax-free earnings, & [3] increase the amount of $ that I would consider 'last resort' (I find the 'if you leave it alone, it has the chance to garner additional tax-free gains' aspect of a Roth to be a kind of ~'force field', psychologically, & one which motivates me to 'stay away from, & for as long as possible'.  Lastly, should there be $ in Roth when I passed away, the tax advantages associated with inheritance are positive in several respects (for me, this is a technical consideration, & not one which would drive my savings or potential withdrawals / is a 'bonus').

Just another option, & some thoughts regarding...

LWCTS:

I appreciate the additional ideas.

Regarding conversion of an IRA to a Roth:

If I contribute the annual maximum of 6k directly to my Roth, am I prohibited from converting anything from IRA to Roth—that is, does the 6k limit apply to any combination of conversions and direct contributions?

I know little about conversions, but am aware that some people do it to the extent it won’t push them into a higher bracket. I am currently in the 28% bracket and that is not likely to change as long as I am working.

Is the following the consensus of what I should do, in this order of preference, so long as it meets my overall asset allocation:

Max out Roth contribution with first 6k of available funds

The next 20.5k should go to the 401k and immediately into the Rollover IRA.

Put anything beyond that into the taxable account.

I could do the above, but I am not likely to have more than 26.5k of investment funds in any one year, which would mean that taxable would stagnate where it is and fall to 10% or less of my portfolio within 5 or 6 years.

Under that scenario, RMDs would be "high", but would not likely be more than my cash requirements if I weren’t working. If I was still working at 73 or 77, the RMDs might not be "needed", but would not likely be enough to push me beyond the 28% bracket limit of 77k and rising.

I work for a small company and could immediately request my boss to start an 80% or 90% payroll deduction to get as much of this year’s allowed 20.5k into the IRA as possible. I could live off my money market fund or taxable account sales for the rest of the year if need be.

Is this hare-brained?

 

[quote user="ignatz"]

For single people, the 28% bracket goes from roughly 31k to I think about 77k.

It's very, very unlikely I will ever have income beyond the current 77k upper limit of the 28% bracket.

I am guessing that........

.... with no earned income..,,,,, my income might be say 20k or 25k, which would mean a lower tax bracket.

[/quote]

First, the income range you mentioned would put you in the 25% tax bracket for a single filer....... and those figures are for AGI (income less deductions... and remember you are eligible for an additional deduction when over 65}.

It looks like you would go down into the 15% bracket if you quit your job and postponed SS (Could even go down to 10% and you shouldn't be "guessing" on this).  If this happened, then that would be a much better time to convert your IRA to Roth (lower 15% or 10% conversion cost than present 25% cost).  Thus, you could lower the impact of job loss by contributing to an IRA at present, rather than to a Roth.

The size of the RMD is not as important as the tax rate on it.  Thus again I would recommend that you run the numbers, perhaps with a tax advisor, to determine the best plan.  You might also want to look over the www.fairmark.com site to get some ideas about Roths, and other tax situations.

To give you some idea of potential impacts, if I now had to take a dollar of RMD, since I am in the 25% bracket, I would have to give 25 cents of it to the government plus an additional 22 cents because 85 cents of my SS would then become taxable (47% tax bracket).  Fortunately I have only a Roth IRA. 

Dick 

 

 

 

 

 

 

 

 

Ignatz,

We didn't plan for RMD's, we were just trying to save for retirement and after the kids were out of college paid "tuition" into our retirement accounts.  We always maxed out Roths from the day they came into existence and converted when and how we could.  We are 65 and when RMD's start, they will put us into the next bracket.  I had to redo our conversions "last" year and can see no more opportunity to be able to do Roth conversions.

We have children and were trying to use Roths as an estate planning tool 

Taxable is 36% of total assets which means 64% is tax sheltered in some way.

Roths are 4.5% of total assets and 7% of sheltered assets.

Roberta 

Dick:

Are you implying that I should wait until I am in the 25% or lower bracket to convert the IRA rollover to a Roth? A lower bracket may never happen and is unlikely to happen unless I lose my job. If I lose my job, all bets are off and "conversion" will be the least of my worries.

I may willing to postpone SS from 66 to 70, but is there any advantage to postponing it beyond 70—such as a higher monthly payment?? If not, I see no reason not to take it, taxation be damned.

If I am likely to remain in the 28% bracket for the indefinite future, what is the point of waiting to convert? Conversion may or may not be a good idea, but if it is a good idea, why wait for a lower tax bracket that I have no reason to believe will occur?

