We currently have a temporary (less than 6 months) cash flow problem and will have to tap investment accounts to cover it.  Part of it is Uncle Sam and last year's large capital gains, part of it is my husband's need for a large cushion and part of it was the effect of some decisions we made which were very right decisions but have helped make things tighter than we like.

We have decided to tap some of our funds rather than tighten our belts or even think about reducing things like travel, while we are still able.  In terms of reality, it means that we may use > 0.05% this year which is way under the "recommended" 4%.

The difficulty lies in deciding where to take this money from.  Conventional wisdom says to access taxable, then IRA's, and lastly Roth's.  I'm, again, questioning conventional wisdom.  As things currently stand, inherited taxable accounts enjoy a step up basis and IRA's are taxable at current income rates.  Point to using IRA money.  RMD's will increase our tax bracket when they start and there will extremely limited opportunities to do Roth conversions.  Point to using IRA money.  Using IRA money will increase tax bill more than using taxable; I've been so gooooooooood about getting tax inefficient things in sheltered accounts.  Point to taxable. I've worked so long and so hard to get things into tax sheltered accounts that it feels like blasphemy to spend it.  Point to taxable.

What am I missing?  Overlooking?  What haven't I considered?  What would you do and why?

Roberta 

Hi Roberta...

You are really very fortunate to have three good sources for cash when you need it.....

Your thinking is right on the head (as usual), and far be it from me to offer much in sage advice.  There is one other thing to consider possibly, and that is taking a Home Equity loan or line of credit. The rate isn't bad right now, the interest is tax deductible, and getting the money won't create taxable income. Of course, one does have to pay the loan back, but if you can put it into a couple of tax years you might find it to be a viable possibility. I did it a couple of years ago when I needed to replace two furnaces and A/C units and a water heater.... Yeah, I spent some interest, but I didn't hit that higher income level that causes your Medicare taxes to go way up. That alone softened the interest hit. And spreading the income over two years kept me out of a higher tax bracket.

I just read Randy Pausch's book "The Last Lecture"... Randy is a Carnegie Mellon professor, married and a 47 year old father of 3 small kids. He also has terminal cancer and will probably die within a few months. In his Last Lecture and in the book one of the words of wisdom is to live each day fully because it might turn out to be the last one. You mentioned cutting back on travel as a way to possibly meet this need. Please, read the book (at Costco for less than $12), or go to lastlecture.com and see the actual last lecture.... and go enjoy those trips with your husband. You won't be sorry. 

Just another thought...

Peace

Bob

I agree with Sailor Bob... > Take out a HELC  loan

and It's good to always have a LOC on one for the future.. for short  term /emergency needs..

I also have 3 credit cards, 6.75, 7 & 8% rates with $15k LOC's on them and at the stand by to use them... I charge my gas , food and other monthly items on them, pay them off monthy ot keep them active and in good standing..

and keeps me from havng to sell in a down market, besides the tax implicatons..

Bob,

I'm familiar with "The Last Lecture" .  I said we wouldn't cut down on travel and it's just for those kind of reasons.  Twenty years ago I had a cancer which has a less than 1 year survival rate.  Forty years ago, I was diagnosed with something and that prognosis was about 5 years.  I still don't know why G-d wants me here but we sure know about living for today.

I fully agree with you'all about the HELOC.  It's not an acceptable solution in this house.  Period.  End of subject.  Not negotiable.  We're going to be buying a new house in the next few years.  I floated taking a mortgage and putting the amount from this house to cover the mortgage in CD's for the tax aspects.  It didn't fly.

So we're back to which account. 

Roberta 

 I still don't know why G-d wants me here but we sure know about living for today.

 [/quote]

Maybe it's so you can continue share your knowledge.

-frequent reader, infrequent poster,  i still have a lot to learn so stay healthy

Thanks John.

Roberta 

Hi Roberta,

You are one of the most knowledgeable posters on these boards, so it's pretty hard to offer you an opinion. What would you tell someone else who asked this question?

If I understand this correctly, you are making a one time withdrawal of less than half percent?  I don't know if it's really going to make much difference, but I guess I'd go with taxable. If you withdraw from the IRA, you will also have to have your custodian withhold taxes and you won't get that back for a year. If you don't withhold you could end up doing quarterly estimates.

And remember, money is not a collectible.

Paul 

Roberta:  Yeah, I know.... you guys have written the book on some conservative elements in risk taking....  Therefore, I will agree with Paul.... YOU might as well get the benefit of the capital gains tax break rather than the inheritors....  and I say that whether Paul is right in the amount (less than 1/2%) or not.....  it is YOUR money, you know... why should YOU pay more to Uncle Sam so someday an inheritor will benefit?  and this comes from a guy who very much wants my kids and grand kids to inherit from us... all the while taking some of those nice trips, too...

