27 Replies Latest reply on Aug 11, 2015 10:43 AM by JerryD

    Keep more retirement income

    Chrysalis

      Just yesterday, I was trying to figure out how much of our traditional IRA retirement funds we should move to a (non-taxable) Roth IRA. I was thinking that we should probably move all of our money into Roths (or non-taxable municipal bonds) before we retire in 5 years. I was not happy to have to lose all that potential growth of funds due to current taxes, but I was concerned about our tax liabilities during retirement.

       

      This article helped me understand that I only need to shelter assets that we will need that exceed $74,900/yr taxable income. For us, that would mean extraordinary expenses like fancy trips, unusual medical expenses or long-term care costs. That makes me feel much better.

        • Re: Keep more retirement income
          MyR Community Manager

          Chrysalis, thanks for starting a discussion thread about this important topic!

          • Re: Keep more retirement income
            JerryD

            The article and I would not agree with quickly converting large amounts from a Traditional IRA to a Roth. That could very easily push you into a much higher tax bracket. A key quote from the article: “It’s not what you earn  (convert) that counts, but how much you get to keep after tax”. For instance, we will probably be doing our major conversions over more like 10 years or so so as to keep the tax rate down. For example, going from a 15% tax rate to 25% means that 10% is lost to taxes and will take more years to recover sheltered in a Roth.

             

            Taking money out of a Roth to live on is NOT part of our strategy. For us, Roth money is a slush fund for emergencies only and for the kids if unused. Of course, this assumes that the IRA RMD's provide sufficient extra income to cover living expenses which it will for us. Actually, as time goes on and the IRS asks for larger and larger amounts, the RMD's will provide excess income which will have to be taxed and re-invested. A big part of our IRA -> Roth conversion strategy is to reduce the IRS cut which is wasted assets in our thinking.

             

            Do the calculations before launching into the conversions, Take a long-term view to get to or as close to your Roth goal as you can while minimizing the tax bite. If you haven't yet done it, try to see where you can reduce your income requirements so as to minimize your usage of sheltered IRA and Roth assets for later use and contingency.    GOOD LUCK!!!!   :-)))

              • Re: Keep more retirement income
                Chrysalis

                Yes, Jerry, you are absolutely correct. One should try to avoid converting large sums from traditional to Roth in any given tax year. The whole point, after all, is to keep your tax rate at 15%. What I learned today (and that you apparently learned a while ago) is that our Roth account should be for extraordinary expenses, not regular expenses. The two of us can easily live below the 15% rate threshold of $74,900/yr. It's only if extraordinary circumstances arise that force us above that amount that we will need the Roth non-taxable funds.

                 

                As usual, Jerry, you seem to have it covered!

                 

                PS. Another thing I learned today is that for the first 5 years of a Roth account, only the principle is tax-free, the gains are taxable. After 5 years everything is tax free. So it's better for us to start converting to a Roth sooner rather than later.

              • Re: Keep more retirement income
                TripleStep

                     Chrysalis and JerryD, I agree with your understanding of Roth conversions. The conversion, or an RMD, or any eligible distribution that the account holder takes from a traditional IRA at any time, is taxed as ordinary income under the current federal tax code. (True, if you originally deferred taxes on the contributions.) Local taxing authorities have their own criteria and rules.

                     However, I made a different decision about converting my retirement savings from traditional IRAs to Roth.

                     When I began making retirement contributions, the Roth IRA and Roth 401(k) did not exist.  When I later looked at conversions from my traditional IRA to a Roth IRA, I decided to leave all of my retirement accumulations in my traditional IRA. I found out that the traditional and Roth IRAs were designed such that both should provide about the same amount of spendable cash in retirement, if you are in the same tax bracket in retirement as when you convert from traditional to Roth.

                     Since I could not foresee what the tax brackets would actually be in the future, I decided not to pay taxes on my retirement account until I was forced to pay. When I have to pay the taxes, I will know what the tax brackets are and which bracket I am in.  At that time, I will look at what steps are allowed to manage my combined federal, state, and local taxes under the tax code as it exists then.

                     If the tax code then has not changed from what it is now, I just have to stay out of a higher tax bracket.

                  • Re: Keep more retirement income
                    JerryD

                    As TripleStep (TS) points out, different people choose different strategies. And all should be aware that what I post is MY opinion and that I am NOT an investment advisor. I am not looking for converts, just for people to look carefully at their own situation and base future actions on rigorous thought and analysis.