I could knock my taxable income down near the bottom of the 28% bracket this year by using 401k payroll deductions, and then fill up the 28% bracket to 77k with IRA to Roth conversions. Bad idea? Why? I have no reason to believe I will ever be in a lower tax bracket, barring a job loss.

I have researched since I started this thread and the research tells me that I can convert without limit and irrespective of any independent 6k annual contribution to a Roth, so long as I can foot the IRS bill the next April. I can do that.

What are the arguments against conversion for a 63 year old single person in the 28% bracket with the personal attributes I have described in earlier posts in this thread?

Roberta:

I appreciate your comments on your personal experience, but I am not sure if you mean that you wish you had done something other than what you did? You state that RMDs will put you in the next bracket. Are you implying that you wish you had taken RMDs into account earlier and that you would prefer to have a smaller taxable account, a smaller IRA account, and a larger Roth? And you are therefore imploring me to get as much under a Roth as possible? Or what? What were your errors, if any?

For the record, I am not using any of my accounts for estate purposes.

 

"Just using random numbers, how large must an IRA be to force a 20k RMD?"
You can get the RMD table here;
Http://im.morningstar.com/im/single-life.pdf
At age 70 the divisor is 27.4, so an IRA/401K total value of $548,000 divided by 27.4 = $20,000 RMD.

"Taxable accounts obviously have the advantage of no RMD, but does that advantage offset the IRA advantage and how do I quantify it?"  
I don't know how to quantify it without knowing what the future tax brackets will be, what will the tax on capital gains and dividends be in ten years, how will SS be taxed,  etc.   Will they scrap the current tax code and convert to a flat consumption tax, therefore forcing us to pay tax on our ROTH withdrawals as we spend those?  All I can do is make a wild guess and my best guess based on what I think I know today is 'tax deferred is better than taxable'.

Gordon

Gordon:

Well, it looks like my IRA will never approach a required 20k RMD--as I suspected. Which means I will likely never be beyond the 28% bracket unless Congress gets frisky.

I understand the extent that a lot of this is speculation based on unknown future policies. Not knowing is kind of why I have hedged my bets by having a 3 pronged approach with significant percentages in all 3 of Roth, IRA, and taxable.

In the last few hours, I located a supposedly authoritative paper by a CPA "expert". The gist of the paper is that in most circumstances, including my own, a Roth has no advantage over a traditional IRA if tax rates at the time of RMDs are the same as tax rates now and if the taxes on the conversion are funded from the IRA. If the taxes are funded from an external account, there is a minor advantage in favor of the Roth in the final balance--typically in the range of 3% to 5%. The advantage would tip more in favor of the Roth to the extent tax rates then are lower than tax rates now, but none of the provided examples showed what I would call a major difference.

I think I will concentrate my efforts on getting tax inefficient stuff in Roth or IRA, leaving highly tax efficient funds like total market in taxable, and getting the riskiest/highest return stuff into Roth. I guess that implies bonds and other fixed income to traditional IRA and more volatile/high turnover funds equities to Roth.

Offhand, I don't think I have the nerve to drive my IRA up to 60% or more of my portfolio, considering how much of this is speculating on Congress. I'd rather speculate on a housefly. I might consider it if I saw an over-riding advantage, but I don't.

A few questions.  If you are in the 28% tax bracket today, while you work, will you be in the zero, 15%, or 25% bracket whenever you retire?  My guess would be, without RMDs, either zero or 15%.

So, if you ARE in one of these lower brackets, once you retire, start converting your traditional IRA to a Roth.  You immediately gain the difference in tax rate.

Regarding conversions, there are limits to how much you can convert in any one year, but conversions are NOT the same as contributions.  Your contribution limit is based on earned income, and SS is not considered earned income.  Nor are interest or dividend distributions.  So, most likely, once you stop working, you have to stop contributing, but you  can still convert.

I would recommend, in general, to spend down your taxable account first.  Then your traditional IRA, and your Roth last.  The reason is that earnings from the first two are taxable, while the Roth grows tax free.

I would also recommend that, if you do convert, pay the taxes from your taxable account, rather then from the amount taken out of the traditional IRA.  If you do this, ALL of the traditional goes into the Roth, rather then 85% (if your in the 15% tax bracket).