PAUL:  You said above: 

If you withdraw from the IRA, you will also have to have your custodian withhold taxes and you won't get that back for a year. If you don't withhold you could end up doing quarterly estimates.       

 I have never paid estimated taxes since I began withdrawing from my IRA..... In the past I usually withheld 10% for the fed tax and made sure I paid in as much as last year's tax bill to avoid any penalties.  This year I was planning to do somewhat the same except I would pay a larger chunk of the tax bill toward the end of the year. My understanding was (is?) that this kind of withholding from IRA distributions is considered as having been paid in throughout the year thus avoiding the necessity of estimated taxes. I hope someone can point me to the chapter and verse in the IRS Regs concerning this...

Peace

Bob

Paul,  Thank you for your kind words.  Bob, I understand the same about IRA distributions being deemed as happening throughout the year.

  We are already paying estimated taxes.  I have calculated the safe harbor and am giving the IRS that amount knowing that the amount of income increase we will eventually have this year means that I will again owe the IRS a lot of money next year but no penalty.  I will need to revisit this issue in the fall when the cash flow resumes to make sure I'm covered in terms of quarters and income.  I always try to do what's right in our eyes when it comes to money. The inheritors live in states with state income taxes so that there would be a bigger bill but I never let the tax tail wag the investment dog.  I just can't help looking at this stuff and thinking what's going to give me the best bottom line.

Bob, I couldn't find chapter and verse on the question you asked.  I know you don't have to pay taxes until you receive the income and can use the annualized method which is partly what I'm doing b/c you can be penalized if you pay the 100% of taxes owed as estimated taxes but didn't cover all the income in a quarter.  I've heard the same thing you did about it being deemed as paid throughout the year but wonder if these individuals are just taking out the money for next year in a lump sum at the end of the year and taking advantage of the fact that you don't have to pay until your receive the money rather than an actual rule that it's considered the same as withholding and having come throughout the year.  I don't know.

In terms of my current problem, Dennis and you may have given me a possible solution with your HELOC advice.  Since the time period is so limited, maybe/probably being resolved by June or certainly by July, I'm considering just writing the checks on the investment account margin and paying the interest.  The interest cost may be less than costs any other way and my husband doesn't consider that debt in the way he does a HELOC or credit card debt.  I have to play with those numbers.

Roberta 

Roberta,

My vote is, as your probably guessed, HELOC (or margin account, keeping Sam happy!)  That would probably be the most tax efficient way to go.

If not, I would go with both conventional wisdom, and your gut, and take it out of taxable.  The reason is quite simple, and that's simplicity.

As long as you have taxable monies, you have to worry about tax issues, in the sense of short versus long term capital gains and losses, qualified, versus non-qualified, dividend issues, tax efficiency, ad neaseum.  If you spend your taxable account down to nothing, then all of that goes away.  Monies taken out  of your tax deferred accounts are taxed at regular rates, monies taken out of your Roth are not.

Bob, you can take distributions anytime during the year without withholding. Then at the end of the year, you can just remove the appropriate amount of tax withholding. I've done it that way. However, doing it made me a little uncomfortable because disruptions in life or other circumstances like health related issues may cause a person to miss the payment. 

Taylor L. and some others have mentioned that they take their annual withdrawals, including taxes, at the end of the year for the next year's expenses. That also minimizes the amount of time the withholding is not working for you. I like this idea and I have been delaying withdrawals a month or two each year by taking 13-14 month's expenses to get to the point where withdrawals are finally at the end of the year. I'm up to August now. 

: - )   

Paul 

Paul: Thanks for your comment. I always make sure I have covered the safe harbor needs, and my records clearly indicate how much is owed Up To Date since I don't want the (far in the future) widow to be surprised.... ;-)

 Roberta: With such a short term need I agree that the HELOC is the way to go. I did that for a longer term need this year. A couple of years ago I had to make some additional withdrawals which kicked my AGI over $150K   surprise!!!!!!  I got a notice that my MEDICARE insurance cost was essentially doubled for both myself and the wife.... That amount is high enough to make a loan and the interest look pretty good....  You might want to look into that... I have no idea where to tell you to look unfortunately...

 Peace

Bob 

The HELOC absolutely will not fly.  I'm going for the margin account.  He's making noises about not liking owing money but I think Bob's information about the increased medicare cost may tip the issue.

Thanks

Roberta 

I'm kind of surprised with the absolute rejection of the HELOC and taking a margin loan.

I would expect that the interest rate on the Margin loan is higher, and it is a non deductible expense. whereas the HELOC is fully deductible from your taxes. Regardless of which one you take, you have to pay it back, so why not take the one with tax advantages?

Also, you might want to look for a 10-15 year mortgage if you can find one at a good rate, not closing costs, and no penalties for prepayment. I did that and my rate is 4.82% on a 15 year note. Hopefully I will pay it off fairly soon, at no penalty. The bank (CityNational) was quite eager to get my loan.

