Anyone want to play with RMD planning?

[kathyc2]

The majority of my clients are more moderate income, so most of my planning is focused on the taxability of SS benefits.

Some people in previous discussion were talking about clients that have the max 85% already taxable and concerns about RMD's.

Would someone like to put forth an example? Include filing status, age, SS benefits, RMD, other income taxed at regular (pension, work, etc), investment income broken down between interest and that taxed at LTCG rates.

Multiple heads collaborating may come up with ideas that none of us on our own would think about.

[kathyc2]

Ok, I'll start. Single person, age 72, 1M in IRA, 30K SS, 20K pension.

Parameters used: rate of return on IRA 7%. No inflation adjustments were used for SS, std deductions, tax bracket ranges, or MC Part B surcharge. No allowance for QCD. Conversion were calculated as if done at beginning of year.

Top section is projections for only taking RMD. As I'm using a return rate of 7%, the balance will continue to grow until age 88.

Lower section is projection for taking RMD and then converting enough to take taxable income to top of 24% bracket.

Roth balance was calculated by using a rate of return at 7%, addition is conversion less additional tax for that year.

Although the total tax paid was more using the conversion option, when I add in a presumption of 22% due at some point by someone on the IRA balance, the combined tax becomes lower.

Tell me what I missed?

		2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
SS	30,000	25,500	25,500	25,500	25,500	25,500	25,500	25,500	25,500	25,500	25,500
Pension		20,000	20,000	20,000	20,000	20,000	20,000	20,000	20,000	20,000	20,000
RMD		36,496	39,000	41,837	44,703	47,762	50,805	54,276	57,980	61,833	65,508
		81,996	84,500	87,337	90,203	93,262	96,305	99,776	103,480	107,333	111,008
Std Deduction		(15,700)	(15,700)	(15,700)	(15,700)	(15,700)	(15,700)	(15,700)	(15,700)	(15,700)	(15,700)
		66,296	68,800	71,637	74,503	77,562	80,605	84,076	87,780	91,633	95,308
Tax		9,893	10,444	11,068	11,699	12,372	13,041	13,805	14,620	15,467	16,276
Add'l Part B								791	791	791	791
Running tax		9,893	20,337	31,405	43,104	55,476	68,517	83,112	98,523	114,781	131,847
IRA balance		1,033,504	1,066,848	1,099,691	1,131,966	1,163,442	1,194,077	1,223,387	1,251,043	1,276,683	1,300,243
Due on balance @ 22%		227,371	234,707	241,932	249,033	255,957	262,697	269,145	275,229	280,870	286,053
Combined		237,264	255,044	273,337	292,136	311,433	331,214	352,257	373,752	395,651	417,901
		2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
SS	30,000	25,500	25,500	25,500	25,500	25,500	25,500	25,500	25,500	25,500	5,977
Pension		20,000	20,000	20,000	20,000	20,000	20,000	20,000	20,000	20,000	20,000
Convert		115,800	117,670	119,765	122,405	125,524	129,299	133,605	138,661	144,596
RMD		36,500	34,630	32,535	29,895	26,776	23,001	18,695	13,639	7,704	738
		197,800	197,800	197,800	197,800	197,800	197,800	197,800	197,800	197,800	26,715
Std Deduction		(15,700)	(15,700)	(15,700)	(15,700)	(15,700)	(15,700)	(15,700)	(15,700)	(15,700)	(15,700)
		182,100	182,100	182,100	182,100	182,100	182,100	182,100	182,100	182,100	11,015
Tax		35,370	35,370	35,370	35,370	35,370	35,370	35,370	35,370	35,370	1,102
Add'l Part B		1,978	1,978	1,978	1,978	1,978	1,978	1,978	1,978	1,978	-
Running tax		37,348	74,695	112,043	149,390	186,738	224,086	261,433	298,781	336,128	337,230
IRA Balance		917,704	829,642	735,417	634,596	526,718	411,288	287,779	155,623	14,317	14,581
Due on balance @ 22%		201,895	182,521	161,792	139,611	115,878	90,483	63,311	34,237	3,150	3,208
Combined		239,242	257,216	273,835	289,002	302,616	314,569	324,745	333,018	339,278	340,438
Difference fron combined		1,978	2,173	497	(3,135)	(8,817)	(16,645)	(27,513)	(40,734)	(56,373)	(77,462)
Roth Balance		96,452	202,206	318,230	445,830	586,373	741,463	913,571	1,103,951	1,314,855	1,415,138

[Rapid Robert]

OK, took me a little while to understand how your model works -- I thought I had a "gotcha" and was going to ask where the money to pay the extra conversion tax was coming from, then I found that you had accounted for that. So far, I do not find that you are "missing" anything, and it looks good. (I have to assume you have solid sources for your RMD amounts and total tax liability, and that you have correctly normalized everything to end of year amounts).

On the other hand, I don't think this model directly relates to the previous discussion (or at least my perspective on the previous discussion). The previous discussion was mostly about making pre-retirement contributions. Post-retirement conversions are not the same thing. In the previous discussion, I illustrated how contributing to a Roth only helps if your future tax bracket will be higher than today's, all other things being equal (and ignoring secondary AGI effects on other taxes or credits -- in other words, let's just assume they are already taxed on 85% of the SS benefit and won't have IRMAA).