If you can, convert as much as you can to the Roth before RMDs kick in.  RMDs end up, by definition, in a taxable account.  It's better to have that money end up in a Roth.  And you can withdraw, from a Roth, as easily as from a taxable account.  In fact, withdrawals from all three types of accounts are quite easy, at least with Vanguard.

Finally, even though the IRS requires you to RMD, you don't have to spend it.  Simply RMD to your taxable brockerage account, into the same fund/investments you had it in in your IRA.  In fact, whenever I convert, I tell Vanguard to convert X amount of shares of a fund to my Roth, and those shares are actually moved.

"The gist of the paper is that in most circumstances, including my own, a Roth has no advantage over a traditional IRA if tax rates at the time of RMDs are the same as tax rates now and if the taxes on the conversion are funded from the IRA."

Circumstances where there would be an advantage:

1) If your IRA is large enough such that RMDs kick you into a higher tax bracket.  For example, if you can convert, today, at zero or 15%, but your RMDs will be taxed at 25%.

2) If the same amount of money ends up in either a taxable account (for an RMD) or a Roth (for a conversion), there is an advantage in that FUTURE earnings are not taxed in the later, but are taxed in the former.

"If the taxes are funded from an external account, there is a minor advantage in favor of the Roth in the final balance--typically in the range of 3% to 5%."

The advantage is tied directly to future tax rates.  Ten years down the road, if you are in the 15% tax bracket, then that's your 'loss', to the IRS, for the money that ends up in the taxable account.  That's the tax you don't have to pay, if that same amount of money is in the same assets in a Roth, earnings the same return, each year.

In general, this is NOT an easy issue to discuss, since it depends so heavily on each retirees specific financial situation.  For me, we have pensions and SS such that our non-conversion tax rate is 15%.  However, I found it advantageous to convert approximately 10% of our traditional IRA money to a Roth each year, and pay taxes at a 25% rate to do so.

We have no taxable investment monies to speak of, having spent same down prior to touching our tax advantaged accounts.  As of this year, we have about 60% of our portfolio in Roths, 40% in traditional IRAs, and will have all converted prior to RMDs.

El Lobo:

I just looked up the 2008 brackets and here is what I see for single people:

10% Not over $8,025

15% $8,025 - $32,550

25% $32,550 - $78,850

Turns out I am in the 25% bracket and don’t expect to move out of it unless I lose my job. I don’t expect to retire voluntarily. If I lost the job, I would be in the 15% bracket.

You state:

So, if you ARE in one of these lower brackets, once you retire, start converting your traditional IRA to a Roth. You immediately gain the difference in tax rate.

I guess I don’t follow that. If my income were to drop to 20k, my tax rate is 15%. Any RMD that didn’t push me above 32,550 would be taxed at 15%. If I convert, I would pay a 15% tax on the amount converted. How am I better off?

You state:

Regarding conversions, there are limits to how much you can convert in any one year

What are those limits?

I understand that I would not be able to contribute to a traditional or Roth without earned income.

I understand and agree with your comments about which account to spend first. I understand and agree with your advice to pay the conversion tax from an outside account, rather than from the IRA.

You state:

RMDs end up, by definition, in a taxable account. It's better to have that money end up in a Roth.

I guess I don’t follow that either. As far as I know, RMDs end up in a taxable account, period. How do you propose to put RMDs in a Roth? If you are referring to AVOIDING an RMD by converting X amount to a Roth, you still must pay the tax on the conversion, and that may or may not be advantageous, depending on the tax rates in place at the time of the conversion. Is that not true?

You state:

Simply RMD to your taxable brockerage account, into the same fund/investments you had it in in your IRA. In fact, whenever I convert, I tell Vanguard to convert X amount of shares of a fund to my Roth, and those shares are actually moved.

The above passage has me confused. What does the first sentence have to do with the second sentence? The first sentence has the RMD going to a taxable account. The second sentence speaks of money going to a Roth. Conversions and RMDs are separate processes, are they not?

I realize you can buy anything you want with an RMD. I assume you are referring to a Roth conversion that has nothing to do with an RMD—in which case you have to pay the tax on the conversion. Can you clarify what you mean?

El Lobo:

You state:

Circumstances where there would be an advantage:

 

1. If your IRA is large enough such that RMDs kick you into a higher tax bracket. For example, if you can convert, today, at zero or 15%, but your RMDs will be taxed at 25%.

That’s true, but doesn’t apply in my case. My IRA is smallish and the RMDs are highly unlikely to be large enough to push me into another bracket. I have no idea if my tax rates will go up or down. It’s entirely a crap shoot and speculation and I don’t want to make a bet on it.