Bob

Maybe I'm missing something here, but a margin loan is deductible so long as it is for investment purposes. The key is to sell enough securities to cover your needs from the resulting account cash balance, and then buy the securities back on margin.

Margin interest rate is quite negotiable at most brokers.  JMO 

I've never used a margin loan so my statement apparently is in error.  Sorry about that!

Golly, I think that's the first time I've been wrong since third grade.... that was in 1945 ;-)

B

The difference between a HELOC and a margin loan is that the house would have a mortgage and that's something he could not tolerate never mind the tax or financial implications.  We also don't itemize.

Roberta 

"We also don't itemize"

I've been waiting for that statement. I was wondering if I was the only one on this Forum who doesn't itemize. There is so much discussion here about paying off mortgages by the time one retires that I've been surprised at the number of comments with Tax Deductible in them.

Billym 

Until recently we had no debt of any kind other than a small HE loan. FOr personal reasons, we had to take out a 35% mortgage on our home last year since the interest was deductible. Since I am receving income to offset the interest I am paying out it is kind of a wash.

Had I withdrawn the funds needed from my IRA (the only source I have) I would have again found our Medicare and other costs go way up again in addition to having to pay a large income tax bite on the IRA withdrawal (probably in at least the 25% bracket. In addition, I would have had to sell mutual funds within the IRA to raise the cash, and this certainly isn't the time to be doing that.

We have always been able to itemize even without the house loan interest... our RE taxes, deductions for medical insurance and copayments, etc,  and charitable contributions are enough to beat the standard deduction. I guess I'm kind of surprised that more retirees are NOT itemizing...

Bob 

Roberta,

With a HELOC, you have a certain amount of credit set up (based on your equity in your home) that you don't pay interest on unless you use the money.  It just like a margin account.  If you HELOC is $100,000, and you need $10k for taxes, you pay interest only on the $10k actually used, not the $90k still in reserve.  Once the $10k is paid back, no interest is charged, or due.  It's like the maximum charge limit on a credit card.

I understand how a HELOC works and its advantages.  He understands how it works and its advantages.  The bottom line is that the house is your collateral and he's not going to let that happen.  Aside from the fact that he'd have to sign the papers to do it and he wouldn't, he does have the ability to access his accounts, our joint accounts and power of attorney over my accounts.  He would start at the top of the list and sell until we were debt free.  And he'd probably be so pissed, he'd sell everything and go totally to cash and CD's. It would get rid of some dogs I haven't been able to bring myself to sell :-).

It is still unclear whether I'll be able to use the margin account without marital friction.  He has weighed in on the side of conventional wisdom and using the taxable rather than sheltered but I don't think he's realized the impact RMD's are going to have on us 

We have not been able to itemize for years.  Mostly it's b/c we never got out of the habits of being poor but the same kind of scrutiny that I apply to investing goes to things like insurance.  That doesn't mean that we do without things we think are important, like travel.

Roberta

Roberta,

"He would start at the top of the list and sell until we were debt free.  And he'd probably be so pissed, he'd sell everything and go totally to cash and CD's. It would get rid of some dogs I haven't been able to bring myself to sell :-)."

I understand your situation.

If he buys off on spending taxable first, that would seem to be the best psycholigical solution.

Prior to retirement, LaLoba and I had a discussion on whether or not it made sense to pay off our mortgage, or put that same amount of money (into VWEHX, as it were!).  This was part of a discussion on whether or not to take a lump sum for half of her pension or take the annuity instead.

I worked the numbers, and it would have been better, financially, to keep the mortgage in retirement.  Several thousand dollars of interest spread over the life of the mortgage were involved.  Anyhow, even though fincially a better deal, it wasn't psychologically, so we paid off the mortgage, and haven't looked back since.

We have an equivalent HELOC set aside, which I do tap (only to smooth out lump sum money problems during the year), but obviously have the ability to pay off within a day or two (the amount of time necessary to transfer funds from Vanguard to our credit union).

But everyone is different.

Good luck in your personal 'prime credit crunch'!

Roberta,

a couple things.  I agree on the mortgage info in prior posts.  I also understand old school, own the house.. You need to decide what work for you.

I just saw this in another column,  you may already be aware.

DUMB: Selling highly appreciated company stock if you're near retirement. "The tax break on net unrealized appreciation will be lost forever," warns Jeremy E. Portnoff, a financial adviser in Westfield, N.J.

This little-known tax dodge works like this: The IRS will allow you to withdraw company stock in-kind (that is, you don't have to sell it first) from a 401(k) or other deferred-compensation plan at retirement and deposit it directly into a brokerage account. The tax "basis" in the stock becomes the value when it is transferred, not when it was originally purchased, when it was presumably worth much less.

Proceeds from retirement accounts are taxed like ordinary income, at rates approaching 40%. With this move, you pay the capital gains rate of 15% or less.

hope it helps dodge the tax man...