Too Much in Retirement Plans??

[underwood24]

My wife (a physician also) & I have 403b's, 457's, and a separate defined contribution plan. We could theoretically put $87k away in tax-deferred accounts each year (& $11k in backdoor Roth's).

Is it possible to have proportionally too much $$ in retirement accounts? If we can put away $100k/year, should we be maxing out these accounts (they have good Fidelity/TIAA options) or should I worry about liquidity issues & put a small chunk in a taxable brokerage account with a low ER index fund/ETF?

I understand the draw of deferring taxes, but at what point are you sacrificing too much in liquidity?

At some point your RMD's blow up so much as to not save a tremendous amount in taxes.

If you die, you could theoretically leave heirs with estate tax issues having to take taxable distributions to pay off the estate taxes (a double tax).

How do you solve these issues? Do you just make sure you have a nice chunk of $$ in a taxable brokerage account to cover said estate taxes?

[AlexxT]

Do the math.  Figure out how much you expect to have in those accounts by the time you retire.  If you expect to have low income years during which you will convert some IRA money to Roths, figure out how much you will be converting so you know how much money you will need in taxable accounts.

Then calculate how much you will have left in your IRA/ 401k accounts after the partial Roth conversions when you turn 70 1/2, and see what your RMDs will be ( approximately 3.76% of the total the first year, going up slightly each year after that).  Add in social security, and any other expected income ( pensions, rental income, etc).  Then see what your effective tax rate will be on the RMD part of that income. ( effective, not marginal, because you're looking at the IRA withdrawal as a single unit).

I know there are a lot of assumptions there, but only you can figure out the answer to that question.

As far as liquidity goes, keep a reasonable amount of taxable money around in an emergency fund.  Also, you can withdraw a lot of your Roth money tax free in necessary ( there are a few rules to worry about).  You can also use your home equity line of credit in an emergency, or even take a 401k loan if you have to.

 

underwood24 wrote:

If you die, you could theoretically leave heirs with estate tax issues having to take taxable distributions to pay off the estate taxes (a double tax).

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There's no double taxation issue, so long as the heirs take the IRD tax deduction ( "income in respect of the decedent").  The heirs will have to tell their accountants that they are eligible for it, and the accountant will have to know what it is.  This deduction also obviates the need to convert IRAs to Roths prior to death to avoid additional estate tax.  This deduction exists precisely to prevent that double taxation.  If you're interested in this issue, Kitces has two articles on this topic.

 

 

[jfoxcpacfp]

underwood24 wrote:

How do you solve these issues? Do you just make sure you have a nice chunk of $$ in a taxable brokerage account to cover said estate taxes?

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You solve these issues with financial planning. A financial planner (a real financial planner who is trained and experienced in holistic financial planning) acts as your co-planner, helping you lay out the issues you need to solve, search for other issues you're probably not yet aware of, offer solutions for you to choose from, and work together with you to reach your personal goals, both short- and long-term, and adjusting your plan for life changes (job change, retirement date adjustment, unexpected pregnancy, market adjustments, etc. etc. etc.) I call it having money clarity. True financial planning is dynamic, whether you DIY or work with a CFP (preferably fee-only). If you work with a CFP, your goal should be that the planning pays for itself.

[The White Coat Investor]

underwood24 wrote:

My wife (a physician also) & I have 403b’s, 457’s, and a separate defined contribution plan. We could theoretically put $87k away in tax-deferred accounts each year (& $11k in backdoor Roth’s).

Is it possible to have proportionally too much $$ in retirement accounts? If we can put away $100k/year, should we be maxing out these accounts (they have good Fidelity/TIAA options) or should I worry about liquidity issues & put a small chunk in a taxable brokerage account with a low ER index fund/ETF?

I understand the draw of deferring taxes, but at what point are you sacrificing too much in liquidity?

At some point your RMD’s blow up so much as to not save a tremendous amount in taxes.

If you die, you could theoretically leave heirs with estate tax issues having to take taxable distributions to pay off the estate taxes (a double tax).

How do you solve these issues? Do you just make sure you have a nice chunk of $$ in a taxable brokerage account to cover said estate taxes?

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I think it is possible to have too much in tax-deferred accounts. But I think that amount is probably somewhere around $10M in today's dollars. Even $87K a year probably won't get you there.

[TheGipper]

WCI, do you come to that 10M amount, as the point where it becomes impossible to Roth convert, withdraw, tax gain harvest, and eventually extract RMDs below today's top marginal income rate, even with good planning to allow for 10+ low income years in between retirement and delayed SS/forced RMDs at age 70.