 

1. If the same amount of money ends up in either a taxable account (for an RMD) or a Roth (for a conversion), there is an advantage in that FUTURE earnings are not taxed in the later, but are taxed in the former.

I realize that all growth and withdrawals from a Roth are never taxed, but I had to pay tax on the money before putting it in the Roth. A thousand dollars of gross income only results in a $750 contribution to a Roth, assuming the 25% bracket. A thousand dollars in gross income results in a $1000 contribution to an IRA, as far as I know. Maybe I have been misinformed.

"If the same amount of money ends up in either a taxable account (for an RMD) or a Roth (for a conversion), there is an advantage in that FUTURE earnings are not taxed in the later, but are taxed in the former." 

"Maybe I have been misinformed."

I think you are confused.  The $1000 that I was talking about was in your traditional IRA, and you are deciding (we are talking about) the advantages of converting that $1000 to a Roth, or withdrawing it (RMD or voluntary) to a taxable account.

Whether to do one, or the other (withdraw or convert), depends on your particular tax situation.  My point was that, if there are no advantages one way or another (tax wise), you are better off to convert, since future earnings are not taxed.

"Turns out I am in the 25% bracket and don’t expect to move out of it unless I lose my job. I don’t expect to retire voluntarily. If I lost the job, I would be in the 15% bracket."

I thought you were close to retirement (voluntary).

"I guess I don’t follow that. If my income were to drop to 20k, my tax rate is 15%. Any RMD that didn’t push me above 32,550 would be taxed at 15%. If I convert, I would pay a 15% tax on the amount converted. How am I better off?"

In general, people are in a higher tax bracket, while working, then whenever they stop working.  While working, you 'saved' 25% on taxes for all monies put into a tax deferred account.  Whenever you retire (voluntary or otherwise), and you withdraw/convert that money back out of the traditional IRA, if you are paying taxes at the 15% rate, you are gaining 10% (the difference in tax rates).

"What are those limits?"

I don't know.  I do my taxes with TurboTax, and I know I don't bump up against those limits.  Roberta probably knows.

"I guess I don’t follow that either. As far as I know, RMDs end up in a taxable account, period. How do you propose to put RMDs in a Roth? If you are referring to AVOIDING an RMD by converting X amount to a Roth, you still must pay the tax on the conversion, and that may or may not be advantageous, depending on the tax rates in place at the time of the conversion. Is that not true?"

You do follow it.  It's just terminology.

"The above passage has me confused. What does the first sentence have to do with the second sentence? The first sentence has the RMD going to a taxable account. The second sentence speaks of money going to a Roth. Conversions and RMDs are separate processes, are they not?

I realize you can buy anything you want with an RMD. I assume you are referring to a Roth conversion that has nothing to do with an RMD—in which case you have to pay the tax on the conversion. Can you clarify what you mean?"

I didn't read your first posts in much detail, but I thought I read where you, or someone else, implied that RMDs had to be spent and/or had to be used to pay taxes.  I think of an RMD as being a certain sum of money that is being moved from a traditional IRA to a taxable account.  That same sum of money, if moved to a Roth, has been converted, not distributed/withdrawn.  Again, terminology.

Anyhow, my only point was that, rather then telling Vanguard to move a certain sum of money from my traditional IRA, I tell them to move a certain number of shares, which happen to be worth something on the day of movement.  That is, I don't have to first sell fund shares, move the proceeds, and repurchase shares (whenever I convert or withdraw).

Imagine this situation:

Suppose 2 people have 10k in a traditional IRA and both will always be in the 25% bracket.

One converts the entire account to a Roth and the other doesn’t.

The Roth account then has a balance of 7.5k (10k minus 2.5k tax on the conversion). The traditional IRA still has a balance of 10k.

Assume both accounts have the same later rate of return and double in 10 years.

The traditional IRA grows from 10k to 20k before taxes and has an after tax value of 15k. The Roth grows from 7.5k to 15k and is not taxed.

 

How does that square with the statement:

"Whether to do one, or the other (withdraw or convert), depends on your particular tax situation. My point was that, if there are no advantages one way or another (tax wise), you are better off to convert, since future earnings are not taxed".

Where is the advantage of the "future earnings" not being taxed? Both accounts have identical after tax values. How are you better off to convert?

I hope someone can show the errors in the above arithmetic.

