Conventional wisdom says that you spend down taxable assets first in retirement, leaving sheltered assets to grow tax free or deferred as long as possible and the numbers support this view.

Conventional  wisdom says that you put bonds and other tax inefficient income yielding funds in tax sheltered accounts and the numbers support this.

How do you reconcile these two correct maxims when you're withdrawing money and your assets are about equally split?  You don't need to take RMD's yet but you need income to live on and your income producing assets are in the sheltered accounts?

Roberta 

I'm in that situation, with assets about equally split between taxable and tax-sheltered.  Since retiring 2 years ago I've done several things to minimize taxes while favoring withdrawals from the taxable pile. 

The biggest help has been converting some of the taxable investments to MLPs, which pay high and tax-deferred yields.  I did take a tax hit in the first year in order to accomplish this.  But now it keeps my taxable income down (in the 15% bracket) because the MLP distributions don't show up as taxable income.  At this taxable income level there is also a 5% tax rate on some of the capital gains and dividends.  And there is also a 0% rate on some captial gains this year and next.

Another ploy has been selling low-dividend taxable investments that have small or no capital gains, and living on the proceeds.  This avoids, or at least minimizes, withdrawals from sheltered accounts.  (Last year, I withdrew only two months of income from the sheltered accounts.) 

My view is that spending taxable account capital does not "eat your seed corn" if it lets you reinvest the same amount of income within the tax sheltered accounts.

 

Scott43 wrote the following post at 05-10-2008 9:26 AM:

I retired just two months ago. Next year I plan to sell a stock I have owned for some time, (Borg-Warner/BWA) it pays low dividends but has had good growth. I will have CG taxes to pay which is OK by me, it will be below the tax rate on my pension. In 2010 I may want to convert some of my IRA to a Roth, which would raise my taxable income at that time.

 

I like the idea of not drawing on deferred income until necessary but there are a couple issues that are hard to forecast; one is whether RMDs will be a problem in raising income and therefore tax levels and the other is that there is a good possibility that taxes will go up and negate the advantages of deferring taxes.

"I like the idea of not drawing on deferred income until necessary but there are a couple issues that are hard to forecast; one is whether RMDs will be a problem in raising income and therefore tax levels and the other is that there is a good possibility that taxes will go up and negate the advantages of deferring taxes."

The best answer to both those problems is to convert to Roth if possible while you have taxable income that may well be only partially taxable.  For example, you sell stock you have owned for a long time;  You pay 15% CG tax on the gain, but nothing on the return of your principal.

As to the OPs question, if you had 50% in taxable and 50% in IRA,  and all the taxable was equities and all the deferred was tax inefficient, then as you sell the taxable equities, you would convert some of your deferred account to equities in order to maintain your desired AA.

After you have exhausted all your taxable, you could still have a 50/50 AA in your deferred and Roth.

best,

Bill

alpha28 wrote:

Hi Roberta-

First, to all you Ladies, who are Mothers...Happy Moter's Day!!!

Now, back to today's entertainment...

"....How do you reconcile these two correct maxims when you're withdrawing money and your assets are about equally split?  You don't need to take RMD's yet but you need income to live on and your income producing assets are in the sheltered accounts?

Roberta"

Never being known to be totally conventional, and I speak mostly for myself...I feel that one should not "reconcile these two correct maxims" when withdrawing money. If you can invest your money in a tax efficient way, fine, do so. But, investing to me has never been defined, or better stated, dependent on whether the monies, or end returns/profits, should be subject or not to to tax having to be paid.

I do agree with the first of Roberta's premises..."Conventional wisdom says that you spend down taxable assets first in retirement, leaving sheltered assets to grow tax free or deferred as long as possible and the numbers support this view."

But, I do not agree that investing should be dependent, or solely dependent, on placing investments which may or may not be tax-efficient, in tax-sheltered accounts.  When one is younger, one places your monies in investments which are likely to be successful, and give you a larger capital, and ultimately enough wealth that you feel secure as you reach your targetted age of retirement.  Many of us did not, and still do not have the luxury of being able to place/or have placed our capital in tax-sheltered accounts.  Most important to me, is to be able to live comfortably, and securely as you make your necessary WDs to meet your retirement needs...and that these be realistic and able to give each individual a long and satisfying retirement, whether you have to pay taxes or not...Again, this is just another opinion...and might not sound as sophisticated or educated as those who ponder the question, and try to save, or at least, have fun trying to beat the taxman.