I, like you, put away a lot into tax deferred accounts (currently about $180k/yr) instead of more aggressively funding taxable account or pre-paying mortgage principal. I sometimes have the same concern as OP but have not yet really crunched the numbers.

[litovskyassetmanagement]

underwood24 wrote:

My wife (a physician also) & I have 403b’s, 457’s, and a separate defined contribution plan. We could theoretically put $87k away in tax-deferred accounts each year (& $11k in backdoor Roth’s).

Is it possible to have proportionally too much $$ in retirement accounts? If we can put away $100k/year, should we be maxing out these accounts (they have good Fidelity/TIAA options) or should I worry about liquidity issues & put a small chunk in a taxable brokerage account with a low ER index fund/ETF?

I understand the draw of deferring taxes, but at what point are you sacrificing too much in liquidity?

At some point your RMD’s blow up so much as to not save a tremendous amount in taxes.

If you die, you could theoretically leave heirs with estate tax issues having to take taxable distributions to pay off the estate taxes (a double tax).

How do you solve these issues? Do you just make sure you have a nice chunk of $$ in a taxable brokerage account to cover said estate taxes?

Click to expand...

You are rightly worried about RMDs.  The solution to this problem requires the ability to make Roth conversions prior to full retirement. Ideally, you want to make these conversions prior to age 70, but even better if you can do so earlier (preferably when you are in a significantly lower tax bracket). If you stop working full time at age 60-65 or so, you have time to make partial Roth conversions (whether inside your plan or outside, in your IRAs) until you hit 70 and 1/2.  This would allow you to prepay your taxes once you are in a significantly lower tax bracket, so depending on a multitude of factors, it is possible to save significant amount as you avoid RMDs and build up a mainly Roth portfolio that you can withdraw from entirely tax free.  This is not a simple calculation, and it requires a rather sophisticated model, but in aggregate,this can be done if you also build up some after-tax money (and potentially a significant amount).  RMDs can be an issue if you have a tax-deferred portfolio in the millions - even $2M or so can produce significant RMDs over time.  Remember that RMD percentage increases from 3.5% to about 12% or so, but as your portfolio grows, the tax liability will increase significantly, so converting most of the tax-deferred assets to Roth would be a good idea.

[TheGipper]

Kon or WCI, without asking for any heavy calculations and assuming the following assumptions, how much do you think is too much in tax deferred account to be able to pull off significant Roth conversion of a bulk of IRA until larger RMDs in 70s/80s start to dominate and push back into an effective tax rate equaling their current top marginal tax rate.

1) Two physician couple will retire at age 60.

2) Lets assume essentially no taxable income from retirement at age 60 until age 70 when plan to take delayed SS and forced RMDs begin.

3) Taxable account, tax free proceeds from primary home downgrade, and liquid savings will be enough to cover any Roth conversions and live off during age 60-70.

4) 95% of retirement funds in traditional IRAs, much smaller amount in Roth (only from annual backdoor Roth conversions).

?3 million, ?5 million, ?10 million ?20 million

Even if eventually RMDs pushed the couple in this example back into an effective tax rate of 35%+ in their mid 70s or early 80s, would not they still be better off NOT doing Roth conversions will they are still working and are guaranteed to pay 45% on the conversion?

 

 

[litovskyassetmanagement]

TheGipper wrote:

Ron or WCI, without asking for any heavy calculations and assuming the following assumptions, how much do you think is too much in tax deferred account to be able to pull off significant Roth conversion of a bulk of IRA until larger RMDs in 70s/80s start to dominate and push back into an effective tax rate equaling their current top marginal tax rate.

1) Two physician couple will retire at age 60.

2) Lets assume essentially no taxable income from retirement at age 60 until age 70 when plan to take delayed SS and forced RMDs begin.

3) Taxable account, tax free proceeds from primary home downgrade, and liquid savings will be enough to cover any Roth conversions and live off during age 60-70.

4) 95% of retirement funds in traditional IRAs, much smaller amount in Roth (only from annual backdoor Roth conversions).

?3 million, ?5 million, ?10 million ?20 million

Even if eventually RMDs pushed the couple in this example back into an effective tax rate of 35%+ in their mid 70s or early 80s, would not they still be better off NOT doing Roth conversions will they are still working and are guaranteed to pay 45% on the conversion?