Ignatz,

You can't discern how I feel about the IRA dilemma b/c I haven't figured it out and thus cannot convey an opinion only data.  The back of my brain kinda, sorta thinks that if that money wasn't segregated in retirement accounts it might have been used for college tuition, travel, cars, etc.  There's something about the forced savings of a retirement account plus their relative inaccessibility that does it's job of forcing retirement savings.

To the best of my knowledge there are no dollar limits on conversion amounts. The big limiting factor is the size of the tax bill.   Income has to be below 100k to be eligible to do a conversion. That does not include the amount of the conversion.   That limit will be lifted for one year in 2008 or 2010 and the subsequent tax bill can be paid over a two year period.

You are correct in your analysis of the tax neutral effect of whether money is in an IRA or Roth.  When that is the only aspect evaluated, there is no difference.  There are big differences in terms of estate planning issues, which don't apply to you, and the impacts of RMD's, which is where the real number crunching and issues are located.

When you retire, the amounts that had been withdrawn and placed in retirement accounts such as IRA's and 401k's is no longer being withdrawn from your SS and/or pension.  The AGI for a 25k salary with those deductions is quite different from the AGI on a 25k retirement income "salary" dependent on income sources.

Simplifying tremendously.  If you need your RMD's for survival, you're probably better off with an IRA.  If you're transfering your RMD's to your taxable account for investment, you need to evaluate Roths in your situation..

Roberta 

Roberta:

Thanks for the clarification.

It looks like in my case, the verdict is tipping away from conversion and in favor of standard IRAs.

If I lost my job, SS could become a major part of my income and I might have to spend any RMD.

Given my status, would you contribute the 6k annual IRA money to the Roth or to an IRA?

Do you have any offhand opinion on whether or not I should keep any investable assets in a taxable account or should I try to get EVERYTHING under some type of IRA if possible?

My taxable account is 27% of total portfolio now and relatively tax efficient. I could move the one tax-inefficient fund in it to my Rollover, in which case the taxable account would generate virtually no taxable income.

What are the reasons to keep some investments in a taxable account, assuming it is highly tax efficient?

Issue number one in thinking about this is future tax rates both for us as an individual and as a country.  I always figure they're going to be higher.  I have been rudely disproved about lower tax bills in retirement and I think a lot of those people who carefully saved and planned and underlived our incomes are now paying taxes at 25 and 28% rates that we avoided 15% rates on.  The other issue that has to be figured into this is the growth of the money over the years and its compounding.

The answer you'll get from me is akin to the one about whether I'm sorry I did it that way.  It's not really a rational, logical decision but has a lot of emotional overtones and a lot dependent on the individual. i.e.  are you disciplined enough to save the money in the taxable account or will the forced savings in the 401k before you see the money work better for you?  What about the accessibility of the money and the temptations to use it?

Someone I've "known" for a lot of years on other boards always preaches the 3 legged stool of retirement - taxable, SS and sheltered.  And the more legs you can put on the stool, the better off you'll be.  I never, ever expected my SS to be taxed.  I can't reconcile your estimate of about 1k/month SS income with your tax bracket and ability to shelter 26k/year.

I think Roths are the best thing since sliced bread but have only been able to get a small proportion of assets in them.  Aside from the estate planning issues, the fact that I am not forced to take money from it but can at my will if I want and that there are no tax issues when I do are very desirable characteristics.  It is another leg on my stool.

My taxable is another leg of the stool.  I, currently reinvest all income and capital gains so that when I sell to fund something or otherwise use the money, I've been able to use the IRS tax laws and sell at a "loss".  I, of course, have been paying the taxes along the way but using other money and thereby increasing my investment rate w/o feeling the pinch as savings but rather as taxes and that works for me.  I can take the money from that to spend on travel and extra's and not feel I'm going to be eating alpo at 85 b/c I'm depleting my retirement resources.

Money, investing and saving and spending has a great deal of emotional components which are very real and not well understood.  No investment plan, no matter how good or reasonable or realistic is going to work if the individual involved has not had their emotional or behavioral needs met.  The trick is figuring out what works best for you and your needs that balances both sides of the brain.

The other issue to be considered in the taxable is the opposite of the Roth.  Any money going into IRA's will come out and be taxed as income while taxable spending will mostly generate capital gains and possibly, as I mentioned, tax losses.

All of this is predicated and planned on who knows what future congresses and politicians will do with tax rates and rules about sheltered income which is a completely different cr*p shoot.