                     

                    Just a few observations: When TS states "if you are in the same tax bracket in retirement as when you convert from traditional to Roth" please be aware from previous discussion that the IRS RMD rules for annual increases will almost insure that anybody with a modest amount in their IRA's WILL be in a higher tax bracket very quickly due to larger and larger RMD's. So if you are in, say, the 15% tax bracket at the start of RMD's, it will NOT be long, probably less than 5 years, before you will most likely be in the 25% bracket due to these rules.

                     

                    And when TS says that he will wait until retirement when he has to pay taxes, again please be aware from previous discussion that the impact when Social Security and then RMD's are added to taxable income, that it will be difficult to stay in the lower bracket and also do large IRA -> Roth conversions at that time. This effect can easily reduce the amount that can be converted by 2/3 while still maintaining the desired lower tax bracket. It will be much easier to start doing the maximum IRA -> Roth conversions at 62 or sooner, say, when one choses to retire without yet taking RMD's while living on other income and/or investments. If you can defer SS until 66 or 67 while doing larger conversions, you will be able to do still larger conversions in those 5 or more years while maintaining the lower tax bracket. Again, should you be in the 15% bracket with modest income to do more than $250,000 in Roth conversions in 5 or more years while staying within the 15% bracket in that time frame. Just some food for thought.    GOOD LUCK!!!!!   :-)))

                      • Re: Keep more retirement income
                        Chrysalis

                        TS, until just recently I thought as you do-- if I'm not working during retirement, my tax rate couldn't possibly be higher than it is while I am working so I won't worry about it. And that is certainly a valid option. Especially since I want to invest as much as possible now so that it grows as much as possible.

                         

                        [Edited to remove incorrect information. Thanks, Jerry! ]

                         

                        In thinking it over, I came to agree with Jerry. During the next few years I'm going to start taking regular distributions from my 403b, paying the taxes and putting them into a Roth. I haven't quite decided how much I will move to a Roth, but probably not more than 25% of our assets.We will not use this money for normal living expenses during retirement, but as a non-taxable emergency fund. That way we will never have to worry about emergency withdrawals (or, heaven forbid, long-term care) bumping us into a higher tax bracket.

                          • Re: Keep more retirement income
                            JerryD

                            Just a few clarifications. The $75,000 top TAXABLE income to remain in the 15% bracket is really more like $95,000 real income due to the minimum standard deduction ($12,600 for two in 2015) and personal exemptions ($8,000 for two in 2015) and even more if you can increase your itemized deductions above the standard deduction levels.

                             

                            Taking your example, if say, your taxable income exceeds the 15% limit by $15,000, ONLY the extra $15,000 will be taxed at 25% and the $75,000 at the old combination of tax levels up to 15%. Here are the 2015 tax brackets. Note the tax amount at $75,000 income is NOT even an effective 15% tax but an accumulation of the 10% amount and the 15% amount (Effective tax rate for the first $74,900 is $10,312.50/$74,900 = 13.76% of TAXABLE income and adding an additional $15,000 taxable at 25% would result in a much lower tax of $10,312.50 + 25% * $15,000 = $14,062.50, much less than your assumed $21,250):

                             

                            MFJ

                            Chrysalis, I recommend that you sit down with a tax advisor before launching into your new retirement strategy so that you can be assured that your assumptions are right on target.   GOOD LUCK!!!!   :-)))

                              • Re: Keep more retirement income
                                George1945

                                There's one additional kicker I haven't seen mentioned anywhere. I won't reach RMD age until l next year, so that isn't an issue yet. However, I've been trying to figure whether it's better to take more out before next year. With pension, ss, and part-time work, I make just enough to begin making enough to pay tax. Yes, my marginal rate is 15%, but my effective marginal rate is 30%, because for each additional dollar I earn or take from my IRA, I have to pay tax on additional dollar of ss income.

                                I would love to have had an easy decision tree to help find the optimum amount to take from the IRA, but always ended up running a set of tax scenarios each year and comparing. I'm sure others are in the same boat, and it would be nice to find a simple model.

                                  • Re: Keep more retirement income
                                    JerryD

                                    George, I never get into what tax I have to pay on SS when I exceed some threshold. We need so much to live on and we have goals for IRA -> Roth conversions while staying in a chosen marginal tax rate. I am getting too old to fret about SS injustices.