 

 

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This is about aggregate comparison.  Just playing with numbers, doing an early Roth conversion can potentially save significant money in RMD taxes (hundreds of thousands, and even millions), and in addition this would provide tax-free Roth to your heirs that can be stretched over their lifetimes. Massive Roth conversions require sophisticated planning, and at the very least you want to have significant after-tax savings.  However, I would still recommend after-tax savings in any case even if not doing RMDs, if only to have a source of tax-free income so that you don't have to make taxable withdrawals for a while.  Also, early Roth conversion is a longevity hedge - the longer one lives, the better the results would be as far as how much taxes are saved vs. taking RMDs.

For one thing, your withdrawals and distributions won't be equal, and in many cases early Roth conversions will put you in the highest tax brackets over several years. Just remember that you are paying taxes at an average RATE, not at your highest bracket in retirement. Going forward, the aggregate effect of not having to pay RMDs (and tax-free compounding) will make Roth conversion pay for itself.  There is a breakeven point somewhere, that's for sure, but the numbers will be different for different people depending on multiple factors, so without doing a full blown analysis that is specific to your situation, someone else's numbers won't make sense for you.

[TheGipper]

Thanks Kon. For me, I'm resolved not to do any Roth conversions prior to retirement, and plan large annual Roth conversions between retirement and age 70. I'll surely enlist the help of software and professionals to get the optimal annual amount to convert when the time nears.

For now the question is how much into cash balance plan vs taxable. My CBP allows as little as 5k or as much as $150k per year. I've gone back and forth about the merits and risks of overfunding a DCBP with Rex, but for now I still favor this approach for a cash balance plan that allows IRA rollovers and keeps a fairly aggressive 5% target benefit and 60/40 AA. Just can't pass up the 45% upfront tax-deferral. If it looks as if my taxable account may lag what is needed to cover Roth conversions or other expenses, I'll ramp it up and cut back on the DCBP plan on next election cycle.

[The White Coat Investor]

Yes, the RMD at age 70 on a $10M tax-deferred account is about $360K. Not enough to get a married couple into the highest bracket by itself. But my point is a $2M or $3M or $5M tax-deferred account is hardly an RMD problem.

[The White Coat Investor]

TheGipper wrote:

Kon or WCI, without asking for any heavy calculations and assuming the following assumptions, how much do you think is too much in tax deferred account to be able to pull off significant Roth conversion of a bulk of IRA until larger RMDs in 70s/80s start to dominate and push back into an effective tax rate equaling their current top marginal tax rate.

1) Two physician couple will retire at age 60.

2) Lets assume essentially no taxable income from retirement at age 60 until age 70 when plan to take delayed SS and forced RMDs begin.

3) Taxable account, tax free proceeds from primary home downgrade, and liquid savings will be enough to cover any Roth conversions and live off during age 60-70.

4) 95% of retirement funds in traditional IRAs, much smaller amount in Roth (only from annual backdoor Roth conversions).

?3 million, ?5 million, ?10 million ?20 million

Even if eventually RMDs pushed the couple in this example back into an effective tax rate of 35%+ in their mid 70s or early 80s, would not they still be better off NOT doing Roth conversions will they are still working and are guaranteed to pay 45% on the conversion?

 

 

As a general rule, don't pre-pay your taxes.

As a general rule, if you can pre-pay your taxes at a rate dramatically lower than you would eventually pay them, then prepay them.

Too many people are afraid of taxes in retirement. It leads them to make dumb investing decisions, like buying cash value life insurance, investing in taxable before maxing out retirement plans, doing Roth contributions during peak earnings years when tax-deferred options are available, doing Roth conversions in high tax brackets etc. There's even a book I reviewed that talks about how awesome it must be to not pay any taxes in retirement. Except the entire premise of the book is wrong. https://www.whitecoatinvestor.com/is-a-zero-percent-tax-bracket-in-retirement-a-good-idea/

James Lange gets this one right in his book Retire Secure. The general rule is to leave your taxes in the tax-protected account as long as possible.

https://www.whitecoatinvestor.com/which-assets-to-spend-first/

Pre-SS Roth conversions make sense when you can do them at some low bracket like 15% or 25% or something. They also make sense for people who will always be in the highest bracket. For the rest of us, leaving that money in tax-deferred accounts as long as possible is often the right answer.

[The White Coat Investor]

TheGipper wrote:

Kon or WCI, without asking for any heavy calculations and assuming the following assumptions, how much do you think is too much in tax deferred account to be able to pull off significant Roth conversion of a bulk of IRA until larger RMDs in 70s/80s start to dominate and push back into an effective tax rate equaling their current top marginal tax rate.

1) Two physician couple will retire at age 60.