Roberta 

Roberta:

I only meant that I can LEGALLY contribute up to 26.5k per year to IRAs. In fact, my investable cash is likely to be closer to 15k per year and I need to decide how much of that will go to taxable, Roth, and IRA.

I just checked my SS annual report. It says I will get about 10k per year if I take SS at 66 and 16k per year if I wait till 70. I suppose that will rise slightly over time as I continue working. I did not begin working under the SS system until about 10 years ago.

I am frugal by nature and not tempted to splurge, so I expect any gross changes in my financial destiny won’t be caused by my spending habits. Unforeseen issues and tax rate changes could drastically alter things, of course.

To this point, I have been at least an informal believer in the 3 legged stool approach—thus my split. But I am unsure of the soundness of that approach and my original post was intended to bring out any errors in my thinking.

I will never be able to get more than say 40% in a Roth, but I could get to 65 or 70 IRA and 30 or 35 Roth, with no or little taxable.

Offhand, the only downside I see to having taxable at 10% or less is that the IRA % would be boosted and RMDs might be "high". However, considering my particular circumstances, I don’t see "high" RMDs as much of an issue and am therefore contemplating putting as much as possible in IRA and Roth, and getting taxable even lower than the current 27%.

Do you see any particular problems with that per se?

[quote user="ignatz"]

 I don’t see "high" RMDs as much of an issue and am therefore contemplating putting as much as possible in IRA and Roth, and getting taxable even lower than the current 27%.

Do you see any particular problems with that per se?

[/quote]

 

Agree with the above strategy.  However, would not convert nor contribute to Roth and would concentrate on building up your traditional IRA. The main reason is that If you lost your job, having an TIRA as opposed to a Roth, would let you take funds from your TIRA (or take RMDs) and pay a lower tax than you would pay if you contributed to, or converted to, a Roth at your present tax rate.

One way of looking at this is suppose you have a 400K TIRA and are in the 25% tax bracket,  Then the government "owns" 100K of that account and you "own" 300k.  If you lose you job, and drop to a 10% tax rate, then the government "owns" only 40K of the account and you now "own" 360K.

Its somewhat similar to owning a 400K home with a 100K mortgage loan on it.  And if you lost your job, the government will reduce the loan to 40K.  This would help soften the blow of a job loss.

Thus, a strategy of building up your TIRA (increasing the size of the government loan) has a sort of insurance aspect to it.  Most would try to build up their Roth, but you are in the position where your tax rate will not go up in retirement, even with RMDs, and you are relying more than others on being able to work after retirement age.

Dick  

 

 

 

  

I don't see any problems but I have a few more questions and thoughts for you to consider. 

Your SS will definitely be higher than you are projecting b/c the current projections only count the 10 years you've been covered and more of those 0 years will drop out of the calculation wit additional time in the system.

Project your IRA balances out to age 80 and the subsequent RMD's.  Unless you are actually selling assets to pay taxes do not remove the taxable portion from compounding projections although that is actuarially correct.

El Lobo has a spreadsheet which was designed to determine ROTH conversions but I think it might have some functionality for you and give you some data to assist in making a decision. 

The fact that you are frugal by nature and not tempted to splurge is much more germane to this issue than where you actually put your assets.  The other aspect of that is it's easier to access and spend taxable assets and tax manage them and there's much more to life than accumulating assets for retirement when you may not be able to enjoy them.  Make sure there's a balance.

There really is no "right" answer to this.  It all goes back, again, to your spending and savings habits.

Roberta 

Dick:

I certainly understand your point about the IRA advantage in a jobless situation.

However, since my last post, I have realized that all withdrawals from an IRA are taxed as ordinary income, whereas long term gains in a taxable account are taxed at a lower rate (at least for the time being).  Of course, that may not be significant in my case if I can restrict IRA withdrawals to times when my tax rate is less than my current rate.

I have no current intention of withdrawing ANYTHING from any account, but in the case of a job loss, I would likely choose between taxable and IRA, and let the Roth ride.

Roberta:

I will give some thought to IRA projections, which will of course be highly fuzzy given the unknown amount of future contributions, let alone tax rates, etc.

I should have said that although I worked under SS in 1966-1972, at least 95% of my lifetime contributions have been in the last 10 years. I had more than 25 consecutive years with no contributions. I expect a new SS update statement shortly.

Can you recall offhand the arguments your forum friend made in favor of retaining the taxable leg of the 3 legged stool?

Thanks for the fruitful discussion that has helped clarify my thinking.