Regards, Curanderotk

Well? It seems to me all we have to do to put this Retirement business to Bed is?

1. Increase SS taxes to equal whatever it takes to provide the same income to someone as their last Yr of working.. Be it the current % ( 7.5%? ) or more?

2. Privatize it, but The Gov't Invest it in Index Funds, that include Energy, Reits that supoort US Business and The Growth of getting more People able to own a Home

this comes not from my Nible Thinking but that from 'Think Tank" PBS show

And it says it's very doable.. as being done in other Countries..

Of course, Our Spending economy would suffer for a few yrs, since it would provide Less $ for People to Blow on Big screen Tv's and SUV's.....and be forced to live more moderately and use less Energy from Gasoline, Nat. Gas  to Electric ...

Now wouldn't that be a shame...

Now what would 7.5% of the ave. Median Income of $50,000 yr be worth  by age 66

= $3,750/ yr and invested in such a Index Portfolio for say 45 yrs?

as for what $ goes in what account? Me thinks that is Only a Problem for the Wealthy and Rich.. everyone else has to invest whatever $ they have in the Highest Rtn Investment, if they want to have a chance at not having to Eat Oatmeal their last few Yrs of life...

Telling someone who Doesn't have enough savings to Provide them using that 4-5% WD rate to just invest in some Conservative Port that only gives them Marginal to Below Income is Wrong.. They will end up running out of $ and live in Poverty..& Destitution..and become a financial burden on society..

Eg: Just met with a Disabled 60 yr old Veteran and His Wife.. They have SS Disability income of $17,000 yr.  and live in a Paid for small 2 bedroom home and  $110,000 in savings and needed $6,000/yr from it to 'Pay the Bills and No frills"  and had been told to invest  it in 50% Index Funds & 50% in Bonds and CD's for past 5 yrs... It's made an ave of 5.7% apy.  He's got about the same as he did 5 yrs ago, but it's now worth only about $93,000 after inflation..and will run out of $ in about 10 yrs or Hope they both Die before then.. Alot of good that Investment advice did, now didn't it?

We moved it into Active Mge. Balanced funds instead.. Inorder to have "at least" a chance of it making more and it lasting longer..( that have ave 12% apy for the past 5 & 10 yrs )

He had a #401k plan.. That Co. went Bankrupt and it paid 11 cents on the dollar..So much for #401ks

 

Those above thinking MLPs might want to consider the MLP closed end funds that focus on them.  They usually trade at a discount to theiir portfolio net asset values and the distributions are largely tax deferred.  FMO, for example, pays almost 7% annualized and has been totally tax-deferred  (ROC from depreciation, depletion and amortization, a non-cash charge against earnings).  With these CEF, you get one IRS  Form 1099 instead of a bunch of K-1s and there is no potential  UBTI liability if held in IRAs.  KYE, TYG, FEN,  are among a dozen total

Of course the obvious way would be to switch holdings - tax deferred become taxable and vice-versa assuming the Yield from the tax deferred side was sufficient for your needs. But if that all at once strategy incurred sizable capital gains with no off-setting capital losses the only way I can think of would be to make the switch slowly or whenever capital losses presented themselves.

On the other hand, if the taxable side is comprised wholly of tax efficient funds and you end up leaving things as they are, I guess you have to bite the bullet and be taxed at the ordinary income rate on any qualified dividends you decide to take in addition to the bond fund interest distributions coming from the tax deferred side.

I was faced with your situation during the 2000 Bear and made the switch - or as much as I was able given the dollar value of the portfolio on each side (Taxable/Tax Deferred) at that time.

Billym 

 

Roberta,

"How do you reconcile these two correct maxims when you're withdrawing money and your assets are about equally split?  You don't need to take RMD's yet but you need income to live on and your income producing assets are in the sheltered accounts?"

Whenever I had a significant taxable account balance, I treated my portfolio as one big account.  It produces so much yield, and I spent less then that amount each year.  It made no difference if 100% of the yield was produced in my tax deferred account, while I spent down my taxable account.  I figured I added it all to tax deferred capital, then spent taxable capital.  Does that make sense?

IOW, if I had $50k in taxable and $50k in tax deferred, and had $5k of yield (10%) within tax deferred, no yield in taxable, I will still spend $5k of taxable monies (capital) while adding the $5k yield to my tax deferred capital.  My net portfolio yield was $5k, and I spent $5k, just not from the account that generated the yield.