But for the current discussion, your choice, starting with identical initial amounts, is between generating 7% annual earnings that will eventually be taxed, vs. 7% annual earnings that will never be taxed, so it's much clearer that "topping up" the Roth is a good choice. Of course, you could achieve roughly the same result by purchasing growth stocks and holding until death. I was convinced early on in my tax pro career that Roth top-up conversions for retirees were a good idea, your model seems to confirm that.

And even though it might go without saying, I'll say that assuming a 7% rate of return over just 10 year horizon is risky, so ideally you'd want to run this through multiple simulations (e.g. Monte Carlo method). And then there's the time value of money (paying tax now vs. later), chances of tax rates going up in the future, using Roth balances for means testing of other benefits (like SS), et cetera, et cetera.

[kathyc2]

I wasn't looking at if the Kiplinger article made sense to convert while working. People were talking about clients that already have 85% max taxable and million $$ IRA's. I was wondering if even in that case it makes sense to convert rather than just accepting the RMD's.

7% is lower than the historical return of S&P. Generally when I project how much retirement money will grow over time, I use a more conservative 6%. However, since on this I was more concerned with that tax effect, I bumped it to 7%.

Yes, I used the Uniform Life Table to calculate RMD's. At the end of 10 years, there is still 1.3M in Traditional and over the next 10 years (2033-42) another 900K will need to be taken out due to RMD's- ~ 200k tax and there will still be a balance of close to 1.3M that will be taxed to someone, sometime.

This is something I put together quick and dirty. It gave me enough information that I see I need to rethink my advise on retirement/ Trad vs Roth and converting rather than just accepting RMD's.

Shortfalls of this are that as I explained, SS, Std ded, and tax rates were not indexed for inflation. I used 2023 rates and marginal rate "buckets" to calculate tax. I'm working on a template that I can use for various clients projection that takes into account that there should be a inflation factor for these items.

Another thing I didn't account for is what happens to the additional money from RMD's in top section. If they are being spent, I should decrease the Roth to account for that. If they are being saved in a NQ account, I should account for extra taxable income from that.

Anyway, thanks for posting the original article as it prompted me to think a little differently that I had been doing.

[TaxGuyBill]

Roth balance was calculated by using a rate of return at 7%, addition is conversion less additional tax for that year.

Although the total tax paid was more using the conversion option, when I add in a presumption of 22% due at some point by someone on the IRA balance, the combined tax becomes lower.

Unlike Robert, I don't see where that extra tax is coming from. Maybe I'm just missing it, but where is that extra money to pay the tax coming from? Or am I just blind?

In year one, you have $9893 in tax versus $37,348 in tax. That's a difference of $27,455. Where did that $27,455 come from? If the taxpayer has that laying around in non-retirement accounts, that could hypothetically be getting 7% as well. Or if the taxpayer needs to withdraw that 'extra' amount from his Roth to pay the tax, then the Roth balance will be lowered (and no interest on that withdrawn amount).


I know a financial advisor would be horrified at this thought, but I would back up and would have told the client they should have semi-retired at least five years earlier. Spend time with their spouse, kids, grandkids, friends, etc. while they are still healthy. Pay for family vacations. It should mean SO much more to both the taxpayer and the family/friends to be having fun with each other, rather than dying old with a large bank account and the beneficiaries just getting a check. Or go back even further and they should have spent more time, effort and money with their family and friends rather than focusing on building a large retirement account.

I know we need to advise on the tax and financial aspect of things, but we can't completely ignore the 'happiness' factor of relationships with each other.

[kathyc2]

In year one, you have $9893 in tax versus $37,348 in tax. That's a difference of $27,455. Where did that $27,455 come from? If the taxpayer has that laying around in non-retirement accounts, that could hypothetically be getting 7% as well. Or if the taxpayer needs to withdraw that 'extra' amount from his Roth to pay the tax, then the Roth balance will be lowered (and no interest on that withdrawn amount).

In 2023 the conversion amount was 115,800 but the only amount I added to Roth balance was net of tax difference and earnings for that year only as I made the presumption that conversion was done at beginning of year. I didn't save the sheet I calculated it on, and now I see it's a little different. Likely I added in the Part B surcharge after I calculated tax difference.

[TaxGuyBill]

Ah, got it. I didn't do the math.

[Art]

kathyc2

I appreciate what you have presented, but I still think that we need to look at this from a cash flow point of view and funding the approx $25,000 in tax each year to fund the conversion. I see that you have added a line to calculate the tax due on the balance remaining in the IRA for each year but the RMD will apply to future years. Unless the client has other non qualified funds available to pay the tax on conversion each year it just doesn't work. And as was pointed out earlier if those funds are available then we would need to include the earnings on those funds. Or maybe I as just not understanding your presentation.

[kathyc2]

Yeah, when I looked at it again there was a big difference when I accounted for the RMD amounts not spent and rather invested. Don't have time to get into detail right now, but when I adjusted for that the savings were negligible.