Wrong advice: Shift FROM tax-deferred retirement accounts?

[TaxGuyBill]

For people in 12% while working, the only time I see it makes sense to do Traditional rather than Roth is if the amount in Traditional is so low that they can get the money back out tax free after retiring

I think that is fairly common for a low income taxpayer to get it back tax-free. A married couple with combined $40,000 of Social Security could withdraw over $20,000 a year tax-free from retirement.

[kathyc2]

I think that is fairly common for a low income taxpayer to get it back tax-free. A married couple with combined $40,000 of Social Security could withdraw over $20,000 a year tax-free from retirement.

Actually, a little over 24K if both over 65. In those cases, I always encourage them to take out the higher of what they need or RMD and then convert to Roth the amount that will take them to the 24K.

[FEDUKE404]

Something else that is rarely mentioned is to convert when markets are down. 2009 markets were down close to 50%, and at the beginning of COVID they were down 20-25%. Converting during the dip and having the rebound in Roth rather than Tradtional would be true tax savings.

Your approach can be valid, but it also can encounter some bumps in the road.

I always tell my clients to envision their retirement accounts to be like "chips." If they want to take out $20k for whatever reason, they have to sell more "chips" when the market is down than when the market is higher. (This assumes something other than $$ in the account.) Granted, in theory they can buy more "chips" in the replacement account when that market is low. But the future actions of stock / bond investments are always an unknown.

As a subtle adjustment, since January I have been taking (monthly) 10% of my 2023 RMD. For the same dollar amount, I had to sell fewer "chips" earlier this year than if I had waited until one big sale in ~October. Of course, in a rising stock market that action can be counter-productive.

The comments by Lion are useful re ways to shrink 401k accounts. There is always the option of withdrawing funds above current RMDs, but that can leave an ugly scar with NIIT and IRMAA. I'm crossing my fingers that the 10-year withdrawal window will go away. . .but I'm not optimistic in the political world of today.

And to repeat, virtually all of my clients are well into the 85% of Soc Sec benefits are taxable category, so there's nothing to do there.

[kathyc2]

Your approach can be valid, but it also can encounter some bumps in the road.

I wasn't talking about the normal fluctuations, but rather extraordinary items like COVID and 2009 that have big swings. On 1/2/20 S&P was 3528. On 3/20/20 it was 2305 or 71% of beginning of year. Say you had 1M in IRA's on 1/2/20. If if follows S&P on 3/20 if would be 707K. Say you convert 250K to a Roth, leaving 457K in IRA. Current S&P is 4284, 1.31 that of 1/2/20 and 1.86 that of 3/20. Not doing the conversion would mean current 1,314K in IRA. Doing conversion would mean 850K in IRA or 65% of doing nothing. That means 35% lower RMD's. IF you use the same tax rates for the conversion and any further distributions, the net will turn out the same. However, lower RMD's could very well result in lower tax rates both to owner and heirs. IF you had funds available in non qualified accounts to pay the tax on conversion, you will be well ahead of the game, as you are effectively getting more money into the Roth and not having to pay tax or NIIT and possibly lower the IRRMA that you constantly complain about on the amounts you moved from NQ to Roth.

[rbynaker]

I once tried to come up with a comprehensive marginal tax rate table but quickly gave up as there were too many variables. It was hard enough integrating federal income tax, QD/LTCG, AMT, NIIT, Add'l MC, and one state (VA) into one big table. At least those taxes have readily determined AGI change points that I can plug into a spreadsheet. But then at the low end you have negative tax rates for EIC/ACTC/PTC. RSC and EV credits extend the 0% "bracket" longer for those who qualify. Then the obscured "taxes" creep in for phase-in of taxable SS, IRMAA, phase out of rental PALs, student loan interest, IRA deductions, QBI, the list goes on and on. Beyond that you can't just look *at* AGI, you have to look *into* AGI. You can have three people, same age, same filing status, same amount of income deposited into their bank account but one has SS, one has QD, one has wages. They all have very different marginal tax rate schedules.

On another note, we see lots of discussions of Roth vs. Traditional. I've seen very few of those professionally written articles consider using a taxable brokerage account as an alternative. In lower income brackets QD/LTCG are taxed at 0%. The same holdings in a Traditional IRA/401(k) will get taxed at ordinary income rates when distributed (and possibly higher than ordinary rates by increasing taxable SS, IRMAA, etc.) But again, every situation is going to be different.

For my own situation, I like to keep my options open. With I Bonds and traditional IRAs I can easily "create" taxable income in years where my marginal tax rate is lower so I'm not wasting space in a lower bracket.

[kathyc2]

I once tried to come up with a comprehensive marginal tax rate table but quickly gave up as there were too many variables. It was hard enough integrating federal income tax, QD/LTCG, AMT, NIIT, Add'l MC, and one state (VA) into one big table.

I have an Excel SS set up where if I enter SS benefits, reg rate income, LTCG/QD income, exempt interest, and AGI adjustment items, It will calculate amount of SS taxable and a good estimate of total tax. This is all I need for planning for most clients. Those with more complex situations, I'll use if as a starting point and make further manual calculations.

My issue with NQ accounts is it makes it hard to plan as you never know what the income will be until mid/late December.