Thanks all.  All of the suggestions are part of the answer and part of the problem.  We have to play with it and just do some thinking and there are other people with different situations asking advice (My sister retires in June).

At this point, I'm so frustrated that I'm almost willing to buy an annuity :-(.  Well, not quite.  Maybe just sell everything, go to muni's in taxable and bonds in sheltered.  Won't happen.  I'm too greedy.  But it means I need to step away from it for a while and let my back brain mull on it.

Thanks again.  I can find academic studies and learned opinions on the internet but there's nothing like the thoughtful opinions of what you do and why and how you reached your conclusion.  Your solution may not be my solution but it sure helps me find my way through the maze.

Roberta 

. 

Hi Roberta!

Like a Canadian Goose flying north, I looked down and saw bilperk's name, so I'm dropping down into this pond for a second.

I use some creative financing to accomplish what you ask.  At age 62, I took out a large Home Equity Line of Credit from which to live on.  My pension, I took as a lump sum, now in an IRA.  Most of my assets (above 1MM) are in IRA's.  I have a huge RMD problem at age 70 1/2.  My only income is thus from social sec, unless I tap IRA's.  To enable converting from Regular to Roth IRA's, I am thus living off the HELOC, freeing up tax space through the 15% bracket to convert.  This year I conveted $80,000.  Others have asked for some more details about this, and I posted the following on another forum:

The majority of my savings are in regular IRA's...a 401.k rollover; a lump sum pension rollover; spousal and my regular. My son in law laid out various tables showing Required Minimum Distributions (RMD's) starting at age 70 1/2. (I'm now age 63). Of course, depending on assumed asset growth rates, one sees very large RMD's ahead, even with lesser growth. Numbers like $250,000 annual RMD at age 88 exist, and would likely be highly taxed.

Converting some regular to Roth IRA monies now, helps mitigate future taxes, as the Roth's do not have RMD's, are nontaxable when withdrawn and make great inhereted IRA's. But to accomplish this now can involve paying additional taxes, now. To minimize such current taxes, I am using the following strategy.

My monthly living money comes from some equity (nonIRA) dividends and interest, social security and periodic withdrawals from the regular IRAs. Based on a lot of studies and tradeoffs on these matters, I have concluded I at least want to convert through my 0% and 10% tax due space...and probably some of my 15% taxable income space (range). So if I can defer taking some taxable monies in any given year, I can convert more to the Roth. To accomplish this, here is what I did.

I established a substantial home equity line of credit (HELOC) on one of my houses. Then, when I need living money I tap the Heloc, rather than withdraw from regular IRA's. The tax space above social security earnings and dividends, I use to convert to the Roth...and it is significant, because I have lots of deductions. The heloc rates are now low (I have Prime minus 3/4%), and I suspect my regular IRA's will grow (tax free) by similar amounts anyway.

At some point I may go to a fixed, regular mortgage, as an option. Since we have pretty low tax rates for next few years, I am doing this now. I now have a significant Roth IRA building up for the future. One downside to this approach is it increases the amount of social security income that is taxable

Complex...a little. Creative financing...to the max.

Roberta,(and others),  perhaps this use of HELOC's could be adapted to your situation.  It is working for me.  Good to chat.  

retired at 48. 

[quote user="meyerr"]

Conventional wisdom says that you spend down taxable assets first in retirement, leaving sheltered assets to grow tax free or deferred as long as possible and the numbers support this view.

Conventional  wisdom says that you put bonds and other tax inefficient income yielding funds in tax sheltered accounts and the numbers support this.

How do you reconcile these two correct maxims when you're withdrawing money and your assets are about equally split?  You don't need to take RMD's yet but you need income to live on and your income producing assets are in the sheltered accounts?

Roberta 

[/quote]

The conventional wisdom is generally predicated on the idea that you retire at about the same age as when you are required to make your RMDs. 

The situation now is what it is now.  Without more specifics, it is hard to recommend the most tax efficient course of action for the future.  Would there be large capital gains if you sold the investments in your taxable account and used them to buy income producing investments in your taxable account?  Keep in mind if that fool obama gets elected, you may see capital gains taxed at ordinary income tax rates in the future.  So paying capital gains taxes at today's rates may be a good thing.  And if cap gains are taxed at ordinary income rates, there may be no tax difference to hold the income producing assets in your taxable account.

Hopefully, the fool won't get elected but you never know.  People in this country elected Jimmy Carter afterall.