                                     

                                    That said, why don't you just create a spreadsheet with a variety of income levels for your pension, SS, job, RMD, etc. and then apply the tax rules to see the effects. The tax rules are pretty well defined so that this exercise should not be that difficult. Maybe you can post your findings here to help out others that are wondering but not drilling down on an important issue.  GOOD LUCK!!!!    :-))))

                                  • Re: Keep more retirement income
                                    BoBraxton

                                    Thanks for illustration.

                            • Re: Keep more retirement income
                              wcaretired

                              Our goal was to keep enough in our IRA to meet our usual expenditures each year.  We limited our ROTH transfers to an amount that did not boost our tax bracket.  Once we retired it was no longer tax efficient to continue transfers.  Had the ROTH been available, we would have contributed to it and started making transfers sooner.  I agree with the writer above,

                              our ROTH is reserved for emergencies.  Hopefully, it will be passed on to our grandchildren.

                              • Re: Keep more retirement income
                                Wasatch

                                I Wish I had read this article 12 years back. Then I would have spent more money and save less for my retirement. Or contribute less to retirement account and invest the money somewhere else.

                                 

                                way back I did not take into my spouse's and my SS income. I did not expect all the value increases of our retirement accounts. Had I known about all these, I would chose to put much less into my retirement instead I would paying much less tax way back. Then invested the money outside our retirement accounts.

                                 

                                Because of our mistake in planning and managing our retirement accounts, now our total taxable income is much much higher than our old salary amount. So we are paying MUCH HIGHER rate than when we were still working.

                                 

                                1. Remember SS that you will receive;

                                2. Need it or not, you will have to take certain amount of money out of your retirement account when  you are 70.5 years old;

                                3. Don't forget to count all your retirement accounts. Not just the accounts with TIAA;

                                4. May be you are better off to keep some money invested outside your retirement account when you are still working.

                                5. Find a very good advisor early on.

                                  • Re: Keep more retirement income
                                    wcaretired

                                    There is an up side in your situation.  I would rather be in a higher tax bracket than not have enough income to meet my needs. A higher tax bracket means your income is higher.  That could provide for increased travel, home upgrades or just a higher standard of living in general.  Modifying your home and making it barrier free can keep you in your own home longer. 

                                      • Re: Keep more retirement income
                                        Wasatch

                                        Thanks for your comment. I agree that it is better in my situation than have not enough money ar one' sold age.

                                         

                                        My point is that earlier and better planning will be the best. And if I had known, I would not penny pinched all those younger years. So don't just save and save, enjoy some of your earning early on if you have "enough" saved for the retirement.

                                         

                                        Thanks again for your comment.

                                         

                                         

                                        Sent from my iPad

                                    • Re: Keep more retirement income
                                      Micker1

                                      I’m not convinced that Roth IRA’s will remain tax-free down the road.    My rationale is that Social Security benefits were always supposed to be tax-free until they were no longer tax-free beginning in 1984. 

                                       

                                      Taxing Roth IRA’s won’t be in the near future and may never happen.   But with federal deficits continuing to run high, I’m  concerned that all options for raising revenue will be on the table. 

                                       

                                      For me, I prefer taking the sure thing at this point instead of hoping it will be there down the road.

                                       

                                      I’m many years away from retirement, so this line of thinking would be much less applicable to those closer to retirement.

                                        • Re: Keep more retirement income
                                          JerryD

                                          Don't let your concerns over the tax-ability of Roth's keep you from using them. Any changes will probably be grandfathered. And those like me that have done large conversions will "attack" any Washington Rep that even hints at changing the promises they gave us.

                                           

                                          SS is a mandated right so far. The pols couldn't let it go under so they attacked the "rich" by taxing "excess" payments beyond what lower paid people get. Ya got to watch the snipers when you pop your head above the trench. 

                                            • Re: Keep more retirement income
                                              Chrysalis

                                              I just read an interesting article that pointed out that an additional advantage of ROTH IRAs is that your spouse can inherit your ROTH IRA without paying taxes on it. If you don't have a spouse, or when your widowed spouse dies, the heirs have a certain amount of time to liquidate the ROTH and pay taxes on the distributions. Maybe somebody else knows more about this??