2) Lets assume essentially no taxable income from retirement at age 60 until age 70 when plan to take delayed SS and forced RMDs begin.

3) Taxable account, tax free proceeds from primary home downgrade, and liquid savings will be enough to cover any Roth conversions and live off during age 60-70.

4) 95% of retirement funds in traditional IRAs, much smaller amount in Roth (only from annual backdoor Roth conversions).

?3 million, ?5 million, ?10 million ?20 million

Even if eventually RMDs pushed the couple in this example back into an effective tax rate of 35%+ in their mid 70s or early 80s, would not they still be better off NOT doing Roth conversions will they are still working and are guaranteed to pay 45% on the conversion?

 

 

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Interesting financial situation. Not clear what your goal is. Is it to leave as large of a Roth IRA as possible to your heirs?

Remember the concept of a "too large" tax-deferred account can only be considered in comparison to something else. So what if I have an $80M IRA, right? So I've got to take some out every year, spend as much of it as I can, and then reinvest the rest in taxable? No big deal. First world problem for sure.

So the real questions are:

1) Should you invest in taxable instead of a tax-deferred account because you project having a big IRA later? The answer is no. You should max out retirement accounts for tax and asset protection purposes.

2) Should you do Roth or tax-deferred 401(k) contributions? Complex issue, discussed here:https://www.whitecoatinvestor.com/should-you-make-roth-or-traditional-401k-contributions/

3) Should you do Roth conversions? If so, when and how much? Mike Piper had a nice article about it this month. http://www.obliviousinvestor.com/when-does-it-make-sense-to-do-a-roth-conversion/

[litovskyassetmanagement]

TheGipper wrote:

Thanks Kon. For me, I’m resolved not to do any Roth conversions prior to retirement, and plan large annual Roth conversions between retirement and age 70. I’ll surely enlist the help of software and professionals to get the optimal annual amount to convert when the time nears.

For now the question is how much into cash balance plan vs taxable. My CBP allows as little as 5k or as much as $150k per year. I’ve gone back and forth about the merits and risks of overfunding a DCBP with Rex, but for now I still favor this approach for a cash balance plan that allows IRA rollovers and keeps a fairly aggressive 5% target benefit and 60/40 AA. Just can’t pass up the 45% upfront tax-deferral. If it looks as if my taxable account may lag what is needed to cover Roth conversions or other expenses, I’ll ramp it up and cut back on the DCBP plan on next election cycle.

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If you are in the highest tax bracket, by all means max out all of your tax-deferred accounts. I would prefer to keep a decent size portfolio after tax as well to generate tax-free income so that you don't have to withdraw from retirement plans, at least initially.

[litovskyassetmanagement]

The White Coat Investor wrote:

Yes, the RMD at age 70 on a $10M tax-deferred account is about $360K. Not enough to get a married couple into the highest bracket by itself. But my point is a $2M or $3M or $5M tax-deferred account is hardly an RMD problem.

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The point I was making is that you can potentially save significant amount in taxes by doing the Roth conversion vs. not doing it, but many factors will affect whether this is a strategy worth taking, and that it does not take $10M for the Roth conversion to make sense (at that point, the savings would be substantial), and someone with as little as $2M can benefit.  I prefer to trust my own calculations (I actually assumed that in retirement the tax rate would not be very high), so unless someone can produce a comprehensive model that shows that Roth conversions are not recommended for the same set of assumptions, I believe that my answer is correct given the conservative assumptions I'm making.  One factor that significantly affects the outcome is longevity, so the longer one is around, the more sense this strategy makes.  I'll definitely try to publish an article on this topic with the assumptions and calculations one of these days.

[TheGipper]

Thank you gentleman, great advice as always.

I've read most of what James Lange has written and much of his radio podcasts and while I'm a huge fan of his estate and trust planning advice, I think he may sometimes err in recommending Roth conversions too early for high earners by overestimating the inflation adjusted compounding of tax free growth. I tend to agree with others such as Harry Sit, who advocate high earners holding off from Roth conversions during working years.

I think the Roth ladder conversion strategy from retirement until age 70, while deferring RMDs and SS until age 70 is usually the winning strategy.

Depending on the size of ones IRA, how early a retirement is feasible, and ability to otherwise minimize taxable income, one could convert millions to Roth staying under a 25% effective tax rate. With a smaller IRA, one could convert the bulk at less then 15% effective tax.

Gamble is future tax law changes, but while the top rate may go up in the future, I think we are safe in that the effective rate we will pay in retirement for Roth conversions should be less than the 45% marginal high earners would pay now.