[quote user="retired at 48"]

I have concluded I at least want to convert through my 0% and 10% tax due space...and probably some of my 15% taxable income space (range). So if I can defer taking some taxable monies in any given year, I can convert more to the Roth. To accomplish this, here is what I did.

I established a substantial home equity line of credit (HELOC) on one of my houses. Then, when I need living money I tap the Heloc, rather than withdraw from regular IRA's. The tax space above social security earnings and dividends, I use to convert to the Roth...and it is significant, because I have lots of deductions. The heloc rates are now low (I have Prime minus 3/4%), and I suspect my regular IRA's will grow (tax free) by similar amounts anyway.

At some point I may go to a fixed, regular mortgage, as an option. Since we have pretty low tax rates for next few years, I am doing this now. I now have a significant Roth IRA building up for the future. One downside to this approach is it increases the amount of social security income that is taxable 

[/quote]

A man after my own heart, although it appears that you've beaten me to it!  Your strategy is exactly the one that I've been considering, but mine may also involve deferring SS from early (age 62) to on-time (age 66).  It's a strategy that seems counterintuitive to the prevaling feeling that having a paid-off mortgage is the way to go for retirees.  While being debt free is a good idea for people on fixed income, adding in the kind of considerations we're talking about here highlight the potential advantages of being in DEBT!

Roth conversion is one of those advantages, of course, and another relates to the concern that inflation and devaluation will eat away at savings - It ALSO eats away at debt!  As you note, at some point it may be advantageous to convert to a fixed-rate mortgage (first or second), but for now, the HELOC is an excellent vehicle for necessary purchases - Like the car I'm going to need to buy shortly.

[quote user="Racqueteer"]

[quote user="retired at 48"]

I have concluded I at least want to convert through my 0% and 10% tax due space...and probably some of my 15% taxable income space (range). So if I can defer taking some taxable monies in any given year, I can convert more to the Roth. To accomplish this, here is what I did.

I established a substantial home equity line of credit (HELOC) on one of my houses. Then, when I need living money I tap the Heloc, rather than withdraw from regular IRA's. The tax space above social security earnings and dividends, I use to convert to the Roth...and it is significant, because I have lots of deductions. The heloc rates are now low (I have Prime minus 3/4%), and I suspect my regular IRA's will grow (tax free) by similar amounts anyway.

At some point I may go to a fixed, regular mortgage, as an option. Since we have pretty low tax rates for next few years, I am doing this now. I now have a significant Roth IRA building up for the future. One downside to this approach is it increases the amount of social security income that is taxable 

[/quote]

A man after my own heart, although it appears that you've beaten me to it!  Your strategy is exactly the one that I've been considering, but mine may also involve deferring SS from early (age 62) to on-time (age 66).  It's a strategy that seems counterintuitive to the prevaling feeling that having a paid-off mortgage is the way to go for retirees.  While being debt free is a good idea for people on fixed income, adding in the kind of considerations we're talking about here highlight the potential advantages of being in DEBT!

Roth conversion is one of those advantages, of course, and another relates to the concern that inflation and devaluation will eat away at savings - It ALSO eats away at debt!  As you note, at some point it may be advantageous to convert to a fixed-rate mortgage (first or second), but for now, the HELOC is an excellent vehicle for necessary purchases - Like the car I'm going to need to buy shortly.

[/quote]

Hi Racqueteer!

Glad to hear someone else "gets it." Yeaaaa.  I debated whether or not to take soc sec, but concluded to take it at age 62, and with the HELOC would enable enough conversions.  But yes, that is a viable option.  And damn, we agree on not being debt free, and how it is good in inflationary times, which I think are just ahead.

Good to chat, and glad I dropped in.  Now I'm transitioning to Saratoga,ny, home of horse racing, ballet and polo, and other fine gentlemanly activities, but I will be computer limited for a week.

retired at 48

 

 

 

 

 

 

Thank you all for the helpful & interesting discussion.  Chamois, re: MLPs - could you please explain what UBTI liability is?  Thanks!

[quote user="retired at 48"]

Hi Racqueteer!

....... 

Good to chat, and glad I dropped in.  Now I'm transitioning to Saratoga,ny, home of horse racing, ballet and polo, and other fine gentlemanly activities, but I will be computer limited for a week.

[/quote]

You'll be just "up the road" from me here in the mid Hudson Valley (around West Point).  We should stay in touch!  ;-)