                                                • Re: Keep more retirement income
                                                  JerryD

                                                  Chryalis, I missed your Roth inheritance question and just saw it when looking at some recent thread activity. Indeed your spouse can inherit your Roth tax-free if you place him as a beneficiary to it. He has an option to re-characterize it as his own also. The same benefit accrues to other beneficiaries such as kids. We have used our Roth beneficiary statements to insure first the spouse and then the kids as beneficiaries of our Roth's by using primary and secondary categories, respectively.

                                                   

                                                  just beware that spouses have more rights as to how they use the Roth than others do. Others will need to take the Roth in distributions over the life time that the IRS defines for them. But this is NOT a big restriction. We have instructed to use this extra tax-free income to fund the grandkids education and to use their income as a basis to allow them to create their own Roth's. This can push the impact of our Roth's into several generations in the future.

                                                   

                                                  I did quite a bit of research on estate planning through trusts and Roth's. One great resource on Roth's is Ed Slott who has written a book on "stretch IRA's" which I bought and studied. I recommend it to you and others.

                                                   

                                                  GOOD LUCK!!!!    :-)))))

                                            • Re: Keep more retirement income
                                              mcr308

                                              Great topic and excellent ideas in this thread.  A strategy that I have used is my tax sheltering of  a maximum contribution via a supplemental annuity (arranged by my employer w/ TIAA-CREF) many years before retirement has been very beneficial for me.

                                              • Re: Keep more retirement income
                                                Susanna144

                                                This is a first rate discussion.  8 years ago I wrote an essay about saving too much for retirement.  The first version of this comment included a link to that here, but it is gone now.  Basically, I said that we should not all save the maximum amount in tax deferred funds, especially at the low end of the income scale. It drives your taxes up in retirement much more than it saves during your working years.  A major penalty is that it makes Social Security taxable.  I've planned for many years to convert my 403b to an IRA immediately after retirement, and to roll over a substantial chunk of my IRA into a Roth in the early retirement years, before RMDs are required.  I was aware of how expensive it is to have even a modest income when you are getting Social Security, because I did my Mother In Law's taxes for a while.  Because my tax bracket is much lower, and my expenses are too, it's reasonable for me for attempt to keep my Social Security benefits from being taxed.  In the past 8 years my thinking on this topic has evolved a little bit.  I no longer want to move my whole IRA to a Roth, because as Micker1 has pointed out, laws can change.  It's difficult to predict tax laws, major illnesses, or other things that can have a big impact on your financial life, so the smart thing is to hold all 3 classes of investment in roughly equal proportions - Roth IRAs, IRAs and taxable investments.  That gives you flexibility.  I got some advice from my favorite investment company in an open discussion on Facebook, and that helped me see why that's a good idea.  I am glad I saw the danger of tax deferring too much when young.  It's a major reason I am able to retire early, and keep my taxes low.

                                                  • Re: Keep more retirement income
                                                    herbyreed

                                                    Kind of missing the point here.  Saving as much as possible for retirement during the work years isn't to reduce the tax burden - that is a side benefit.  It is to provide enough money for retirement.  One cannot be sure how much the retirement accounts will grow.  What we do know though, is that more money saved earlier will grow more.  And as someone pointed out, having to pay more taxes in retirement means you have more money for retirement in the first place. Your point about having some money in various financial vehicles is a good one. Of course one should not defer so much income that it keeps them from building up some conventional savings, buying a house etc.   All in all though, I have a hard time believing that many people have the problem of deferring too much income while they are young.  But many people have the opposite problem. 

                                                      • Re: Keep more retirement income
                                                        Susanna144

                                                        I think many people who work at an institution that requires all employees to tax defer at least 15% of their pre-tax salary, and who earn less than the median do have that problem.  This is because moderate income people get proportionately greater support from Social Security, and the maximum contribution limits are defined as a dollar amount, not a percentage of salary.  Imagine I am a single, 56 years old, and earning $30K annually.  Do you really think it's necessary that I tax defer half my salary?  I think saving 50% of your income is obviously too much, and yet that's the advice that is frequently given.  If you want to see some analysis and an estimate of how much it is necessary to save for retirement as a function of income level and age at which you start saving, you can search for observations and notes on blog spot.  We're all different.  I suspect your work history has exposed you to a lot more of the folks who need to save more, which is mostly people who earn substantially more than the median, and my work history has exposed me to huge employers who have extraordinarily generous retirement benefits, making it easy to save too much.

                                                          • Re: Keep more retirement income
                                                            herbyreed

                                                            Employers cannot require that you contribute to a deferred comp program.  However, some employers will only contribute to a supplemental retirement program if the employee contributes - the employer will match the employee contribution up to a certain percent.  An employee is wise to contribute enough to get the maximum match because it is free money. But the maximum match usually is nowhere near 15%.  Typically it is 6% with the employer match of 50% of that or 3%.  So 9% of the employee salary total goes into the plan but only 6% was actually subtracted from the employee salary.  Or if one is fortunate, the employer match is 100% and the match would be 6% so the total contribution to the plan would be 12% of the employee salary.  As for deferring half your salary, I have never heard of anyone recommending that. Sometimes when people are nearing retirement they put in the maximum the IRS allows if they are able but that is of course their choice entirely and it would be foolish to do that if they need the money for living expenses.  Usually people are only able to do that if they have a spouse who has a good salary or pension.

                                                            As for the tax implications of deferred comp vs. Roth IRAs and how much SS gets taxed - these are fairly complex calculations so that for most people expert financial advice is needed.  However one thing is sure - if you have so much retirement income that your SS is taxed this is a good problem to have.  You still have more money to live on in retirement even though you are paying more taxes.  And you have more money to save and reinvest to provide for the possibility that you might live a very long time and need some assistance or long term care. 

                                                              • Re: Keep more retirement income
                                                                Susanna144

                                                                herbyreed  I know it sounds odd, but there are places where saving for retirement is mandatory.  For example the University of Colorado:  "Mandatory Plans:  University of Colorado 401(a) plan - The employee contributes 5 percent of gross compensation.  The university contributes 10 percent of gross compensation.  You are immediately vested at 100 percent in your CU 401(a) Retirement Plan"  The CU website is where I am getting the 15% figure I used in my example.  I work at a small nonprofit now, with a similar 401(a) plan... The mandatory saving for retirement provision is in effect no matter your age or income level.  Graduate students are included. I interpreted your suggestion that we "save as much as possible" to mean contributing the legal limit to tax deferred retirement accounts.  I apologize for misunderstanding.  I frequently see investment companies suggesting we max out our contributions to retirement accounts, even contribute $15K annually when over 55, with no cautionary language saying that it is possible to drive your taxes higher doing so.  There is a post on this forum entitled "How To Catch Up On Retirement Investing" which seems to say that.   I am not saying that we should limit our savings to some fixed percentage, I am saying that we shouldn't tax defer too much, especially if we are already in a low tax bracket.  Tax deferral can get pretty expensive then.  I agree that tax questions are very complicated, which is one reason I appreciate the effort other forum members like JerryD have put into explaining these issues as a part of this discussion.

                                                                  • Re: Keep more retirement income
                                                                    herbyreed

                                                                    The CU deal is actually very good - basically a 2-1 match.  Note that the employee contribution is still only 5%, so this is a good deal to get 15% of your gross income deferred.  Yes the tax implications should be considered but there are opportunities even after retirement to convert traditional IRAs to Roth IRAs.  For many people the problem with Required Minimum Distributions isn't going to occur early in their retirement - it will be a few years later because with each year in retirement the divisor for calculating the RMD gets smaller.  So if you have a fairly large IRA and are getting good returns on it (a happy problem but still a problem), your taxable income can quickly increase.  One can mitigate this effect by doing Roth conversions near retirement and after.  It is complex, so most people would probably benefit from consultation with a financial planner.  Balance among different kinds of saving and balance between saving and enjoying life is still best of course.  It is sad to see some folks penny pinch all of their lives, never taking vacations etc, only to die the year after retirement with several million dollars in retirement savings.  

                                                                    • Re: Keep more retirement income
                                                                      JerryD

                                                                      I too worked for a government prime contractor that was (is?) administered by a major university. At age 30 one was required to contribute 5% to a defined contribution plan and the employer contributed 9%. In addition, one could contribute up to a limit of a total of some thing like $9,500 to a supplemental plan. Due to a small inheritance we did max out these extra contributions. Once and a while the spouse would ask why we were doing so much retirement saving. I am sure that now we both know why!!   :-)))))